Global Markets

Equities declined last week after Federal Reserve Chairman Ben Bernanke’s post FOMC press conference. Global markets tumbled on the news that the Federal Reserve said it would begin tapering its asset purchase program if new economic data matched their updated forecasts. The credit crunch in China combined with its weaker than expected manufacturing PMI to also weigh on the markets. The U.S. dollar rose as investors abandoned carry trades and U.S. bond yields jumped.

With markets in Europe and the Asia Pacific closed for the global market day prior to the FOMC announcement, the brunt of selling occurred on Thursday. Markets steadied somewhat on Friday but still tumbled for the week.

There were other factors besides the Fed at work. Global concern about a credit crunch in China along with the weakening economy there also played a negative role in the sell-off. Investors were unnerved by reports that Chinese banks had become reluctant to lend to one another, causing interest rates in the interbank market to spike to punishingly high levels. A purchasing managers’ report added to fears that China, which has been an engine of growth in the world economy, might not be able to carry the load indefinitely. The report suggested Chinese manufacturing was contracting.

Markets were already jittery after hearing about the Federal Reserve’s plans to taper the bond buying operations it has been using to add liquidity to shore up the financial system. On Wednesday, Bernanke said the Fed hoped to begin reducing the size of its monthly bond purchases by the end of 2013 and end the program as soon as the American jobless rate fell to 7 percent. He noted that this was a threshold and not a target. Investors had become accustomed to the so-called quantitative easing policies used by central banks to provide liquidity and support asset prices. In recent years, markets faltered when the authorities talked about ending those policies and the central bankers had backtracked. But this time, investors have grasped that the Fed is much more confident.

Global Stock Market Recap

Europe and the UK

Equities in the UK and Europe retreated last week. For the FTSE, CAC and SMI, it was the fifth consecutive week of declines while the DAX was down for a third week. The markets were positive in early Friday trading, but slipped into negative territory as the session progressed. The markets dropped Thursday, thanks to comments from Fed Chairman Bernanke following the two day FOMC meeting. He stated that the Fed might be able to unwind some of its asset purchases if economic conditions warrant later this year. On the week, the FTSE lost 3.0 percent, the DAX dropped 4.2 percent, the CAC was down 3.9 percent and the SMI declined 2.8 percent. The MIB and IBEX lost 5.6 percent and 4.6 percent respectively.

Global stock markets climbed to multi-year highs earlier in the year, largely due to aggressive easing measures from central banks, including the Federal Reserve. But when Bernanke in late May mentioned the central bank could begin to scale back its asset purchases later this year, stock indexes headed for a correction. The European markets dropped sharply on Thursday — their first opportunity to react to the statements late Wednesday by the Federal Reserve and its Chairman. The Fed indicated that it is moving closer to slowing its bond buying program later this year, as long as incoming data remains broadly consistent with the Fed's forecasts. Investor sentiment was also negatively affected by the weaker than expected flash manufacturing PMI from China.

Greece’s coalition government looks to be on shaky ground with a deadlock in talks over the shutdown of the state broadcasting company and new worries about a financing gap in the country's bailout program. Greek stocks slumped after the Democratic Left party pulled out of the coalition government amid disagreement with Prime Minister Antonis Samaras’ abrupt decision to close the state broadcaster. Although the defection still leaves the Government’s traditional core intact, its majority is razor thin with 153 seats in a parliament of 300. The government is now just a few defections away from collapse but still has plenty of hard choices to make. Adding to worries about Greece, the International Monetary Fund threatened to suspend aid payments to the struggling country unless Eurozone leaders move to plug a gap of €3 billion to €4 billion in the country’s rescue program. The report said the gap stemmed from central banks refusing to roll over Greek bonds and that Athens was not to blame.

Swiss National Bank

The Swiss National Bank’s quarterly Monetary Policy Assessment (MPA) left its target for three month Swiss franc LIBOR at zero to 0.25 percent. The SNB will continue to seek to hold rates as close as possible to the lower end of this band. At the same time, the monetary authority reaffirmed its commitment to cap Swiss franc strength with the lower target limit for the currency held at CHF1.20 against the euro. There had been some limited speculation about the introduction of negative interest rates to deter safe haven inflows and weaken the currency.

Since its first quarter MPA, economic growth has accelerated but final domestic demand is still very fragile and CPI inflation has remained steadfastly in negative territory (the 2013 inflation forecast has been lowered again and now stands at just minus 0.3 percent). The local currency is well off its highs but, as the SNB is at pains to point out, is still significantly overvalued. However, worries about a possible bubble in the Swiss housing market have not gone away and additional measures to slow mortgage lending may yet have to be introduced at some point. There was little fresh news from SNB Chief Jordan's press conference.

Asia Pacific

Equities with the exception of those in Japan dropped last week. Thursday was a pivotal day as the markets had their first chance to react to Wednesday’s FOMC announcement and press conference and to the latest flash PMI reading for China. Markets dropped and extended their losses into Friday although stocks closed off their day's lows following the previous session's brutal selloff. Investors continued to worry about U.S. stimulus measures and China's growth outlook as the nation's money market rates climbed to record highs. Media reports indicated that the People's Bank of China conducted the so-called "window guidance" with the nation's major state run banks to release more cash into the system, easing fears of a liquidity shortage to some extent.

The most dramatic moves were in Southeast Asia where equities in the Philippines and Indonesia were hit hardest after a sharp run up earlier in the year that has left them vulnerable to sudden outflows. The heavy selling came after losses in U.S. markets. Japan's Nikkei bucked the regional downward trend as it recovered from several weeks of sharp selling that sent the index into a bear market.

But much of the focus was on China as the week ended where shares traded lower in Shanghai and Hong Kong on signs mainland banks are short of cash and the economy is slowing faster than expected. Friday’s declines though were less than Thursday’s as money market rates dropped sharply, relieving some of the pressure in the financial system.

Mounting evidence of weakness in China's economy and increasing stress in its financial system are testing the government's determination to ride out a slowdown without resorting to stimulus measures. June’s flash manufacturing PMI contracted at a faster rate compared with May — the latest sign that the economy may be faltering, after exports, industrial output and fixed asset investment all slowed last month. The results hit Asian financial markets and commodities markets on Thursday amid worries that China's slowing growth could have a ripple effect.

China at the same time is grappling with an increasingly tight cash squeeze, as rates surge in the market at which banks lend to each other. The crunch stems in part from a slowdown in foreign capital inflows due to skepticism over China's growth prospects. Both present a challenge to new leaders in Beijing who have suggested they are committed to reforming China's economy — even if that means slower growth in the short term. That commitment will now be tested in the face of a structural fall-off in demand for China’s exports, overcapacity in key sectors like steel and cement and fears of a build-up of bad debt as a legacy of past stimulus.

Reserve Bank of India

The Reserve Bank of India left its key lending rate unchanged at 7.25 percent saying that the local currency's sharp decline against the U.S. dollar could adversely impact inflation which has been slowing in the past few months. The RBI said that it is also concerned about a flight of capital from India recently. Foreign institutional investors have pulled $3.2 billion out of Indian stocks and bonds this month amid a broader pullback from emerging markets as they try to benefit from rising yields on U.S. bonds. Investors have also been concerned about India's large current account deficit. A weak rupee makes the cost of oil and other imported goods higher in rupee terms, adding to inflationary pressures. The rupee lost more than 6 percent against the U.S. dollar since May first.

India's inflation — a key concern for the RBI in recent years — has lately fallen to below 5 percent, a level the central bank has in the past said it is comfortable with. To tame inflation, the RBI had raised interest rates 13 times between March 2010 and October 2011. But since April 2012, it has been cutting rates intermittently in a bid to boost economic growth, which has slowed to the lowest level in a decade.

Currencies

The U.S. dollar climbed against all of its major counterparts after the Federal Reserve indicated on Wednesday that it might end its bond buying programs soon if economic data continue to improve along the lines of the Fed’s new forecast. The dollar soared as did bond yields while equities sank. Analysts noted that it is dollar strength that is gradually being absorbed. Rising bond yields are making the dollar more attractive to traders. With the Fed becoming more hawkish relative to other central banks while the Bank of Japan is just beginning its massive easing program, monetary policy divergence could drive the dollar upward.

Selected currencies — weekly results

Indicator scoreboard

EMU

April seasonally adjusted trade surplus was €16.1 billion, down from a smaller revised €18.1 billion in March. The unadjusted surplus was €14.9 billion, a sharp improvement over the €3.3 billion surplus posted a year ago. The shrinkage in the adjusted headline was mainly due to a 0.8 percent monthly slide in exports, their first decline so far in 2013. It was compounded by a 0.5 percent increase in imports, their first advance since the start of the year. Compared with April 2012, exports were up 9.0 percent and imports just 1.0 percent. Among the larger four member states, France (€1.4 billion), Germany (€15.4 billion) and Italy (€1.9 billion) were all in the black except Spain who recorded a deficit of €1.9 billion.

June flash manufacturing PMI gained just 0.4 points to 48.7. Its service sector counterpart was up 1.4 points to 48.6. Combined, the composite output index was up 1.2 points at 48.9. The decline in manufacturing output was the smallest during the 16-month downswing so far and new orders, while declining again, did so at their weakest rate in two years. The slide in backlogs also became a little less steep but employment continued to suffer as manufacturing payrolls were trimmed only slightly less than in May. Input costs and factory gate prices were also down again. The more robust service sector registered its smallest decline in new orders in five months and backlogs, while lower once more, declined at a slower rate than in mid-quarter. Nonetheless, job losses accelerated to a 4-month high and a pick-up from May's 5-month low on business optimism left a level still well short of the long-run average. Regionally, the flash German composite output index reading was 50.9 while the French index climbed to 46.8. However, both the German and French manufacturing PMIs remained in contractionary territory with readings of 48.7 and 48.3 respectively. Flash readings are available only for the manufacturing sector in the U.S. and China. China’s PMI deteriorated to a reading of 48.3 from 49.2 the month before while in the U.S. the PMI was virtually unchanged at 52.2.

Germany

June ZEW was a little more optimistic this month about German economic prospects while retaining a broadly unchanged view of current conditions. At 8.6, the current conditions index was just 0.3 points weaker than in the May survey and remains in the relatively tight 8.4 point range already seen over the year so far. Expectations were up 2.1 points to 38.5, the highest level since March. However, June’s reading was still some 10 points shy of the 2013 peak for expectations (48.5).

United Kingdom

May consumer prices were up 0.2 percent and 2.7 percent from a year ago. On the year, prices in the transport sector climbed from minus 0.1 percent in April to 1.1 percent. This alone added 0.2 percentage points to the 12-month headline rate and reflected higher charges for fuel and air fares (the latter up 22 percent on the month). The other main driver was the clothing & footwear sector where a 1.2 percent monthly bounce left prices 0.7 percent higher on the year after a 0.6 percent drop last time. Seasonally poor weather seems to have had a significant impact here. Other contributions were typically small but the core CPI was still 2.2 percent above its level in May 2012, up from a 2.0 percent increase at the start of the quarter.

May output prices were unchanged on the month after declining 0.2 percent in April. On the year, output prices were up 1.2 percent. Input prices declined 0.3 percent on the month and were up 2.2 percent on the year. Core output prices edged just 0.1 percent higher on the month and were up 0.8 percent on an annual basis. Factory gate prices remain very well behaved as producers continue to struggle to raise charges in what is still a very competitive market. Excluding food, drink and tobacco, input costs dropped 0.4 percent from April and were 1.9 percent above their level in May 2012.

May retail sales rebounded 2.1 percent on the month and more than reversed April's smaller revised 1.1 percent decline and put volumes 1.9 percent higher on the year. Excluding fuel, the picture was much the same with a 2.1 percent increase on both the month and the year. May's rebound was led by a jump in food purchases which followed April's 4.1 percent monthly drop with a 3.5 percent spurt. This alone added almost 1.5 percentage points to the overall monthly change. More significantly, non-food demand was up a less robust but still respectable 0.7 percent from April and, over the last three months, was 0.3 percent stronger. Non-store retailing sales jumped 4.3 percent above their April level and were 19.1 percent higher on the year. Elsewhere, clothing & footwear advanced 1.4 percent on the month, household goods 0.7 percent and the other stores category 0.5 percent. The only decline was at non-specialized stores (0.1 percent).

Asia/Pacific

Japan

April tertiary index was unchanged on the month and up 1.0 percent from a year ago. Among the components that increased on the month were finance & insurance, scientific research, professional & technical services, medical, health care & welfare, information & communications and electricity, gas, heat supply & water. Declining components included wholesale & retail trade, transport & postal activities, living related & personal services & amusement services, real estate & goods rental & leasing, accommodations, eating & drinking services, miscellaneous services (except government services etc.), learning support and compound services.

May unadjusted merchandise trade deficit was ¥993.9 billion and less than the expected ¥1.169 trillion. Exports were up 10.1 percent from a year ago while imports were 10.0 percent higher. Exports were up for the third month while imports posted their seventh straight annual increase. Exports to Asia were up for a third month, this time by 11.1 percent, while exports to China were up 8.3 percent for the second consecutive month. Exports to the U.S. were up 16.3 percent. It was the fifth consecutive increase. However, exports to the EU continue to fall. Exports declined 4.9 percent. It was the 20^th straight drop. On a seasonally adjusted basis, the trade deficit was ¥821.0 billion. Exports were up 3.2 percent from April and up 7.9 percent from a year ago. Imports were up 4.7 percent and 11.2 percent on the year.

Americas

Canada

May consumer prices were up 0.2 percent on the month and 0.7 percent from a year ago. Excluding food and energy prices were up just 0.1 percent on the month and 0.5 percent on the year, in line with the annual gain last time. Similarly, the BoC's preferred measure which excludes eight volatile items climbed only 0.2 percent on the month and 1.1 percent from May 2012, also unchanged from its April rate. Seasonally adjusted, the CPI edged up 0.1 percent from April. On the same basis, both ex-food and energy index and the BoC's core gauge showed no change for the second month in a row. Within the adjusted data the main upward pressure on the overall CPI stemmed from alcohol & tobacco where prices increased 0.7 percent. Food was up 0.3 percent but elsewhere monthly moves were small and there were declines in household operations, furnishings & equipment (0.2 percent) and in health & personal care (0.1 percent).

April retail sales edged up 0.1 percent and were 1.5 percent higher from a year ago. However, volumes posted a 0.5 percent monthly rise. This made for an annual increase of also 1.5 percent. The latest minimal advance in cash sales was underpinned by a 1.4 percent monthly increase at motor vehicle & parts dealers and without help from this quarter sales would have fallen 0.3 percent from March and risen only 0.7 percent on the year. Higher monthly purchases were reported at six of the eleven subsectors. General merchandise (0.7 percent), electronics & appliances (2.1 percent) and miscellaneous stores (2.9 percent) advanced as did health & personal care (1.2 percent). However, gains here were almost offset by falling sales elsewhere, notably in gasoline (2.9 percent), clothing & accessories (2.6 percent) and building material & garden equipment & supplies (1.0 percent).

Bottom line

The Federal Reserve’s announcement that it would consider tapering its bond buying programs later this year sent the U.S. dollar and bond yields up and equities down. Concerns about the health of the Chinese economy also weighed on equity investors. Both the Reserve Bank of India and the Swiss National Bank left their respective monetary policies unchanged.

With the last week of the month and quarter, investors will want to rationalize their portfolios especially in context of what occurred this past week and prepare themselves for earnings season. Japan will unleash its data for the month of May. In Europe, the EC sentiment index along with the German Ifo will give a reading of European sentiment. Final GDP data from the UK and France for the first quarter are also on tap.

Looking Ahead: June 24 through June 28, 2013

Anne D Picker is the author of International Economic Indicators and Central Banks.