Global Markets

Equities were mixed last week on a combination of disappointing Chinese and European data and actions by the central banks of Australia, UK and the Eurozone. Markets continue to be sensitive and vulnerable to central bank rhetoric. With Fed chairman Ben Bernanke’s comments of two weeks ago still echoing in investors’ ears, the new governor of the Bank of England, Mark Carney, inaugurated his term at the Bank by issuing a statement along with its decision — a very uncommon move when there is no policy change. This was followed by the European Central Bank’s announcement and President Mario Draghi’s press conference, both providing guidance for the first time. In short they reassured markets that they will continue to provide stimulus for some time going forward. This is in contrast to Bernanke’s comments concerning the possibility that the Fed — assuming economic growth meets its forecast — would consider tapering its monthly bond purchases.

Reserve Bank of Australia

As expected, the Reserve Bank of Australia left its cash rate at 2.75 percent where it has been since May 2013. The RBA board continued to note that the Australian dollar remains at a high level even though it has declined over the last few months and may depreciate further over time. That would help to foster a rebalancing of growth. As mining investment wanes, the RBA has lowered its key interest rate by 2 percentage points since late 2011 as it seeks to shift growth toward employment intensive industries such as construction.

Since the RBA unexpectedly cut rates to a record low on May 7^th, the Australia dollar or Aussie has dropped almost 10 percent and suffered the biggest worldwide slide last quarter after the Syrian pound. In the July statement, RBA governor Glenn Stevens said, “The inflation outlook, as currently assessed, may provide some scope for further easing, should that be required to support demand.” It added that, “easier financial conditions now in place will contribute to a strengthening of growth over time.”

In a speech later in the week, Stevens said the board “deliberated for a very long time” before keeping its key interest rate unchanged, sending the currency to the lowest level since September 2010. Stevens said that the bank has lowered rates seven times since late 2011 hoping lower borrowing costs would drive up consumer spending on homes and in shops. An important step in rebalancing the resource rich economy was boosting confidence among businesses outside the mining industry and encouraging them to invest. Stevens said he was surprised the exchange rate had not corrected sooner after a recent steep drop in commodity prices, and that the currency would likely continue to weaken if the economy — which has grown for the past two decades straight — slowed further.

Bank of England

At the first meeting of new Bank of England governor Mark Carney, the monetary policy committee left its bank rate at 0.5 percent and its quantitative easing ceiling at £375 billion. The decision was virtually a foregone conclusion in the wake of a raft of generally positive economic news that leaves the Bank's May forecast scenario looking comfortably on track. Growth is accelerating and inflation, while still well above target, is performing much as officially expected.

The BoE took the unusual step for them of issuing a statement explaining the decision. Although this contained no surprises, it did point out that the increase in interest rates discounted in the money markets was not justified. This is clearly an attempt to restore a degree of normality after the volatility prompted by recent speculation about Federal Reserve policy.

The minutes of this meeting (due July 17) anxiously will be awaited to see how Carney voted. But the likelihood is that, in contrast to his predecessor Mervyn King, he will have gone with the majority. Following the recent upbeat economic data, there is a reasonable chance that the minority call for additional QE was eliminated altogether.

The next major policy focal point for financial markets will be the August MPC discussions which, while unlikely to see any move on QE or interest rates, will include the Bank's response to the changes to its remit introduced in the March Budget. In particular there is significant speculation that the monetary authority will detail plans to adopt some form of forward guidance. From his time at the Bank of Canada, Carney is known to be a supporter of such a policy regime.

The pound dropped against the dollar and also declined against other major currencies after the BoE said that any expectations interest rates would soon rise from their current record low level were misguided. Equities rallied.

European Central Bank

As expected the European Central Bank left its key monetary policy rates on hold. The refinance rate remains at 0.5 percent and the deposit and marginal lending facility rates stay at 0.0 percent and 1.0 percent respectively. With recent economic news a little more upbeat than at the time of the June meeting, today's decision will surprise no one. However, amid the recent heightened volatility in financial markets in general and in the EMU peripherals in particular, investors were hoping for some soothing words from President Mario Draghi at his press conference.

To this end Draghi went significantly further than at previous meetings, indicating that, as part of a unanimous decision, rates will stay at current levels or move even lower over an extended period of time. Note too that the option of another cut includes the deposit rate, implying that a negative rate here has not been ruled out. While not offering any specific time horizon or intermediate target levels, this is still the closest the ECB has come to adopting a formal policy of forward guidance.

The bottom line is that monetary policy will operate with an easing bias and stay accommodative for as long as is as needed. By ECB standards, the announcement is a substantial step and Draghi's comments clearly signal that exit strategies are not up for discussion now and will remain off the table for some considerable while yet. With the promise of easy money, Mario Draghi offered more certainty to investors at a time when tensions in the Eurozone are rising again. Forward guidance is considered one of the tools available to central banks, but one the ECB had never used before.

The ECB appears unwilling to take more radical steps to stimulate the economy, such as massive, broad-based bond purchases similar to the quantitative easing used by the Federal Reserve or Bank of England. Already, the Bank faces a legal challenge in Germany’s Constitutional Court to the bond buying program and is probably reluctant to further alarm Germans who are fearful that they will wind up paying for problems in Italy and Spain.

The ECB’s job is further complicated by signs that the Federal Reserve could begin to gradually roll back its economic stimulus. Expectations of tighter monetary policy in the U.S. have rattled financial markets in Europe. Draghi may try to reassure investors that the ECB is a long way from going in the same direction.

Global Stock Market Recap

Europe and the UK

Equities first waited for the Bank of England and European Central Bank announcements and then reacted to them by rallying on Thursday. However, they retreated Friday thanks to an unexpected decline in German factory orders that weighed on investor sentiment. Also, investors were unsure what the better than expected U.S. jobs report may mean in terms of Federal Reserve tapering. The FTSE jumped 2.6 percent, the SMI gained 1.3 percent and the CAC was up 0.4 percent on the week. The DAX however, declined 1.9 percent.

European Central Bank President Mario Draghi said on Thursday that euro area interest rates are likely to remain low for an 'extended period' of time, a statement that was construed as forward guidance aimed at easing concern over the Portugal political crisis and the Federal Reserve's tapering announcement. In an unusual step, Bank of England monetary policy committee issued a statement with a no policy change decision. The bank said the implied rise in the expected future path of bank rate was not warranted by the recent developments in the domestic economy. The unexpected statement triggered sharp gains for London stocks and losses for the pound.

Asia Pacific

Most of the major indexes advanced last week after the European Central Bank and Bank of England both surprised investors by issuing forward guidance on interest rates to shield themselves from a potential pullback of the Federal Reserve's stimulus efforts. The Nikkei made the biggest gains and was up 4.6 percent after increasing 3.4 percent the week before. The Nikkei continues to fluctuate in concert with the yen — when the yen rises against the U.S. dollar, stocks tend to decline. However when the yen deteriorates against the U.S. dollar, shares tend to rise.

The Nikkei got an added boost from the quarterly Tankan. It showed that large manufacturers’ sentiment had turned positive for the first time since the third quarter of 2011 indicating confidence in Prime Minister Shinzo Abe’s reflationary policies even amid stock market volatility. The quarterly Tankan index for large manufacturers rose to plus four in June, up from minus eight in March.

The Shanghai Composite gained 1.4 percent, a contrast to the previous week when it was the worst performing index losing 4.5 percent. However, the gain was muted by disappointing Chinese manufacturing and services PMI data for June.

During the week investors were marking time as they waited for policy announcements from the Bank of England and the European Central Bank. While no policy changes were expected, caution remained in place. Investors reacted positively to the introduction of guidance from both banks. It meant that regardless of the Federal Reserve’s stance on stimulus going forward, market players could count on the BoC and ECB. However, investors remained cautious before the release of the U.S. employment situation report which would be published after markets here were closed for the week.

Currencies

The U.S. dollar rallied against all of its major counterparts amid speculation that the Federal Reserve would begin to taper its bond purchases while the Bank of England and the European Central Bank appear ready to add more stimulus. Increasing stimulus generally weakens a currency — the aim of stimulus is to drive down borrowing costs which makes the currency less appealing.

The pound sterling declined below $1.50 to the weakest level in more than three months against the dollar amid speculation the Bank of England is ready to add more stimulus. It was its biggest two day decline since September 2011 after new Governor Mark Carney signaled Thursday it will keep interest rates at a record low for longer than investors anticipated. The pound extended losses Friday after the U.S. added more jobs than analysts forecast, attracting investors to the U.S. dollar in anticipation of higher yields there. Carney was attempting to ensure that market expectations remain more focused on the UK economy than on the U.S. He wanted to draw attention to the fact that the recovery is very nascent and very fragile.

On Wednesday, RBA Governor Glenn Stevens drove the Australian dollar down to near three year lows against the U.S. dollar and jolted bond traders, who ramped up bets the Bank was closer than thought to another rate cut. The bearish trades quickly reversed on Thursday, however, when Mr. Stevens' deputy, Philip Lowe, used another public opportunity to suggest the governor's comments were being taken way too seriously. He said that some people in the financial markets and press misinterpreted the intention of those remarks. Stevens is not the first senior finance official to send confusing signals to the market of late. Fed Chairman Ben Bernanke roiled global markets only a few weeks ago when he hinted at a sooner than expected tapering of the Fed’s massive bond buying program, a position fellow Fed officials were quick to disavow.

While the RBA has conventionally telegraphed its thinking to the market, it is not obliged to provide guidance on its intentions on interest rates. As a result, investors have occasionally been wrong-footed. For example, last May the Bank cut the benchmark rate by 50 basis points while most economists were expecting no change.

Selected currencies — weekly results

Indicator scoreboard

EMU

June flash harmonized index of consumer prices climbed to 1.6 percent on the year, up from 1.4 percent in May. However, the acceleration in the headline rate was not matched in the core. Hence, non-energy industrial goods posted a 0.7 percent 12-month increase while services similarly registered a 0.1 percentage point slip to 1.4 percent. Excluding energy, food, alcohol & tobacco, inflation was steady at May's 1.2 percent. The deterioration in overall inflation was attributable to the energy sector where the rate jumped from minus 0.2 percent in mid-quarter to plus 1.6 percent.

Revisions by Eurostat have raised EMU-wide May unemployment from the 12.1 percent rate initially reported to 12.2 percent. At the same time, the April figure is now put at 12.1 percent, up 0.1 percent from Monday's report but still 0.1 percentage points lower than its original print. The adjustments reflect new data on France where the unemployment rate in May is now put at 10.9 percent, 0.5 percentage points above the originally quoted level. The newly calculated Eurozone rate for May remains a record high. There was a monthly increase in joblessness of 67,000, up from 55,000 in April and 11,000 in March. The number of people out of work now stands at a new peak of 19.340 million. The picture would have looked a good deal worse but for the relative buoyancy of Germany which, in contrast to most EMU states, saw its unemployment rate slip to 5.3 percent. Among the other larger members, Spain recorded a 0.1 percentage point rise to 26.9 percent and Italy, a 0.2 percentage point increase to 12.2 percent. Elsewhere, the rate in Cyprus jumped a further 0.5 percentage points to 16.3 percent after having already surged 0.7 percentage points in April. Portugal saw a very welcome 0.2 percentage point decline to 17.6 percent.

June manufacturing PMI reading improved to 48.8 after May’s 48.3 — a 16 month high but still short of the 50 growth threshold. Regionally there was good news inasmuch as all the national PMIs outside of Germany registered multi-month highs and the decline in the Eurozone's largest member was only minimal Still, among the larger four members, France (48.4), Germany (48.6) and Italy (49.1) all remained sub-50 leaving just Spain (50.0) to reach that mark. Elsewhere, only Ireland (50.3) posted a positive growth reading. However, there was the smallest drop in Eurozone new orders in two years and the mildest decline in employment since March.

Germany

May manufacturing orders declined 1.3 percent following a marginally smaller revised 2.2 percent slide in April. The drop left workday adjusted orders 2.0 percent below their year ago level. The headline drop was broad-based with consumer & durable goods down 3.1 percent on the month, capital goods off 1.8 percent and basics declining 0.1 percent. Moreover, with monthly declines of 2.0 percent and 0.7 percent respectively, the domestic market performed even worse than overseas. Within the latter, a 3.9 percent monthly slump that left orders fully 7.1 percent below their level in May 2012 provided further evidence of the sluggishness of Eurozone demand. By contrast, non-EMU orders were up 1.1 percent from April and 3.8 percent higher than a year ago.

Asia/Pacific

Japan

June Tankan for large manufacturers improved to an as-expected reading of plus 4 from minus 8 in March. It was the first positive reading since September 2011. The pick-up was led by steel, production machinery, electronics and autos. It also reflects a gradual increase in exports and production. The Tankan index for small manufacturers also improved – to a reading of minus 14 from minus 19 in March. For fiscal year 2013, large firm capital expenditures (capex) are expected to jump 5.5 percent while small firms see capex for the same time period falling to 8.1 percent. The decline is an improvement from the minus 12.1 percent last time. For all firms, capex is expected to increase 2.0 percent, again an improvement from a drop of 3.9 percent. Non-manufacturers reading was plus 8 led by construction, hotels and restaurants and wholesale. They also reported better business conditions as expected thanks to improved consumer confidence.

Australia

May retail sales edged up a less than expected 0.1 percent after slipping 0.1 percent in April. On the year, retail sales were up 2.3 percent. Other retailing was up 0.8 percent with food retailing at plus 0.2 percent, department stores were up 0.8 percent and clothing, footwear & personal accessory retailing was 0.4 percent higher. These increases were largely offset by declines in cafes, restaurants and takeaway food services (down 0.6 percent) and household goods retailing (down 0.3 percent). Over the longer term, food retailing remains the largest contributor to growth. Sales were up 1.6 percent in Western Australia followed by Queensland which was up 0.5 percent. Sales in South Australia (0.6 percent), Tasmania (0.6 percent) and the Northern Territory (0.8 percent) also gained. However, they were largely offset by declines in New South Wales (down 0.4 percent), Victoria (down 0.3 percent) and the Australian Capital Territory (down 1.7 percent).

May merchandise trade surplus was A$670 million, up from a surplus of A$170 million in April. Exports were up 3.6 percent on the month and 1.5 percent from a year ago while imports were up 1.6 percent and dropped 2.8 percent from May 2012. Non–rural goods exports were up 4.0 percent, non–monetary gold was up 10 percent and rural goods were 2 percent higher. Net exports of goods under merchanting remained steady at A$12 million while services credits were up 1 percent. Imports of consumption goods were up 7 percent, intermediate & other merchandise imports were up 4 percent. However, capital goods were down 5 percent and non-monetary good was 3 percent lower.

Americas

Canada

May merchandise trade deficit was C$0.30 billion and followed April's larger revised C$0.95 billion deficit. The headline improvement masked a contraction in both sides of the balance sheet with exports down 1.6 percent on the month and imports off a steeper 3.2 percent, their first decline in five months. Sales to the U.S. were also 1.6 percent lower than in April but with purchases 2.0 percent weaker, the bilateral surplus was little changed at C$3.45 billion. The slide in overall exports was led by metal & non-metallic mineral products which retreated 15.0 percent on the month. The other main areas of weakness were motor vehicles & parts (down 3.8 percent) and aircraft & other transportation equipment & parts (down 4.9 percent). However, there were respectable monthly increases in metal ores & non-metallic minerals (3.9 percent), industrial machinery, equipment & parts (4.3 percent) and consumer goods (2.1 percent). Imports were dragged lower by a hefty monthly drop in energy products (18.4 percent) and an even sharper decline in metal ores & non-metallic minerals (38.8 percent). Metal & non-metallic mineral products (down 8.5 percent) and aircraft & other transportation equipment & parts (down 17.6 percent) also fared particularly poorly. The strongest increase was seen in farm, fishing & intermediate food products category (7.6 percent) which was well ahead of basic & industrial chemical, plastic & rubber products (4.2 percent), electronic & electrical equipment and parts (3.5 percent) and consumer goods (2.4 percent).

June employment slipped 400 after soaring by 95,000 in May. Both the participation and jobless rates were unchanged at 66.7 percent and 7.1 percent respectively. The underlying picture was rather less positive with a 32,200 rise in part time positions masking a 32,400 decline in full time jobs. While the public sector expanded its headcount by 1,000, the private sector registered a 5,300 contraction. The number of self-employed was up 4,000. June was a modestly respectable month for goods producing jobs where employment climbed 7,900. Within this, manufacturing increased 4,200 and utilities (2,300), agriculture (2,000) and construction (1,400) all posted minor gains. Only natural resources (down 2,100) really underperformed. Services declined a net 8,100, mainly reflecting a 20,300 slide in accommodation & food and a 14,500 drop in information, recreation & culture. However, trade was also off 9,500 and finance, insurance, leasing and real estate down 6,000. Still, professional, scientific & technical services recorded a solid 27,000 increase and there were smaller gains in education (8,800) and other services (6,000).

Bottom line

Equities were mostly higher last week thanks to reassurances from the Bank of England and European Central Bank that their respective stimulus programs would continue. Bond yields have increased to uncomfortable levels for both central banks since the Federal Reserve indicated that it might curtail its bond buying programs. The Reserve Bank of Australia, the BoE and ECB all left their monetary policies unchanged.

June manufacturing and services PMIs in China disappointed while those in Europe showed signs of stabilization. However, Eurozone unemployment continues to climb. In the UK, both services and manufacturing PMI readings continue to show growth. In Japan, business sentiment has improved according to the Bank of Japan’s Tankan survey.

The Bank of Japan meets this coming week while the Federal Reserve releases the minutes of its June meeting. Industrial production data for many European countries are expected. China releases its monthly slew of data including consumer and producer prices and merchandise trade.

Looking Ahead: July 8 through July 12, 2013

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