Global Markets

Global equities tumbled — investors fretted over disappointing earnings from Alphabet and Amazon and the technology sector in general. This was enough to send shares lower globally. Only the Shanghai Composite advanced on the week. With three trading days left in October, all indexes covered here were down significantly on the month.

The Bank of Canada and European Central Bank held policy meetings during the week. The Bank of Canada increased its Bank Rate by 25 basis points to 1.75 percent while the European Central Bank left its policy rata at zero.

Bank of Canada

As universally anticipated, the Bank of Canada increased its target for its overnight rate to 1.75 percent. The Bank Rate is correspondingly 2 percent and the deposit rate is 1.5 percent. The BoC last increased rates at their June 2018 meeting. The Governing Council agreed that the policy interest rate will need to rise to a neutral stance to achieve its inflation target midpoint of 2 percent. In determining the appropriate pace of rate increases, Governing Council said it will continue to take into account how the economy is adjusting to higher interest rates, given the elevated level of household debt. In addition, they will pay close attention to global trade policy developments and their implications for the inflation outlook.  

According to the BoC the global economic outlook remains solid. The U.S. economy is especially robust but is expected to moderate over the projection horizon. The new US-Mexico-Canada Agreement (USMCA) is expected to reduce trade policy uncertainty in North America, which has been an important curb on business confidence and investment. However, trade conflict, particularly between the United States and China, is weighing on global growth and commodity prices. Financial market volatility has resurfaced and some emerging markets are under stress but, overall, global financial conditions remain accommodative.

According to the BoC, the Canadian economy is continuing to operate close to its potential and the composition of growth is more balanced. Despite some quarterly fluctuations, growth is expected to average about 2 percent over the second half of 2018. Real GDP is projected to grow 2.1 percent this year and next before slowing to 1.9 percent in 2020. The projections for business investment and exports have been revised up, reflecting the USMCA and the recently-approved liquid natural gas project in British Columbia. Household spending is expected to continue growing at a healthy pace, underpinned by solid employment income growth. CPI inflation dropped to 2.2 percent in September, in large part because a summer spike in airfares was reversed.

European Central Bank

As entirely anticipated, the European Central Bank left the benchmark refi rate at zero percent and the rates on the deposit and marginal lending facilities at minus 0.40 percent and 0.25 percent respectively. The ECB also reaffirmed that it will continue to make net purchases under the asset purchase program at the monthly pace of €15 billion until the end of December 2018. It anticipates these purchases will end, subject to incoming data confirming the medium-term inflation outlook. The ECB stated it intends to reinvest the principal payments from maturing securities purchased under the program for an extended period of time after the end of the net asset purchases.

There was no modification to the forward guidance, with the Governing Council expecting to keep key ECB rates at their present levels at least through the summer of 2019, or in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2 percent over the medium term.

During his press conference ECB President Mario Draghi acknowledged that the Eurozone’s economic growth momentum had weakened, but confirmed it would press ahead with plans to phase out easy money policies this year. The Eurozone economy has lost traction in recent months, according to the latest economic data and indicators. A closely watched survey of business managers suggested growth is at its weakest level in about two years. He said it was still unclear whether the slowdown is due to one-off factors — including a drop in German automobile production linked to new emissions standards — or more long-lasting drags. “It’s not simple to distinguish what is transitory from what is permanent,” he said, noting the ECB’s economists will publish new growth forecasts in December.

The ECB said it expects to end bond purchases through its €2.5 trillion bond-buying program at the end of December. The ECB also said it would likely hold its key interest rate at its current level of minus-0.4 percent at least through next summer. Regarding the Italian situation, Draghi seemed unperturbed by the conflict between the European Commission and the Italian government. In a first, officials in Brussels have rejected the populist government’s budget, saying it violates European Union rules on government spending. The Italian government has been defiant. But Draghi said that he was confident that an agreement will be found. He also said that he had no inside information about how a compromise might look. He also said neither he nor the ECB would play a mediating role in the dispute.

Global Stock Market Recap

Europe and the UK

Equities tumbled in Europe ending Friday with a substantial loss. Global markets are under pressure thanks to the continued slide in the U.S. markets. The latest drop came in reaction to disappointing earnings from U.S. companies like Amazon.com and Google parent Alphabet. The FTSE dropped 1.6 percent, the CAC retreated 2.3 percent, the DAX slid 3.1 percent and the SMI was 2.3 percent lower.

Italy told the European Commission on Monday it would stick to its 2019 budget plans in defiance of EU fiscal rules, but promised not to further inflate its deficit in coming years. The Italian government appeared to be counting on the European elections in the second quarter of 2019 to overcome resistance from Brussels. Although Italian bond prices rose on relief after Moody’s did not slap on a negative outlook as the market had feared, yields remained elevated, with 10-year bond rates above benchmark German bonds.

The European Commission rejected Italy’s draft 2019 budget Tuesday, saying it broke EU rules on public spending, and asked Rome to submit a new one within three weeks or face disciplinary action. Italian bond yields jumped on the unprecedented move by the EU which was exerting for the first time a power obtained during the 2013 sovereign debt crisis, to send back a budget of a Eurozone country that violates its rules. Having recently emerged from the Greek debt debacle that nearly destroyed the single currency, the EU is concerned about another possible crisis if debt-laden Italy were to lose market trust. The Commission has previously dealt with France, Spain, Portugal and previous Italian administrations that broke EU fiscal rules, but none of those violations were as blatant as the latest Italian budget draft, the Commission said.

Rome will now have to send a new draft budget that would cut the structural deficit, which excludes one-offs and business cycle swings, by 0.6 percent of GDP, rather than increase it by 0.8 points as in the current plan, the Commission said. In a letter to the Commission on Monday, Italy acknowledged that the draft violated EU rules, but said it would stick to it. Italy has the second highest debt-to-GDP ratio in the EU after Greece, at 131.2 percent in 2017, and the highest debt servicing costs in Europe. But it believes additional spending through a higher deficit would boost growth, helping reduce the debt-to-GDP ratio. The Commission believes Italy’s growth assumptions are overly optimistic making the debt reduction plan questionable.

Asia Pacific

All but one Asian/Pacific equity index tumbled this week — the Shanghai Composite which was up 1.9 percent. Losses ranged from a decline of 0.9 percent (Jakarta Composite) to 6.0 percent (Nikkei and Kospi). Investors’ anxieties about the outlook for U.S. earnings sent equities tumbling. A range of other factors including trade worries, Italian government finances and Brexit dampened investor sentiment too. Chinese shares ended the week higher on hopes for more government support to boost growth.

Asian shares skidded to 20-month lows and China’s yuan weakened at the end of a turbulent week for financial markets as anxiety over corporate profits added to lingering fears about global trade and economic growth. Chinese shares were pulled lower amid the generally dismal mood, and as the yuan fell past the psychologically important 6.96 yuan level to the dollar, touching its lowest levels against the greenback since December 2016. Chinese shares have been hit by volatility amid a string of official announcements and measures aimed at supporting the markets following a recent plunge.

Equity investors have become increasingly nervous about lofty equities valuations, a likely peak in corporate earnings momentum, faster rate increases in the United States and an ongoing Sino-U.S. trade war that threatens to hurt world growth.

China and Japan met Friday and pledged to forge closer ties as both countries stood together at an “historic turning point”, signing a broad range of agreements including a $30 billion currency swap pact, amid rising trade tensions with Washington. Japanese Prime Minister Shinzo Abe and Chinese Premier Li Keqiang also agreed the two countries would work together to achieve denuclearization on the Korean Peninsula. The pacts were reached on Abe’s three-day visit to Beijing as they looked to carve out new areas of cooperation and seek new ways to promote trust, which has been fragile at times since diplomatic relations resumed in 1972.

The move to boost economic ties came as China and the United States have slapped tariffs on each other in recent months. Japan is at risk as it exports to China manufacturing equipment and electronic parts, which are used to make finished goods for the United States and other markets.

Currencies

The U.S. dollar saw its strength erode on Friday after the GDP data were released. At week’s end, the yen and Canadian dollars had changed direction and were now higher on the week. The Swiss franc was unchanged for the week. However, the Australian dollar, euro and pound were down against the U.S. currency for the week. The yuan also retreated on the week. The exchange of tariffs between the United States and China has lifted the value of the dollar, which serves as a safe haven in times of geopolitical turmoil. While a strong currency lifts the value of U.S. assets, it also raises the cost of imports and exports, which can slow growth.

On Friday, the first estimate of third quarter GDP showed that the Fed’s preferred inflation gauge, the personal consumption expenditures (PCE) price index excluding food and energy, missed expectations after it increased 1.6 percent in the third quarter. The core PCE price index rose at a 2.1 percent pace in the April to June period.

The euro fell to a 10-week low of $1.133. It hit a two-month low of $1.135 the previous session, following European Central Bank President Mario Draghi’s failure to convince traders the ECB could pursue monetary tightening after next summer as political and economic uncertainties grow in the monetary union.

Selected currencies — weekly results

Indicator scoreboard

Eurozone

October flash estimate for the composite PMI was 52.7, down from 54.2 final for September. The manufacturing component was down to 52.1 from the final 53.3 in September while the services component slipped to 53.3 from 54.7. The decline in services sector activity to a two-year low was accompanied by a similar fall in the manufacturing survey's measure of output from 52.7 in September to a 46-month low of 51.2 in October. Similar weakness was also evident in new orders, with service sector respondents reporting increases at the second slowest pace in nearly two years and manufacturers reporting a drop in orders for the first time since November 2014. Export orders for manufacturers fell for the first time since June 2013, with many respondents citing the impact of global trade tensions. The surveys' measures of business confidence also fell to multi-year lows while employment growth also reports to have slowed in both sectors. Price pressures remained strong in October.

Germany

October Ifo indicated that conditions, expectations, and sentiment have all weakened. The headline business climate indicator fell for a second consecutive month from 103.7 in September to 102.8 in October. The headline reading reflected similar declines in the two components. Current conditions declined from 106.4 in September to 105.9 in October while the expectations retreated from 101.0 to 99.8. The survey's diffusion index measure of sentiment fell from 26.8 in September to 24.8 in October, reflecting declines in three of the four sectors covered. Manufacturing declined from 23.3 to 19.2, services slid from 32.7 to 31.4 for the services sector, and wholesale from 11.7 to 10.1. These declines were partly offset by a fourth consecutive increase for the construction sector from 31.8 to 32.7.

Bottom line

Equities tumbled for the week thanks to mixed earnings. The Bank of Canada increased its policy rate while the European Central Bank left its policy unchanged. The European Commission rejected Italy’s draft budget and required the nation to rewrite it within three weeks or face penalties. Economic data were light. U.S. trade in goods widened to a record. Third quarter GDP increased more than expected. The flash PMIs were weaker as was the German Ifo.

This week brings a full plate of data. Two central banks — the Bank of Japan and Bank of England both meet and both are anticipated to maintain current policy. France, Italy and the Eurozone release flash estimates of third quarter GDP. Final manufacturing October PMI will be posted. Australia reports third quarter consumer and producer price indexes.

Looking Ahead: October 29 through November 2, 2018

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