Monday, July 4, 2005
Global Markets
There was little reaction in the financial markets to the Federal Reserve's 25-basis-point increase which took the Fed funds rate to 3.25 percent. There was some reaction in the foreign exchange markets where activity - at least for now - was focused on relative interest rate spreads. The dollar hit an eight month high against the Japanese yen and a ten month high against the Swiss franc. The rate increase widened the gap between U.S. rates and those of other countries. Short rates in Japan and Switzerland are both below 1 percent, while some investors bet that the next move by the ECB (currently 2 percent) seems more likely to be down than up. Even the pound sterling dropped. A string of disappointing UK economic data combined with the narrowing spread between U.S. and British interest rates have sunk the currency to its lowest level in nine months. Analysts now expect Bank of England interest rates to head in the opposite direction of the Fed's - down from the current 4.75 percent level.
But the yield is not the only factor influencing exchange rates. Two other factors - differential economic growth rates and the U.S. trade deficit - are currently canceling each other out for now. Most likely the Fed rate increase will be interpreted as good news in Europe. Indeed, the euro dropped below $1.20 per euro in Friday morning trading. The weaker euro could help the export dependent and anemic growing economies (Italy and Germany) come out of their lethargy.
At the end of the first six months of 2005, only equities in the U.S. (both the Nasdaq and Dow) and Hong Kong were below their 2004 year end level. But in the second quarter, both the Nikkei and Topix lost ground as did the Dow. On the week, the Hang Seng and STI in Asia along with the S&P/TSX composite in Canada were down.
Global Stock Market Recap
Europe and Britain
European equities continued to climb bolstered by the dollar's strength against the euro. A weaker euro helps struggling exporters to increase sales and profits. Exporters gain because their goods can be priced more competitively, which takes the strain off profit margins. Both the DAX and CAC registered healthy gains last week of 1.1 percent and 1.7 percent respectively.
Despite a backdrop of sluggish economic growth and political uncertainty it has been an encouraging first half for European equities, Much of the strength has been due to the euro's weakness especially in the wake of the French and Dutch rejections of the European Union constitution. According to Goldman Sachs, the euro's trade weighted index has dropped about 5 percent from its first quarter average - and this is almost equivalent to an interest rate cut of 1 percent. They also estimate that for each 10 percent fall in the euro versus the dollar, European company profits are boosted by about 3 percent over the following year. In the first half of 2005, the CAC was up 10.7 percent while the DAX climbed 7.8 percent. Both managed to fend off a dreadful April to rebound in May and June.
The FTSE 100 did not set a three year high on the last day of the second quarter, but did on the first day of the new quarter. Through June 30th, the FTSE 100 was up 6.2 percent - but the gain was lower than the 7.5 percent growth in the corresponding period in 2004. The market rally this year has been supported by increasing earnings expectations. The FTSE also recovered nicely from a disastrous April when the index dropped below its December 31, 2004 level. In the second quarter, the CAC jumped 5.5 percent while the FTSE was up 4.5 percent and the DAX, 4 percent.
German Chancellor Gerhard Schroeder deliberately lost a confidence vote in parliament on July 1st, allowing him to ask President Horst Koehler to call an election in September, a year before the end of his four year term. A win would give the chancellor a new mandate for a program that has included welfare cuts. His ability to push through legislation has been cut by losses in eleven regional ballots, increasing domination of the upper house by the opposition. Polls indicate Schroeder would lose an election, with unemployment close to a record and the economy struggling. That would make CDU leader Angela Merkel Germany's first woman chancellor. The markets see the possibility of a new government in Germany as a very positive piece of news. The DAX has risen 4.6 percent since Schroeder first announced his intention to seek an election on May 22nd. Calling and losing a confidence vote is the only procedure allowed under the Germany's constitution to heads of government seeking an early election. Only the president can decide to dissolve parliament before the end of its four-year term, and then only after a confidence vote has been lost. That is in contrast to the U.K., where the prime minister has the power to call an early election at any time.
Asia/Pacific
Equities were mixed with the Hang Seng and STI ending the week on the negative side. The Nikkei was boosted by a combination of a weaker yen and a better than expected Tankan. Just as the weaker euro helps those dependent on exports in Europe, so too does the weaker yen benefit Japan's exporters. This is important to Japan because their recovery has been dependent upon export growth, which has been hit by slower demand from the U.S. and China. This has in turn lowered Japan's trade surplus significantly.
All indexes followed here were up at the end of the first six months of 2005 with the exception of the Hang Seng which was down a mere 0.2 percent. Asian/Pacific indexes were slower to pull out of the April slump that permeated world markets. On the quarter, the Nikkei was down 0.7 percent while the broader Topix lost 0.4 percent. The Nikkei has now risen six weeks in a row and is back to levels last seen in mid-April. But over the first six months of the year it only rose 0.8 percent.
Currencies
The yen dropped this week, first because crude prices were over $60 a barrel and second, because of the growing differential in yields between the U.S. and Japan. Japan imports all its oil, and fears grew that record crude prices would hamper the country's recovery. Some analysts attribute the yen's slide more to its lack of yield, arguing that the currency was increasingly being used as the funding currency for yield-seeking carry trades. Another factor that has been weighing on the yen recently is the prospect of a deteriorating trade surplus. Recent merchandise trade data showed that the surplus had its steepest drop in over four years. The Bank of Japan interest rate has been almost zero since August 2001. The dollar is up 3.4 percent compared with the yen in the second quarter and has strengthened versus the Swiss franc and British pound as well.
The dollar gained 6.4 percent against the euro in the second quarter. The widening yield advantage with the euro region and faster U.S. economic growth for a fourth consecutive year both played a role. The euro has slumped especially since the two negative votes against the EU constitution a month ago. Many traders did not expect the dollar to climb given steep U.S. trade and fiscal deficits combined with low interest rates.
Indicator scoreboard
EMU - May M3 money supply jumped 7.3 percent when compared with last year. For the three months ending in May, M3 was up 6.9 percent when compared with the same three months a year earlier. This is well above the ECB's target for the moving average of 4.5 percent growth on the year.
June flash harmonized index of consumer prices edged up to 2.1 percent compared with last year from 2 percent in the previous month. As with all flash reports, no details or monthly change were available.
June EU economic sentiment index edged up for the first time in five months to 96.3 from 96.1 in May. Industrial sentiment inched up to minus 10 from minus 11 in May while consumer sentiment was unchanged at minus 15. Sentiment dropped in the services, retail and construction sectors. The results were mixed across countries.
June manufacturing purchasing manager's index was up for the first time in five months, increasing from 48.7 in May to 49.9. The latest reading indicated a marginal deterioration in the health of the manufacturing sector. However, the rise in the index signaled an easing in the rate of decline compared to that seen in the previous two months. The upturn in the PMI reflected an improvement in export orders during the month, which increased at the fastest pace in four months. Despite the increase in new orders, employment fell for the forty-ninth successive month in June. The PMIs are produced by NTC Research in Britain.
May seasonally adjusted unemployment rate dipped to 8.8 percent from 8.9 percent in April. Declines in Germany, Spain and Ireland led to the decline. Eurostat estimated that in April 2005, 12.8 million people were unemployed in the eurozone. These data are seasonally adjusted in line with ILO criteria.
Germany - June Ifo business sentiment index edged upward to 93.3 from 92.9 in the previous month. It was the first increase after four months of declines. Future expectations climbed to 92.9 from 92.3 in the previous month while current conditions were up to 93.7 from 93.4 in May. The improvement in sentiment can be traced to improvements in the manufacturing, wholesale and retail sectors. Construction was down.
June seasonally adjusted unemployment was down by 23,000 with a decline of 4,000 in the west and 19,000 in the east. In June, 4.8 million were unemployed. The unemployment rate for all of Germany inched down to 11.7 percent from 11.8 percent in May while the rate declined to 19 percent from 19.1 percent in the east. The unemployment rate was unchanged at 9.8 percent in the west. May seasonally adjusted employment managed to gain 4,000 jobs.
France - May producer price index declined 0.3 percent but was up 2.4 percent when compared with last year. Excluding food and energy, the PPI was unchanged and up 2.3 percent on the year. Fuel prices were down 2.5 percent after jumping by 2.6 percent in April.
May seasonally adjusted unemployment rate remained at 10.2 percent for the third month. The number of jobless edged up 1,000 to 2.776 million according to the International Labour Organization definition which excludes jobseekers who did any work during the month. There were 2,300 fewer jobseekers working less than 78 hours per month according to the national employment agency ANPE. The number out of work for more than a year accounted for 29.6 percent of the total.
First quarter final gross domestic product was revised upward to an increased of 0.3 percent from 0.2 percent in the prior release. When compared with the first quarter a year ago, GDP was up a revised 1.8 percent from the previously released 1.7 percent. Most of the major categories including public consumption, private consumption and business investment were revised upward slightly.
Italy - May producer price index was down 0.4 percent but up 3.1 percent when compared with last year. The PPI was down thanks to a decline in energy and intermediate goods prices. Excluding energy, the PPI was down 0.1 percent and up 1.8 percent on the year. Energy goods prices were down 1.5 percent as prices for refined petroleum products sank 3.7 percent.
Britain - Final first quarter gross domestic product was revised down sharply to 0.4 percent compared with 0.5 percent in its previous estimate. The annual rate of growth was revised downwards more sharply from an initial estimate of 2.7 percent to 2.1 percent. The revisions were due partly to upward revisions in previous years which underlined the extent of the slowdown since last autumn when higher interest rates dampened consumer spending.
June Nationwide house price index was down 0.2 percent but up 4.1 percent when compared with last year - the lowest annual rate since July 1996. The seasonally adjusted price of an average house climbed to Stg157,791 from Stg157,272 in May. Nationwide opined that weakening consumer sentiment linked to the more uncertain economic outlook seemed key to the weak house price numbers. They also said that uncertainty about interest rates was also playing a role.
June seasonally adjusted CIPS/NTC Research manufacturing purchasing managers index remained below the no-change mark of 50.0 at 49.6 indicating of only a slight rate of overall contraction. Manufacturing new orders rose for the first time in three months while export orders rose for the first time in six months.
Asia
Japan - May seasonally adjusted industrial production dropped 2.3 percent but was up 1.9 percent when compared with last year. Technology companies pared inventories and demand from China and the U.S. weakened. Industries that mainly contributed to the decrease are transport equipment, information & communication electronics equipment, and electronic parts & devices. Commodities that mainly contributed to the decrease are as follows: large passenger cars, steel ships and personal computers. Shipments decreased 2.7 percent and were down 0.3 percent from the previous year.
May unemployment rate remained steady at 4.4 percent. The total number of jobless fell for the 24th straight month, decreasing by 120,000 on the year to 3.07 million people. The number of those with jobs was up on the year for the first time in three months, increasing by 460,000 to 64.35 million people.
Second quarter Tankan survey of large manufacturers' business conditions increased to 18 from 14 in the first quarter. However, large manufacturers expect business conditions to slip back slightly three months ahead - they forecast the September sentiment index to be down to 17. For large non-manufacturers, the June index stood at 15, up from 11 in March, although the forecast for September was a bit lower at 14. The index for small manufacturers stood at 2 in June compared with 0 in March, while that for small non-manufacturers was minus 12, improving from minus 14 in March.
June Tokyo consumer price index dropped 0.5 percent and was down 0.8 percent when compared with last year. Tokyo core CPI was down 0.1 percent and dropped 0.4 percent when compared with last year. May nationwide CPI was up 0.3 percent and 0.2 percent on the year. Core CPI was up 0.2 percent but flat on the year. The core CPI is the Bank of Japan's inflation measure. The core CPI figures exclude usually volatile prices of fresh food.
May spending by households headed by wage earners fell 1.8 percent and was down 1.5 percent from a year earlier. Wage earner household spending is an important gauge of personal consumption, which accounts for roughly 55 percent of Japan's gross domestic product.
Australia - May retail sales were up 0.9 percent and 2.8 percent when compared with last year. Department store sales were up 9.1 percent, and clothing and footwear spending was up 4.5 percent.
Americas
Canada - April monthly gross domestic product was up 0.4 percent and 2.8 percent when compared with last year. It rebounded mainly on the strength of higher oil extraction after first quarter production difficulties in the western tar sands, higher retail sales, as well as the restoration of educational services in Quebec after a strike. Goods producing industries were up 0.4 percent while services were up 0.3 percent.
May industrial product price index was unchanged and down 0.3 percent when compared with last year. Lower prices for petroleum products and lumber and other wood products were offset by higher prices for motor vehicles and other transport equipment, meat, fish and dairy products, primary metal products, chemical products and electrical & communication products. Petroleum and coal products prices decreased 3.4 percent on the month as gasoline and fuel oil prices declined for the first time in four months. If petroleum and coal product prices had been excluded, the IPPI would have increased 0.4 percent rather than remaining unchanged.
May raw materials price index dropped 3.1 percent but was 7.0 percent higher than prices in the same month a year ago. Prices declined for mineral fuels, wood products as well as ferrous materials. Mineral fuels were down 6.0 percent compared to April, as crude oil prices decreased 7.2 percent due to higher levels of inventories and a slight decline in demand. Ferrous materials decreased 3.3 percent as iron and steel scrap prices were down 6.5 percent.
In May, the value of the Canadian dollar fell 1.6 percent against the U.S. dollar. As a result, if the impact of the exchange rate had been excluded, the IPPI would have declined 0.4 percent instead of remaining unchanged from April. The value of the Canadian dollar rose 9.8 percent against the U.S. dollar on the year. If the impact of the exchange rate had been excluded, producer prices would have risen 2.2 percent between May 2004 and May 2005, rather than their actual 0.3 percent decline.
Bottom line
The upcoming week is a busy one. Aside from the Group of Eight meeting in Scotland, The Reserve Bank of Australia, Bank of England and the European Central Bank will all hold meetings and make policy pronouncements. None are expected to alter their current policy interest rates from their respective levels of 5.5 percent, 4.75 percent and 2 percent.
Leaders from the Group of Eight (U.S., Canada, Japan, the UK, France, Italy, Germany and Russia) will probably discuss risks to global economic growth, including expansion of the U.S. current account deficit and rising oil prices, when they meet.
Looking Ahead: July 4 through July 8, 2005
International markets respond to higher dollar