Monday, July 5, 2004
The Fed finally ups rates, the ECB bides its time
As expected, the Federal Reserve edged interest rates up by 25 basis points to 1.25 percent. Now only Japan with a zero interest rate and Switzerland with a libor rate of zero to 1 percent are lower. The markets, which long had priced in the 25 basis point increase, took the news calmly. The Fed has now joined the Bank of England and the Reserve Bank of Australia in raising rates, although the RBA and BoE have been much more aggressive in doing so. Both meet next week but are not expected to increase rates this time round. The dollar fell and equities climbed slightly immediately after the announcement. Markets in Asia and Europe were already closed.
To no one's surprise, the ECB left their policy making interest rate unchanged at 2 percent. The spread between the Fed and ECB policy rates is now 75 basis points. Growth in Europe is significantly slower than that in the United States and Asia, and export demand has failed to ignite investment and employment in such countries as Germany and France. In his press conference immediately after the meeting, ECB President Jean Claude Trichet said that the Bank has "no bias" on interest rates and remains "vigilant" against the threat of accelerating inflation. Regarding the Fed's decision, Trichet said the ECB was "not influenced in any respect by what has been decided across the Atlantic" (or across the channel). Although rates remained at 2 percent for the 13th month, Trichet appeared to take a harder rhetorical stance on inflation. In spite of the recent moderation in oil prices, he warned that inflation would probably remain above 2 percent into the first half of next year.
The Norwegian central bank today left its main interest rate at a record low 1.75 percent. Norges Bank said inflation will probably be lower than its 2.5 percent target in two years, indicating it may pare borrowing costs.
The EU and ECB deputies agreed that Estonia, Lithuania and Slovenia should enter the exchange rate mechanism (ERM II) as a precursor to euro entry. The central rate of the Estonian kroon was set at 1 euro = C15.6466 kroon; for the Lithuanian litas, at 1 euro = 3.45280 litas; and for the Slovenian tolar at 1 euro = 239.640 tolar. The standard fluctuation band of plus or minus 15 percent will be observed around the central rate for all three currencies. In turn, each of the countries pledged to closely monitor macroeconomic developments together with the responsible EU bodies and strengthen fiscal measures if warranted. Joining the ERM is a precursor to membership in the European Monetary Union. In assessing which countries can join the ERM and when, euro-area governments and the ECB examine candidates country by country and judge them based on the degree of "real" economic convergence with the EMU.
The criteria for euro membership are that the budget deficit has to be below 3 percent of GDP; public debt should be less than 60 percent of GDP; inflation should be within 1.5 percentage points of the three EU countries with the lowest rates; long-term interest rates must be within 2 percentage points of the three lowest interest rates in the EU; and exchange rates must be kept within "normal" fluctuation margins of the ERM II for at least two years.
Global Markets - a mixed picture at mid-year
The half year ended on Wednesday and performance comparisons are inevitable. The order of the top three index performers was unchanged from the first quarter. Despite losing ground in the second quarter, the Bolsa was the best performer among the indexes followed here. The Nikkei and the Topix are numbers two and three on signs that the economic recovery in Japan could be sustainable. The Kospi was the worst performer in the second quarter followed by the Hang Seng. Both had gains in the first quarter but lost them and more in the second. The DAX was able to rebound from a first quarter loss to a positive stance in the second quarter, while the FTSE regained most but not all of the first quarter's loss.
Global Markets - waiting for events weighed on stocks
It was a heavy week for potentially market moving events. Equity trading, as for that matter trading in bonds and foreign exchange, was dominated by the protracted debate over the impact of Fed rate increases. Disappointing U.S. data culminating in the U.S. employment situation report added to investors' anxieties. And then there was the inevitable profit taking after the quarter's end that was added to the stew.
Global Stock Market Recap
Europe and Britain
Markets were already closed on Wednesday when the Fed announced its decision to edge up U.S. interest rates by 25 basis points to 1.25 percent. The move offered no surprises. Equities were down on Thursday as investors shifted their focus back to economic data. And they were disappointed. The PMI's in Britain and Germany were down, while France managed to inch up slightly. U.S. data were also weaker than expected. Since Europeans tend to trade on U.S. data, equities fell further in unison with U.S. stocks that were also down on the day. Concern that rising U.S. interest rates and higher oil prices may slow the economy and hamper profit growth has limited gains by such companies as Royal Philips Electronics NV and other cyclical stocks. Oh - the ECB left monetary policy unchanged. That had absolutely no impact on the markets.
In Britain, good news was bad news for equities. The FTSE slid after a revised report for GDP showed Britain's economy grew at the strongest annual pace in 3� years, prompting speculation the Bank of England may increase borrowing costs for a fourth time this year. Equities continued to decline on Friday especially after the disappointing U.S. employment report that showed employment gains of only half of what had been expected by analysts.
Asia/Pacific
Japanese investors were optimistic as a full week of promising economic data began, driving up stocks ahead of economic data. Although they were disappointed by industrial production data, which were weaker than expected, they were not disappointed by the Tankan, which was much better than expected. The Tankan confirmed that Japan's economic recovery is spreading and suggested there was little to worry about going forward, which is positive for the stock market. Asian investors, however, were uneasy leading up to the FOMC meeting. Interest rates are still the biggest risk for the markets. Reliance on the United States for export growth still dominates investor concerns, and they buy and sell on their latest projection of U.S. growth. Optimism in the stock market did not last the week. On Friday, both the Nikkei and Topix not only lost gains from earlier in the week, but even more. And this was before the U.S. employment report!
Currencies
The Canadian dollar traded near its highest level since April versus the U.S. dollar on speculation the Bank of Canada will raise its key interest rate from 2 percent to maintain its yield advantage relative to the U.S. Federal Reserve (1.25 percent). The Bank of Canada has lowered interest rates three times in 2004 to spur economic growth. The current spread between the two is 75 basis points. But with growth picking up, the BoC is expected to reverse direction in September. The Canadian dollar also benefited when Prime Minister Paul Martin's Liberal Party won enough seats in the national election to form a minority government. The Canadian dollar surged 21 percent versus the U.S. dollar last year as the country's rate premium reached as wide as 2.25 percentage points. The gap in rates has fallen to 0.75 percentage point, helping to trigger the Canadian dollar's 2.2 percent drop this year.
The dollar sank at week's end against the euro after the jobs report disappointed traders and ahead of a holiday weekend that prompted nervous investors to square speculative positions. But other concerns were also on the minds of investors, not least a renewed climb in oil prices along with fears of the possibility of terror attacks over the Independence Day holiday weekend.
The yen also fell, driven lower by a drop in the Japanese stocks. The Nikkei fell as investors locked in profits following the stronger-than-expected Tankan. Weekly securities flows indicated that foreign investor purchases of Japanese stocks had slowed from the previous week - and any weakening of the Nikkei poses further risk to these inflows. When foreign investors are not purchasing Japanese equities aggressively, investor outflows have a greater impact on the direction of the yen.
Indicator scoreboard
EMU - May M3 money supply was down 0.2 percent but was up 4.7 percent when compared with last year. For the three months ending in May, M3 was up 5.5 percent when compared with the same three months a year ago. The 3-month moving average with a target of 4.5 percent growth rate is used by the ECB to track money supply growth.
June seasonally adjusted Purchasing Managers manufacturing survey eased to 54.4 from 54.7 in May. An index reading above 50 denotes expansion and the higher the reading, the more rapid the expansion. According to NTC, which compiles the survey, demand is cooling somewhat in key export markets and prices are not competitive. France was the only country covered to increase in June.
May seasonally adjusted unemployment rate remained at 9 percent for the second month. Spain registered the highest unemployment rate at 11.1 percent while Luxembourg and Austria had the lowest rate at 4.2 percent. Eurostat calculates unemployment according to the International Labour Organization definition which excludes jobseekers who did any work during the month.
June flash harmonized index of consumer prices slipped to 2.4 percent from 2.5 percent in May. The HICP continues to be above the ECB inflation ceiling of 2 percent. Eurostat does not provide a monthly change figure with the flash release. In order to compute the HICP flash estimates, Eurostat uses early price information provided by Germany, Italy, Spain and - if available - other member states, as well as information about energy prices.
EU - June economic sentiment index edged down to 99.8 from 100.1 in May. Declines in the services and retail sectors outweighed improving industry, consumer and construction sector sentiment. Confidence was down in Spain, Germany and Italy while it was up in France.
Germany - May total retail sales including autos and gasoline stations sank 1.5 percent and dropped 2.7 percent when compared with last year. Excluding autos and gas stations, sales declined 1.9 percent and decreased by 2.2 percent on the year. Total sales have dropped in six of the last seven months.
France - May producer price index jumped 0.6 percent and 2.3 percent when compared with last year. Excluding food and energy, the PPI was up a tame 0.2 percent and 0.7 percent on the year. Upward pressures stemmed from energy prices which were up 2.5 percent and 7.5 percent on the year.
May seasonally adjusted unemployment rate remained at 9.8 percent for the fourth month even though the number of jobless was up by 14,000 according to the ILO definition which excludes jobseekers who did any work during the month. The recent jobless trends are probably less a reflection of the economic cycle than of the impact of political factors on official statistics.
Revised first quarter gross domestic product was up 0.8 percent and 1.7 percent when compared with the same quarter a year ago. Upward revisions to inventory accumulation offset downward revisions for consumption and investment.
Italy - May producer price index jumped 0.9 percent and 2.9 percent when compared with last year. The jump was attributed to higher oil and metals prices. Excluding energy, the PPI was up 0.3 percent and 2.6 percent on the year. Oil prices soared 7.3 percent on the month.
Second quarter unemployment rate was 8.8 percent. The calculation was based on a new survey method. According to ISTAT, the data are not comparable to the old series because both the survey method and the period in which the survey was conducted have changed. The survey method changes were made to harmonize data collection with those used by other major EU economies. No data were available for the total number of unemployed in April nor for the total number of employed.
Britain - June Nationwide house price index was up 0.9 percent and 19.1 percent when compared with last year. Nationwide expects that house prices are likely to slow gradually and housing market activity will be low, rather than suffering a slump.
Revised first quarter gross domestic product was up 0.7 percent and 3.4 percent when compared with the same quarter in 2003. Although output for manufacturing, mining & quarrying and agriculture & fisheries declined, services, distribution, transport and communications were all up. Household expenditures were revised to an increase of 0.6 percent from the earlier 0.9 percent estimate. Gross fixed capital formation estimate was increased to 1.7 percent from the initial estimate of 1.1 percent. National Statistics (NS) released revisions going back to 1995, reflecting higher government expenditure and improved measurements of health output.
Asia
Japan - May industrial production was up 0.5 percent and 4.2 percent when compared with last year. On a seasonally adjusted basis, industrial production was up 0.7 percent and 7.7 percent on the year.
May seasonally adjusted spending by Japanese households headed by wage earners dropped 2.7 percent but jumped 6.0 percent from a year earlier. The data adds to growing evidence of a steady pickup in consumption. Wage earner household spending is an important gauge of personal consumption, which accounts for roughly 55 percent of Japan's gross domestic product. The seasonally adjusted propensity for wage-earner households to consume, a ratio which measures the amount of disposable income that went to household spending, fell to 72.8 percent from 76.9 percent in the previous month.
May unemployment rate was 4.6 percent, down from 4.7 percent in April. However, the decline was the result of fewer people looking for work. Jobs fell by 110,000 and the labor force shrank by 210,000 people.
Second quarter Tankan survey of large manufacturing enterprises jumped to 22 from 12 in the first quarter. Small manufacturing enterprises climbed to plus 2 from minus 3 in the previous quarter. June's reading was the highest since 1991, surpassing peak levels during two short-lived recoveries after the asset bubble popped. Large companies reported they plan to increase business investment by 5.7 percent on average during the fiscal year through March 2005, revising their plans upward from a planned cut of 0.6 percent reported three months ago.
Americas
Canada - May industrial product price index (IPPI) jumped 1.5 percent and 5.5 percent when compared with last year. Higher prices for petroleum and coal products contributed to about half of the monthly increase. Prices for motor vehicles and other transport equipment were up mainly due to exchange rate effects. If petroleum and coal product prices had been excluded, the IPPI would have increased 4.0 percent on the year.
May raw material price index jumped 2.9 percent and 15.0 percent when compared with last year. Mineral fuels were responsible for most of the increase. Crude oil prices rose 7.8 percent due to strong demand and tight inventories. If mineral fuels had been excluded, the RMPI would have increased 7.0 percent on the year.
Between April and May, the value of the U.S. dollar strengthened 2.7 percent against the Canadian dollar. As a result, the total IPPI excluding the effect of the exchange rate would have risen 0.7 percent, compared to the 1.5 percent actual increase. However, on a 12-month basis, the influence of the dollar had no impact. The change in IPPI excluding the effect of the exchange rate was 5.5 percent on the year.
April monthly gross domestic product inched up 0.1 percent after jumping 0.8 percent in March. Monthly GDP was up 2.8 percent when compared to last year. Goods producing industries were up 0.3 percent while services producing industries were unchanged. Higher prices for oil and gas propelled the mining sector. The housing market provided gains in related areas. Electricity generation bounced back. Industrial production (mining, manufacturing and utilities) increased 0.3 percent. Offsetting these increases were declines in health care, new auto sales and a drop in tourism. Oil and gas production jumped.
Bottom line
Now that the FOMC meeting is out of the way (and the U.S. employment situation report as well), central bank watchers will turn their focus to the Bank of England. The big question is will the Bank increase their key interest rate for the third month in a row' Analysts think not, saying the Monetary Policy Committee will probably wait another month before increasing rates for a sixth time despite last week's upward revision to first quarter GDP that put growth above trend.
The Reserve Bank of Australia also meets next week. The RBA's current key interest rate is 5.25 percent after two back-to-back increases at the end of 2003. Analysts are split on whether another increase is imminent given the stubborn strength of the housing sector.
Looking Ahead: July 5 through July 9, 2004
A split decision on interest rates