Global Markets

World equity markets again struggled with worries about credit quality, interest rates, oil prices, and mixed economic data. Problems in the U.S. sub-prime mortgage market contributed to more generalized concerns on credit quality, which in turn led to higher credit spreads in a number of areas. Oil futures rose again on Wednesday after weekly U.S. energy inventory data showed a mixed picture, with analysts focusing on unexpected declines in gasoline and distillate inventories, rather than on higher crude oil supplies. Crude oil prices traded close to $70 a barrel for the rest of the week, ending around $70.60. Oil had last traded in a sustained way above $70 in September 2006. It is up about 14% on the year.

The Federal Open Market Committee’s policy statement on Thursday moved markets in this hemisphere on Thursday and the other markets on Friday -- but not in any clear direction. Analysts found various ways to interpret the statement, with some focusing on the removal of the word “elevated” to describe inflation, while others emphasized the FOMC’s uncertainty that inflation improvement would be sustained. A well behaved core PCE for the U.S. on Friday, along with other indications of slow economic growth, contrasted with some signs of a healthy recovery in Europe. These opposing trends encouraged further expectations that the Federal Reserve was unlikely to raise rates, in contrast to expectations for higher rates from both the European Central Bank and probably also the Bank of Japan where policy rates are lower. The prospect of a narrowing in interest rate spreads tended to weaken the U.S. dollar relative to other currencies.

GDP revisions for the first quarter were reported for a number of countries, including France and the UK as well as the United States. Generally they were similar to slightly stronger than previously reported figures. UK figures, which already showed strength, looked a bit stronger; French figures still showed modest growth, and U.S. figures remained weak. Canadian GDP monthly data for April suggested significant weakening, although monthly figures can be quite variable. 

Global Stock Market Recap

Europe and the UK

Stock price declines were widespread in Europe for the first three days of the week as market participants continued to worry about credit issues in the face of widening problems in the U.S. sub-prime mortgage market and persistently high oil prices. They rallied on Thursday before the FOMC statement was released in hopes that the decision would be benign for the markets. While the statement led to market confusion in the U.S., European markets, looking at the Fed's assessment of growth, saw indications of continued U.S. demand for exports. The bulk of European data reports released on Friday were also seen as supporting a view of moderate growth in Europe.

United Kingdom — a new prime minister

Gordon Brown became UK prime minister Wednesday, succeeding Tony Blair. Brown’s previous position had been as Chancellor of the Exchequer, a title he held throughout Blair’s tenure. Alistair Darling will be the new Treasury chief.

International Monetary Fund — changing of the guard

Mr. de Rato, Managing Director of the IMF and a former Spanish economy minister, told the executive board of the 185-nation lending organization that he would leave in October after the IMF's annual meeting. He was due to end his five-year term in May 2009. He cited family reasons for his early departure. Throughout the IMF’s history, the organization’s lead position has been held by a European. That tradition has been subject to criticisms from emerging market countries who feel it's outdated.

Asia/Pacific

Over the first three days of the week, Asian stock markets followed moves in other parts of the world and saw some sharp declines. These markets had closed before the previous Friday’s sell-offs elsewhere and they joined in on Monday. They, along with the rest of the world, were focused on credit quality concerns related to the U.S. sub-prime mortgage market. The partial recovery on Thursday responded to Wednesday’s recovery in the U.S. and to positioning ahead of the FOMC meeting. Encouraging economic data from Japan on prices and employment helped Japanese equity markets at week’s end. On the other hand, South Korean stocks had their worst week since March. The won appreciated to a seven-week high against the dollar, raising concerns about the effect on exports.

Americas

Trading was marked by high intra-day swings in prices. For the most part these didn't show through to the closes in the U.S., though the swings were more evident in closes in Canada and Mexico. Early weakness in those markets was largely attributed to the specifics in those countries. The Mexican market was hit particularly hard by a general sense of risk aversion that can be a problem for developing economies. The Canadian index was hit by early declines in commodity shares. In general, the week was marked by debates about how widespread the spillover would be from credit problems stemming from the sub-prime mortgage meltdown. On Thursday, after the FOMC announcement, volatility also reflected differing interpretations of the Federal Reserve’s future course of action. By week’s end, it seemed unlikely that the Fed would be raising rates any time soon.

Currencies

Nervousness about credit quality issues and efforts by the New Zealand central bank to discourage capital inflows put a damper on the carry trade, with less selling of Japanese yen to convert to high interest rate currencies, especially the New Zealand dollar. In consequence, the yen made modest gains against the U.S. dollar and was about flat against the Australian dollar, euro and sterling.

The Euro regained some of its recent lost ground against the U.S. dollar as investors continued to see a greater likelihood of a near-term policy-tightening move by the European Central Bank than by the Federal Reserve. On Friday, the dollar fell to its lowest level against the euro in more than three weeks after reports showed that the U.S. core PCE price measure slowed in May and consumer spending rose less than expected, reinforcing expectations that the Fed would not raise rates.

Indicator scoreboard

A flurry of European economic data were released on the last two days of the week, presenting on balance a sense of economic gains. Japanese data issued during the week were mixed.   

EMU — M3 strengthened further in May, extending a familiar pattern. On the back of a monthly increase of 1.0 percent, double the pace seen in April, both annual growth and the ECB’s preferred three-month moving average picked up to a year-on-year 10.7 percent. This was significantly above expectations. European Central Bank chief Trichet had repeated just a few days before the important role played by rapid M3 growth in the central bank’s decision to start tightening policy in December 2005. Hence, these latest figures can only serve to fuel speculation of another rate hike. M3 growth has now risen every month since August 2006. In addition, private sector credit growth accelerated to 10.9 percent year over year from 10.7 percent in April with hefty increases in loans to both non-financial corporations and households, notably for house purchases.

The flash harmonized index of consumer prices measure of inflation was unchanged as expected for June, putting the year-over-year increase at 1.9 percent. As usual there was no breakdown of the data; this will come in the final release scheduled for July 16. June marks the 10th consecutive month in which the headline rate has held below its 2 percent target, but the central bank expects inflation to climb later in the year as favorable base effects from the oil market fall away. Inflation concerns, the sense that rapid M3 growth may mean something, and signs of continuing economic expansion all firmed expectations that the ECB will tighten at least once more in order to keep a lid on prices. 

EU—Economic sentiment, at 111.7 for June, was a little weaker than expected following a slightly stronger revised six-month high in May (112.1 from 111.9). The June data showed industrial confidence holding steady at +6, but sentiment in the consumer sector fell a point to -2 on the back of slightly reduced optimism about employment prospects. Within the region, sentiment strengthened in Spain (+1.2), Poland (+3.5) and the UK (+1.8) while Italy (-1.4) and Germany (-0.4) saw modest declines. France was essentially unchanged. After its unbroken upward trend since January, confidence in the services sector fell by a couple of points, but at 21, remains at a relatively high level for the current business cycle. Led by Germany, confidence in the retail sector dipped a point but is still at a solid level while construction confidence held stable for the sixth month is a row. Overall, today’s report is consistent with a number of other surveys pointing to a flattening in the region’s growth profile this quarter.

Germany — The labor market proved stronger than expected in June. Unemployment fell by 37,000 to nudge the overall jobless rate down a notch to 9.1 percent. Declines were registered in both the East (-11,000) and West (-26,000). Overall, employment rose 1.5 percent month over month, the seventh monthly gain of 1 percent or more. Furthermore, another 9,000 increase in vacancies points to another possible rise next month. These data are consistent with the May ILO report released earlier, which also highlighted an ongoing improvement in the labor market with a 16th consecutive increase in payrolls. That said, most leading indicators of German economic activity have been mixed recently, raising doubts about the prospects for significant further declines in unemployment.

Retail sales, excluding cars and gasoline, disappointed in May when volumes fell by much more than expected. However, following an equally large surprise on the upside in the previous month, the trend recovery in demand remains broadly intact and the average April/May level is still 1.1 percent above its first quarter value. The sharp fall in annual growth to -3.7 percent from -2.0 percent in part reflects working day distortions, nevertheless the data showed sharp declines in sales at gas stations (-3.7 percent), special food and beverage shops (-4.9 percent) as well as non-food outlets (-4.0 percent). The German data inevitably add to downside risk to total Eurozone retail sales, due for release on July 4.  

United Kingdom — Revisions to earlier quarters lifted annual GDP growth through Q1 to 3.0 percent from a previous estimate of 2.9 percent. Economy-wide growth for the first quarter was unrevised at 0.7 percent. Within the national accounts, household and government spending both rose 0.5 percent for the quarter while fixed capital formation posted a solid 1.1 percent quarterly gain. Production industries remained in the doldrums (-0.1 percent for the quarter) leaving services (0.9 percent for the quarter) to provide the growth stimulus once again. The current quarter should see a slightly better balance. Against the current background of rising interest rates, one of the more significant elements of the report was the acceleration in the GDP deflator. This jumped from 2.8 percent year over year at the end of 2006 to 3.2 percent. While it is not directly a Bank of England target variable, it is now far enough above the central bank’s 2 percent CPI target to feed expectations for more tightening. Also of note was a drop in the savings ratio to just 2.1 percent compared with 3.9 percent at end-<%Response.Write(Year(Now))%>, its lowest level since 1960. The risk is that the slide is another indication of the rising debt burdens that threaten to undermine future consumption. In any event it makes for a very difficult balancing job for the central bank.

France — unemployment, GDP, producer prices show better tone

Friday was a busy day for data in France. Unemployment continued to fall in May as had generally been expected, slipping by 0.1 percent to a 25-year low of 8.1 percent. A 21,000 (0.9 percent) drop in the number of jobseekers was reported. Statistical problems continue to raise doubts about the accuracy of the data but as it stands, the latest survey points to declines in joblessness in all age categories. Yet the apparent slowdown in economic activity suggested by a number of recent releases suggests that the trend decline in unemployment – the number of jobseekers has fallen some 10.5 percent in the last year – may be about to slow. Much will depend upon whether domestic demand in general, and consumption in particular, can rebound after a sluggish start to the current quarter.

The final GDP figure for the first quarter, using not seasonally adjusted data, was unrevised at 0.5 percent, leaving annual growth at 2.2 percent, but there were some small shifts among the major expenditure components. On a quarter over quarter basis, private consumption showed a 0.5 percent rise (from 0.3 percent) and investment was also nudged firmer to 1.3 percent (from 1.2 percent). A negative 0.3 percent quarter-over-quarter contribution in inventories was revised to negative 0.1 percent but the earlier positive contribution made by net foreign trade of 0.2 percent was revised away. Prospects for the current quarter are mixed with industrial output particularly erratic and surveys suggesting little change in overall economic momentum.  

Producer prices were unexpectedly soft in May with no change for the month. Although the flat headline was helped by falling energy prices (-0.4 percent month over month) the core rate was little different, showing a rise of just 0.1 percent month over month. Prices of consumer goods were again very weak, falling 0.3 percent month over month for the second month in four, while capital goods costs, unchanged, extended their flat profile of recent months. Annual growth in total producer prices now stands at just 1.4 percent. While the core rate is rather faster (2.5 percent year over year), there are few signs of any significant pressure on consumer prices from this quarter. Recently released INSEE and central bank surveys point to a mild hardening in firms’ pricing intentions, but sluggish retail sales suggest this may well be wishful thinking.

Asia/Pacific

Japan

Japanese retail sales beat expectations for May and were about unchanged for the year as a whole. The gains were concentrated in supermarkets and department stores. Some analysts attributed the gain to generally good weather during the golden week holidays.

Japanese industrial production fell 0.4 percent in May. This was substantially below the consensus forecast for an increase of 1.0 percent. May’s decline was the third in a row with declines of 0.2 percent and 0.3 percent in April and March, respectively. Industries that mainly contributed to the decrease in May were electronic parts and devices, information and communication electronics equipment, and ‘other’ industry. On a seasonally adjusted basis, production was up 2.3 percent year over year in May, compared to up 2.4 percent in April. Not seasonally adjusted, production was up 3.7 percent on a year-on-year basis in May, compared to up 2.2 percent in April. For May, shipments rose 0.1 percent while inventories fell 0.3 percent.

According to the Survey of Production Forecast in Manufacturing, production is expected to increase 1.9 percent in June and increase 1.7 percent in July. The Ministry of Economy, Trade and Industry lowered its assessment of the manufacturing trend, stating in its report that "Industrial production is showing a tendency to remain flat," compared the prior month’s statement that "Industrial production is on a moderately upward trend."

The general consumer price index for Japan was unchanged for the year ending May, as it was for the year ending April. The CPI excluding fresh food was down 0.1 percent in May on a year-on-year basis, also the same as in April. On a monthly basis, the general CPI rose 0.3 percent in both May and April while the CPI excluding fresh food rose 0.2 percent in May, slightly slower than the 0.3 percent gain for the prior month. On a year-on-year basis, the CPI was held down by declines in costs for housing, furniture and household utensils, transportation and communications, and reading and recreation. Components seeing increases were food; fuel, light and water charges; clothes and footwear, medical care, education, and miscellaneous. The CPI excluding fresh food is referred to as the core index in Japan. A more standard core index is also computed, removing energy and food. It was down 0.3 percent for the year.

Japan’s unemployment rate was unchanged at 3.8 percent in May and equaled a nine-year low set in April, according to data in a report from the Ministry of Internal Affairs and Communications. May’s unemployment rate was slightly below the consensus expectation for a 3.9 percent rate. Prior to April, a 3.8 percent unemployment rate was last seen in March 1998. The number of employed persons in May 2007 was 64.99 million, an increase of 510,000 or 0.8 percent from May 2006. The number of unemployed persons was 2.58 million, a decrease of 190,000 or 6.9 percent from May 2006. The labor force participation rate stood at 61.2 percent in May 2007, up 0.1 percentage point from May 2006.

Americas

Canada — product prices and monthly GDP

Manufacturers’ output prices fell 0.5 percent from April to May, following six consecutive monthly increases. Consequently, the Industrial Product Price Index slowed to 3.0 percent year over year from 3.8 percent in April. The price decline in May primarily reflected the strengthening of the Canadian dollar. The one-month drop compared with expectations for a small increase and was mainly attributable to a sharp 2.2 percent drop in prices for motor vehicles, the largest fall in 30 months. There were also declines in other transportation equipment as well as primary metal products (-1.2 percent month over month) and pulp and paper products (-2.0 percent month over month). The weakness in the headline index would have been more pronounced but for increases in the prices of petroleum and coal (2.7 percent month over month). Excluding petroleum and coal, the IPPI would have declined almost 1 percent month over month. There were declines in the finished and intermediate categories that matched the headline IPPI.  

The Raw Materials Price Index fell 0.2 percent month over month in May, the first decline in four months. The driving force behind the drop was weakness in mineral fuels (-1.2 percent month over month) and ferrous materials (-5.6 percent month over month), the latter essentially a function of weak auto demand in the U.S. These falls were partially offset by rises in non-ferrous metals (2.2 percent month over month). Over the last year, the RMPI has risen 1.9% percent, sharply lower than the 8.0 percent posted in the year through April. On this basis, the slowdown can be attributed to significantly lower mineral fuel prices (down 11.8 percent) without which the headline index would have increased nearly 18 percent year over year. Non-ferrous metals (29.7 percent year over year) are by far the main factor behind the annual rise.

Economic expansion appeared to stall in April with monthly GDP essentially unchanged compared to March. This figure was weaker than market expectations and raised questions whether the Bank of Canada would raise rates at its July 10 meeting, as has been widely expected. The pause in GDP growth reflected the already announced slump in wholesale trade (-1.9 percent month over month) together with weaker oil and gas exploration (-15.8 percent month over month) and motor vehicle manufacturing (-5.2 percent month over month). The introduction of new emission standards has significantly boosted truck prices and manufacturers are now paying the price of heavy 2006 sales as purchasers rushed to beat the new regime. Outside of these sectors, GDP would have grown by 0.3 percent month over month, matching its March pace. Both the goods and service sectors ground to a standstill but utilities (2.5 percent month over month) grew strongly. Other increases were in oil and gas extraction, construction (0.3 percent month over month), retail trade (0.5 percent) and the financial sector (0.3 percent). Despite soft data in April, it may be that the current quarter will demonstrate a similar pattern to the previous two when growth almost stalled at the start of the period before picking up strongly over the concluding two months. Certainly most indicators of economic activity have held up fairly well in recent months and the April/May PMI average is comfortably above its first quarter level.

Bottom line

Volatility continued to be the watchword in markets, although net daily changes were often not large. A number of economic indicators, including GDP reports from France, the UK and the United States, contributed to the sense that growth in the first part of 2007 had been slow, but other indicators suggested more moderate growth more recently. The U.S. sub-prime mortgage market hung over world credit markets with worries that it could lead to more generalized flight to quality trades. The U.S. dollar resumed its downward course as interest rate spreads between the dollar and lower-yield instruments seemed likely to narrow as policy tightening seemed less likely in the U.S. than in Europe and Japan.

Looking Ahead: July 2 through July 6, 2007

Ann-Marie Meulendyke is the author of U.S.Monetary Policy and Financial Markets