Global Markets

Stocks began the week in a jittery mood with most major indexes down in daily trading. Investors were gloomy as a resurgence of subprime lending worries surfaced after the ratings agencies Standard & Poor's and Moody's downgraded bonds backed by subprime home loans. The news hit credit markets badly, driving the cost of insuring junk debt in Europe to its highest level of the year. Sentiment was further hit by earnings warnings from some big U.S. retail companies.

However, the gloom was short-lived as a huge merger in the metals and mining sector unfolded. U.S. stocks turned up on Wednesday which, in turn, had a positive impact on most Asian and European equities Thursday. However, after Asian and European markets were closed, the U.S. indexes staged a major rally as equity investors set aside the heightened concerns of earlier in the week — that problems with U.S. subprime mortgages could prove more contagious than expected in other financial markets. U.S. stocks traded in record territory in spite of oil prices rising towards new record highs.

Disappointing U.S. retail sales data Friday had minimal impact on stocks, but helped push the euro to a new all-time high against the dollar above $1.38. But the U.S. currency recovered some of its poise following an unexpectedly strong reading for the mid-month University of Michigan consumer sentiment index. Elsewhere on the currency markets this week, the dollar set fresh 26-year lows against the pound sterling and also weakened against the yen. But the Japanese currency also came under pressure amid fading expectations that the Bank of Japan would raise interest rates next month.

On the week, all indexes followed here were up with the exception of the Mexican Bolsa, which after a very volatile week slipped 0.1 percent.

Global Stock Market Recap

Europe and the UK

Equities in Europe and in the UK were up on the week after merger and acquisition news grabbed the spotlight. Early losses were more than offset on Thursday and Friday as mergers between major miners and major food companies helped to dispel concerns about credit markets and reassure investors that the recent wave of global M&A activity had a ways to go. The German DAX climbed to a new high of 8,092.77. The FTSE, boosted by the strong U.S. stock market performance, zeroed in on a new seven-year high but fell about 16 points short. Financial stocks gained as the U.S. credit market showed signs of stabilizing.

Asia/Pacific

When the dust settled last week, all indexes followed here were up on the week. After a strong start on Monday, stocks were mixed and down Tuesday but sank on Wednesday after exporters drooped, the yen strengthened and the Australian dollar traded near an 18-year high. But thanks to reversals in U.S. stocks to positive, Tuesday and Wednesday’s losses were swept away with new records set on Friday. On Friday, Asian stocks were up the most in two months, spurred by Rio Tinto Group's bid for Alcan Inc. and Thursday’s higher sales reported by some U.S. retailers. Other mining company stocks benefited as well. Analysts think it is likely that there will be further consolidation in the sector. Both the Hang Seng, which climbed over 23,000 and Kospi hit new records. Singapore's Straits Times (STI) also is at a fresh historic peak after data showed that the economy grew at the fastest pace in two years.

According to the Bank of Korea, the South Korean economy will expand 4.5 percent this year. Growth will accelerate on robust exports and a recovery in consumer spending. Stocks continue to attract investors as the Kospi sets new highs thanks to strong exports and despite the strong Korean won.

Bank of Japan on hold for now

As expected, the Bank of Japan kept its policy interest rate at 0.5 percent. The vote was eight to one. With an important Upper House (parliamentary) election scheduled for July 29, no one expected the Bank to alter policy immediately before it. The interest rate has been at this level since February 2007. Economists are split, however, whether the BoJ will increase rates to 0.75 percent in August. Japan's jobless rate is at a nine-year low. Household spending rose for a fifth month in May, extending the longest streak of gains since 2004. Retail sales were up for the first time in eight months. In his news conference following the meeting, BoJ governor Toshihiko Fukui said that the Monetary Policy Board is waiting for more proof that economic growth will be sustained and inflation will take hold. Board member Atsushi Mizuno opposed the decision.

Economists are split about whether the Bank, with the election behind it, will increase rates in August or September. By waiting one more month, the Bank of Japan's policy makers will be able to check a report on second-quarter gross domestic product to be published in mid-August as well as monthly data on consumer prices and industrial output.

Canada

As expected, the Bank of Canada increased its key interest rate to 4.5 percent from 4.25 percent where it had been since May 2006. In its statement, the Bank said that a modest tightening might still be needed to curb inflation. The rate is now at its highest in six years and 75 basis points less than the Federal Reserve’s target of 5.25 percent. The Fed is now the only Group of Seven central bank that hasn't increased rates this year. The Bank of Canada's statement differs from the previous one. The previous statement said an increase may be needed "in the near term." Last week’s statement added the word "modest."

The Canadian dollar has been increasing in value and is approaching parity with the U.S. dollar — a level last seen in 1976. The Canadian dollar has gained over the past year on a strengthening economy and rising global prices for exported commodities such as oil and copper. The Bank’s inflation measure which excludes eight volatile items such as fuel has been above the central bank's 2 percent target for 10 months. (The Bank has an inflation target range of 1 to 3 percent and focusing on the mid-point of 2 percent.) The Bank also increased its economic growth forecast to 2.5 percent from an April prediction of 2.2 percent. It also said that it expected inflation to be higher and more persistent than it had earlier. The economy is being driven by surging investment in the tar sands in the Province of Alberta, which in turn is driving up wages, housing costs and prices of other goods and services. However, the surging value of the Canadian currency has made manufactured goods less competitive abroad and has caused plant closures.

Currencies

U.S. dollar’s decline against the euro must be making exporters happy, but not those who want to spend a vacation in Europe. The euro was boosted in part by upward revisions to first-quarter gross domestic product growth and healthy May industrial production. Against the dollar, the single currency struck a fresh record of over $1.38 on Friday. The U.S. dollar has continued to sink under the weight of subprime fears and corporate earnings concerns. The euro was unaffected by political wrangling between French President Nicolas Sarkozy and ECB President Jean-Claude Trichet. Sarkozy sought greater convergence of economic policy between eurozone countries and added that the ECB should put in place an exchange rate policy. Trichet responded by saying it “won't work” for European governments to tell him what to do on foreign exchange.

Pound sterling stays above $2.00

Sterling soared above $2.03 mid-week after 2 weeks above the $2.00 level — a level it had breached for the first time since 1981. Sterling has been regarded as a "strong" currency for the last 10 years. After the lows sustained following its exit from the European exchange rate mechanism in 1992, it began to climb in 1996-97 and has remained on a plateau despite repeated predictions of a decline. Those bearing the brunt of the higher pound are exporters to the U.S. and other dollar-denominated markets. Sterling's strength has taken its toll on manufacturing. It has also exacerbated other woes, notably competition from China and other low-cost producers and, until recently, a prolonged period of weak eurozone demand. The pound's strength has been the main reason for Britain's loss of market share in exports in the face of greater competition from lower-cost industrializing countries, such as China, according to a recent Bank of England study.

Indicator scoreboard

EMU — May industrial production rebounded 0.9 percent and was up 2.4 percent when compared with last year. The gains were led by a solid 2.0 percent jump in Germany. All major sectors contributed to the increase with energy up 1.8 percent on the month, just ahead of durable consumption, up 1.7 percent, and followed by capital goods, up 1.1 percent. Intermediate goods were up 1.0 percent and non-durable consumption was up 0.4 percent. Across the region, activity rates differed markedly as usual with Portugal soaring 3.8 percent and Greece up 2.7 percent while Slovenia, down 1.8 percent, and Belgium, down 0.3 percent, registering the weakest performances.

First quarter gross domestic product was revised a notch higher to 0.8 percent from the previous estimate of 0.7 percent. When compared with the first quarter of 2006, GDP was up 2.4 percent. The previously estimated decline in household consumption was revised away (now 0.0 percent on the quarter) and exports were adjusted higher (0.8 percent). Elsewhere there were small changes to gross fixed capital formation (now 2.4 percent) while government consumption was left unrevised (0.8 percent). All member states posted positive growth with Spain leading with 1.1 percent growth on the quarter and well ahead of France and Germany (both 0.5 percent) and all three overshadowing a relatively sluggish Italy (0.3 percent).

Germany — May industrial production (excluding construction) soared 2 percent and was up 5.1 percent when compared with last year. This followed a disappointingly weak April that was distorted by warning strikes in the engineering and metal working sector and calendar effects related to the May 1st holiday. However, the recovery was still short of expectations and not large enough to boost average April/May production levels above the 1Q average. In May, the only negative contribution came from energy, which was down 0.9 percent while all other sectors posted solid increases, notably in consumer durables, up 5.9 percent. Manufacturing jumped 2.3 percent, essentially wiping out the April decline and within this sector, both intermediate and capital goods registered healthy gains.

May merchandise trade surplus was €17.6 billion, up from €15.8 billion in April. Exports were down 0.7 percent while imports sank by a hefty 3.6 percent. On the year exports are up a solid 11.5 percent, little changed from the 12.1 percent pace set at the start of the year. There are few signs at this stage that euro strength is hurting the competitiveness of local exporters.

France — May industrial production (excluding construction) was up a much lower than expected 0.4 percent but was down 0.3 percent when compared with the same month a year ago. Manufacturing edged up 0.1 percent on the month while performance across the other major sub-sectors was mixed. Only energy managed to grow in both April and May. Consumer goods matched the headline increase and semi-finished goods were up a relatively strong 0.7 percent. However, capital goods were unchanged and production in the auto industry — one of the few sectors to strengthen in April — slumped 3.5 percent.

United Kingdom — June producer output prices were up 0.2 percent and 2.4 percent when compared with last year. Core output prices, which exclude food, drink, tobacco and petroleum, were up 2.1 percent on the year. Among the main subcategories, food was up 3.5 percent on the year while tobacco and alcohol climbed by 4.2 percent and metal products were up 3.8 percent. Only petroleum products, down 0.8 percent on the year, and electrical and optical products, down 1.1 percent, are currently below their respective year ago levels. Producer input prices were up 0.7 percent and 2.1 percent on the year. Crude oil prices jumped 6.6 percent on the month and were only partly offset by lower fuel and metals prices. The core index (excluding food, drink, tobacco and petrol) was up 0.4 percent and 3.2 percent on the year.

May merchandise trade deficit narrowed to £6.3 billion, its lowest level since October 2005. The shrinkage reflected a rebound in exports (3.4 percent) and essentially flat imports (down 0.2 percent) and was largely concentrated in net trade with non-EU.  The core deficit (excluding oil and other erratic items) also shrank, to £6.0 billion. The underlying volume trends on both sides of the balance sheet are negative with both real core exports and imports down. These declines are solely attributable to flows with the EU. Core export and import volumes outside of the EU continue to expand modestly and there is a risk that the full effect of sterling’s climb against the U.S. dollar has yet to materialize. 

Asia/Pacific

Japan — June corporate goods price index edged up 0.1 percent and was up a less than expected 2.3 percent when compared with the same month a year ago. Prices for gasoline were up as were those for chemicals and related products. However, electrical machinery and equipment were down on the month. Export prices were up 0.1 percent on the month, while import prices were up 0.4 percent.

Australia — June employment increased by 2,500 jobs to 10,459,800, substantially below analysts’ estimates for a 25,000 rise. Full-time employment decreased by 34,300 to 7,495,400 and part-time employment increased by 36,900 to 2,964,400. Unemployment increased by 8,100 to 472,000. The number of persons looking for full time work increased by 4,400 while those looking for part-time work increased by 3,800. The increase in the number of unemployed pushed the unemployment rate to 4.3 percent from 4.2 percent in the previous month. The participation rate edged down to 64.9 percent from 65 percent.

Americas

Canada — May merchandise trade surplus was essentially unchanged at C$5.9 billion. Both exports and imports were down by roughly the same amount. Exports drooped 1.2 percent while imports sagged 1.4 percent. The weakness in the export side again reflected declining shipments of automotive products which sank 5.8 percent. Exports of agricultural and fishing products dropped nearly 7 percent while forestry products dropped 3.8 percent as soft prices and weakness in the U.S. housing market took their toll. However, strong demand for aircraft, engines and parts helped to boost growth in transportation equipment to nearly 17 percent and energy edged up 0.6 percent. Geographically exports posted declines with the U.S. which were down 1 percent, Japan, down 4.3 percent, and the EU down 5.7 percent. Within total imports, outside of energy which was up 11.3 percent, declines were posted in most categories, notably motor vehicle parts which fell below C$3 billion for the third time since 2001. Imports of other consumer goods were down 5.7 percent while industrial goods and materials imports were off 3.4 percent.

Bottom line

The past week was dominated by subprime worries, profits as the second quarter reporting season picked up and the antidote to bad news — mega-mergers and acquisitions. The sinking dollar against the euro brought attention to the benefits U.S. exporters will have when they repatriate profits. The softer dollar will also give them price advantages in overseas markets.

Inflation will be this week’s focus, with many key price indexes scheduled to be released in the U.S., UK and eurozone. A major feature of the week’s events will be Fed Chairman Ben Bernanke’s semi-annual Congressional testimony before the House Financial Services Committee on Wednesday and the Senate Banking Committee Thursday.

Looking Ahead: July 16 through July 20, 2007