Global Markets

While Federal Open Market Committee meetings are always front and center for investors, the pitch was several decibels higher before Tuesday’s meeting. At stake was whether the Federal Reserve would lower the fed funds target interest rate by 25 basis points or 50. Analysts were split — but nevertheless were shocked when the decision for a 50 basis point reduction was announced. Disagreement with the decision immediately surfaced. Many analysts felt that it was too big a decrease while others looked at it as a one (move) and done deal. Still investors think that more rate cuts will be needed. Undoubtedly the rhetoric will heat up as new economic data become available and other central banks — European Central Bank, Banks of Japan, Canada and England — all have their say before the next FOMC announcement on Halloween.

While equities worldwide initially celebrated the Fed’s move for the most part, the dollar sank against all major currencies and reached a new low against the euro. And the Canadian dollar, which had been rising against its U.S. counterpart, finally reached parity. The pound sterling was up against the dollar after Bank of England governor Mervyn King defended the Bank’s liquidity crunch response in front of a select committee of parliament and despite stronger than expected retail sales that indicated the British consumer was alive and well.

Spot gold came within a whisker of $740 a troy ounce on Friday — the highest level in nearly 28 years — after the U.S. dollar sank to a new record low against the euro and oil prices surged to a new high above $83. On the week, all equity indexes followed here were up, thanks to strong mid-week gains immediately after the Fed’s rate cut.

All indexes followed here were up on the week, ranging from 0.2 percent (STI) to 4 percent (DAX). Only Japanese stocks are down since the 2006 close. The Nikkei is down 5.3 percent while the Topix is down 7.7 percent.

Global Stock Market Recap

Europe and the UK

The FTSE, CAC and DAX were up three of five days last week, with the biggest gains registered on Wednesday. Markets in Europe and the UK were already closed when the FOMC announcement was made. Stocks were down on Monday and Thursday. Thursday’s decline was attributed to renewed concerns about the liquidity crunch and its impact on banking industry profits — and perhaps some profit taking. On the week, the FTSE was up 2.7 percent, while the CAC gained 2.9 percent and the DAX jumped 4 percent. After falling below 2006 year-end levels, the FTSE and CAC are up 3.8 percent and 2.9 percent respectively for 2007. The DAX is up 18.1 percent.

The Bank of England monetary policy committee voted unanimously to keep its policy interest rate at 5.75 percent at its September 6 meeting. They said it was too soon to assess the impact of the credit crunch. They said that recent economic news had not materially changed their outlook. This implied that the committee was in a wait and see mode. The MPC thought that inflation would remain around the Bank’s 2 percent inflation target. The minutes predated the recent drama over Northern Rock’s liquidity problems. They noted that a fall in financial sector activity would have a direct impact on economic growth and that uncertainty over the economic outlook could lead businesses to postpone investment.

Asia/Pacific

All Asia/Pacific indexes followed here were up last week thanks to the Fed’s interest rate cut and big one-day gains on Wednesday. But the results were more equivocal from day to day as the glow from the cut wore off and as investors continued to take a cautious attitude towards risk. Record high crude prices plus the declining value of the U.S. dollar eroded investor enthusiasm. Stocks in Japan, although up on the week, continue to be dragged down by financial and auto stocks, while the Australian market wilted under profit taking at the week’s end. Expectations of strong corporate earnings kept the rally going in South Korea. Meanwhile, the Hong Kong market set another record closing high despite weakness in the property sector. Exporters such as auto makers all over Asia are vulnerable to the shifting currency values as the U.S. dollar declines.

Hong Kong markets reacted very favorably to the Fed move and ended the week setting yet another new high. The Hong Kong dollar is pegged to the U.S. counterpart and benefits immediately from any reduction in U.S. interest rates. The Hang Seng was up just under 1,000 points or 4 percent in post-FOMC trading on Wednesday. The index is heavily weighted towards interest rate-sensitive stocks with financials, utilities and property comprising over 60 percent of the index. Saudi Arabia’s currency is also pegged to the dollar. In contrast to Hong Kong, the Saudi Arabian central bank chose not to pass through the interest rate cut on inflation fears.

Earlier in the week (pre-FOMC announcement) Asian stocks dropped on Tuesday as fresh fears over turmoil in the credit markets weighed on banking shares, though energy companies benefited from a record price for U.S. crude. Asian markets were down as British savers continued to line up to withdraw money from the Northern Rock mortgage lender despite the government's reassurance that depositors would not lose money. Rumors that regional banks might need emergency funds in Australia were swiftly denied by the Reserve Bank of Australia.

Bank of Japan stands pat

No surprises here. As expected, the Bank of Japan, which had hoped to raise interest rates gradually, left their key monetary policy interest rate at 0.5 percent. The decision was adopted by an eight to one majority vote. The BoJ last increased rates in February, when they raised their target interest rate to 0.5 percent. The Bank might have a difficult time boosting rates in the coming months because of the still-lingering U.S. subprime loan turmoil and worries of slower growth in its major export market. Growing uncertainties over the domestic Japanese economy and political instability at home also contribute to doubts. On Tuesday, the Federal Reserve lowered the Fed funds target interest rate by 50 basis points to 4.75 percent rather than by 25 basis points as had been expected by many Fed watchers. When the BoJ kept rates unchanged in August, Governor Toshihiko Fukui cited the need to closely watch international financial markets and the global economy.

Credit crunch concerns in the U.S. and Europe stemming from the subprime mortgage crisis have not been extinguished. And it is still difficult to read how much of an impact the U.S. economic slowdown will have on Japan's real economy. There are concerns that a slowdown in the U.S. housing market will cause consumption to decline and that could lead to a drop in Japanese exports. Japan's second quarter gross domestic product saw negative growth and the consumer price index has declined on the year for six straight months. Market expectations of a rate hike in Japan have cooled rapidly.

The BoJ kept its assessment of economic conditions basically unchanged from its previous monthly report of recent economic and financial developments. The Bank said that the economy is and will continue to expand moderately. In regards to inflation, the BoJ expects the pace of increase in the annual rate of corporate goods price index to slow and the annual rate of consumer prices to be around zero in the short term.

Governor Fukui acknowledged that Japan's interest rates remain very low relative to its economic growth, but said the bank has no choice but to put off any rate hike while it monitors growing downside risks to the U.S. economy and continuing volatility in global financial markets. BOJ officials have expressed the desire to "normalize" rates by lifting them further, and such tightening steps looked likely until the subprime loan crisis emerged this summer. But now, most market players expect the central bank to stand pat next month as well, and possibly for the rest of the year.

Currencies

The U.S. dollar continued to sink against major currencies last week as the already downward trend was accelerated by the decline in interest rates. One reason was growing concern that the interest rate cut would rev up inflation. The Canadian dollar rose to parity against the U.S. currency for the first time since 1976 while the U.S. currency sank to a record low against the euro. Gold, in reaction to the dollar’s decline, soared to its highest level since February 1980. However while inflation expectations have picked up, most measures remain well below levels reached during last spring's inflation scare.

On Thursday, the euro soared above the psychologically important $1.40 level for the first time. Investors are concerned that the climbing euro will put a dent in exports, which have been an important part of improved growth. The current level is the highest against the dollar since its launch in 1999. The question for analysts (and politicians) is whether the soaring currency would encourage the European Central Bank to defer further interest rate increases on concern that the high value of the euro could damage growth. The euro hit a record $1.4120 on Friday but the dollar rebounded slightly on weak eurozone data.

1 C$ = 1 US$

The Canadian dollar reached parity with the U.S. dollar for the first time in more than 30 years. Canada has benefited from rising demand for copper, gold, wheat and oil from the U.S. and from emerging economies such as India and China. The country is the world's largest producer of uranium, the second-biggest exporter of natural gas, and sits on the largest pool of oil reserves outside the Middle East. Canada is also the second-largest exporter of wheat, which rose to a record this month. Rising tax revenue and energy royalties have allowed the Canadian government to post 10 straight annual budget surpluses, the only country among the Group of Seven nations with a balanced account.

Indicator scoreboard

EMU — July seasonally adjusted merchandise trade deficit was €0.6 billion. It was the first monthly deficit since August 2006. Earlier surpluses were also revised downward so that the black ink for the second quarter as a whole now stands at €10.9 billion. Following a 1.8 percent increase in June, exports dropped 0.5 percent while imports jumped 3.6 percent after a 1.0 percent gain in June. On an unadjusted basis, the merchandise trade surplus was €4.6 billion, down from €7.6 billion in June. Exports were up 0.7 percent while imports climbed 3.2 percent.

Germany — September ZEW current conditions index declined to 74.4 from 80.2 in August and the lowest level since the end of last year. The expectations component turned sharply more negative (minus 18.1 from minus 6.9) suggesting that confidence in future economic performance is less optimistic than it was just a couple of months ago (plus 10.4 in July). The nature of the ZEW survey makes it particularly susceptible to shifts in financial market sentiment. Nonetheless, both the current and expectations components have been trending south for several months now, and the risk is that the trouble in the financial markets could accelerate what already appears to be a loss of momentum in the German economy.

August producer price index was up 0.1 percent and 1.0 percent when compared with the same month a year ago. The 12-month change was the lowest since April 2004. Excluding energy the PPI was up 0.3 percent and 2.6 percent on the year. Among the major sectors, both basic and capital goods were unchanged from the previous month while consumer goods were up 0.6 percent (non-durables 0.7 percent) and energy declined 0.5 percent. However, the divergence between the core and headline rates is likely to narrow over coming months with oil prices hitting new record highs overnight.

Italy — Second quarter unemployment rate edged down to 6 percent thanks to a decline in job-seekers in the south of the country. The 6.0 percent jobless rate reflected a 2.2 percent drop in the number of unemployed and constituted the lowest level since the data series began in 1992. Employment rose by 82,000 on the quarter to 23.114 million. The largest gains in employment on the year were in the Center followed by the Northwest with just the South posting a decline. Manufacturing jobs were up 1.5 percent, in construction 4.3 percent and in services 0.1 percent. But the trend decline in agricultural jobs continued with a drop of 6.6 percent.

United Kingdom — August consumer price index was up 0.4 percent and 1.8 percent when compared with the same month a year ago. Core CPI was also up 0.4 percent and 1.8 percent on the year. The main downward impact came from miscellaneous goods and services (1.1 percent from 2.0 percent), largely in response to a cut in mortgage exit fees. The other main negative effect came from clothing & footwear as heavy discounting boosted the pace of price declines (3.5 percent from 2.6 percent). Prices in the overall goods producing sector are essentially flat on the year (0.1 percent from 0.5 percent) while services have seen a pick-up (3.8 percent from 3.5 percent).

August retail sales were up 0.6 percent and 4.9 percent when compared with last year. A significant proportion of the increase was attributable to a 1.3 percent jump in food purchases. Excluding food, sales would have risen a much more modest 0.2 percent. Even so, non-food sales were up at a rapid 6.3 percent annual rate. Clothing and footwear were one of the biggest winners with a 1.6 percent monthly gain but non-specialized stores declined 0.6 percent and household goods dropped 2.5 percent.

Asia/Pacific

Japan — July tertiary activity index declined 0.5 percent but was up 1.0 percent when compared with the same month a year ago. Six of the major industry groups declined while five increased. Those declining included wholesale & retail trade, medical, health care & welfare, eating & drinking places and accommodations, electricity, gas heat supply & water, compound services and transport. Activity picked up for finance & insurance, real estate, services, learning support and information & communications. The service sector employs more than half of Japan's workforce, and spending on services such as retailing, dining and travel is closely tied to changes in income and consumer confidence.

July all industry activity index was down 0.4 percent but up 0.8 percent when compared with last year. The all industry index takes a reading of activity in the 11 industries that comprise the tertiary index (released earlier this week), along with activity in the construction, agricultural & fisheries industries, the public sector and industrial output. This index is considered a close approximation of gross domestic product growth as measured by industrial and service sector output.

Americas

Canada — August consumer price index dropped 0.3 percent and was up 1.7 percent when compared with the same month a year ago and comfortably below the Bank of Canada’s inflation target midpoint of 2 percent. The key driving force behind the deceleration was a 2.3 percent slide in energy costs combined with a 0.4 percent drop in food prices. Core CPI was up 0.1 percent on the month and was up 2.2 percent on the year. The Bank of Canada’s core CPI which excludes eight volatile items was up 2.2 percent on the year. Transportation was down 1.9 percent on the month.

July retail sales were down for the second month. Total retail sales were down 0.8 percent but up 4.5 percent when compared with the same month a year ago. Excluding the auto sector, sales were down 0.3 percent but up 5.3 percent on the year. Sales in the auto sector were down 1.3 percent. Food & beverage sales dropped 1.2 percent while building & outdoor home supplies were down 1.1 percent. Elsewhere there were more modest declines in general merchandise stores, miscellaneous retailers and clothing sectors. The declines were partially offset by increases in furniture, home furnishings & electronics stores and pharmacies & personal care stores.

Bottom line

Last week’s news focused on the impact of the Federal Reserve’s surprise 50 basis point cut in the federal funds target interest rate to 4.75 percent from 5.25 percent. The immediate impact was a soaring stock market and a sinking dollar. The Bank of Japan also met and deferred increasing its policy rate thanks to the unsettled conditions in the financial markets and U.S. economy.

This week brings an avalanche of data — especially at the end of the week. Much of the data concerns the time period after the subprime crisis mentality surfaced and will give investors along with central bankers critical input for decision making.

Looking Ahead: September 24 through September 28, 2007

The following indicators will be released this week...
Europe
September 25	Germany	Ifo Business Survey (September)
	France	Manufactured Goods Consumption (July, August)
September 26	UK	Gross Domestic Product (Q2.2007 final)
September 27	EMU	M3 Money Supply (August)
	Germany	Unemployment (September)
	France	Unemployment (August)
September 28	EMU	Harmonized Index of Consumer Prices (September, flash)
	EU	Consumer and Business Confidence (September)
	France	Producer Price Index (July. August)
		Gross Domestic Product (Q2.2007 final)
	Italy	Producer Price Index (August)
Asia/Pacific
September 26	Japan	Merchandise Trade Balance (August)
September 28	Japan	Household Spending (August)
		Unemployment, Employment (August)
		Industrial Production (August)
		Retail Sales (August)
		Consumer Price Index (September, August)
Americas
September 28	Canada	Monthly Gross Domestic Product (July)
		Industrial Product Price Index (August)
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