Global Markets

Stocks are crumbling amid new waves of risk aversion. Investors have been shocked by the magnitude of write-offs at major financial companies and the related dismissal of CEOs. And technology stocks joined the sell off on escalating fears that the credit crunch will force companies to curb capital spending. The disappointing company news was exacerbated by soaring crude and gold prices. Seemingly each day brought another record — for oil and gold, new highs and for the dollar, new lows.

The main events of the week, however, involved central bank decisions. Both the Bank of England and the European Central Bank left their policy rates at 5.75 percent and 4 percent respectively while the Reserve Bank of Australia increased rates to 6.75 percent despite a looming national election. The interest rate decisions provided fresh downward pressure on the U.S. dollar especially after Fed Chairman Ben Bernanke warned that U.S. growth will slow noticeably in the fourth quarter and into the first part of 2008. Markets priced in further interest rate cuts in the U.S. which accelerated the dollar fire sale while the pound sterling for example soared to a new 26 year high of $2.1117 on the Bank of England’s decision.

Global equity markets were down last week as financial stocks sold off as more and more write offs were announced and CEOs resigned as banks warned of further sharp revenue reductions due to exposure to the subprime mortgage market. Investors have been trying to get a handle on the magnitude of the losses while financial companies have been at the same time reluctant to admit to losses — in part because of measurement problems. Markets do not like uncertainty and the uncertainty over the size of these losses and lack of transparency have been issues.

As the dollar tumbles, prices for crude and gold continue to rise. Since records are made to be broken, most analysts feel that it is only a matter of time before the $100 a barrel of crude level is reached and breached. Continued worries in the political hotbed of the Middle East plus soaring Asian demand continue to pressure supplies. When stocks are low, minor reductions in supply become significant. Prices jumped recently when Mexico's state-owned oil firm announced that it would close down some offshore fields because of bad weather. North Sea oil platforms were abandoned for the same reason.

Global Stock Market Recap

Europe and the UK

The CAC, DAX and FTSE were down for the second week as subprime bank woes sent investors scrambling for safety. Equities continue to get pummeled in part by their poor showing in the U.S. and the tendency for European investors to follow the direction set in the U.S. The FTSE and DAX were down three of five days, losing 3.5 percent and 0.5 percent on the week respectively. The CAC was down four of five days and lost 3.4 percent on the week and slipped below its 2006 end level. The DAX continues to outperform the other two indexes. The FTSE has been hit hard by major bank and finance company results and ensuing rumors of big write offs. The three markets were little affected by the lack of interest rate action by the Bank of England and the ECB since none was anticipated. Concern was voiced though about the ever rising euro and its potential impact on export dependent EU members. The exception was Germany — it was said there that the stronger euro could help keep inflation at bay that would otherwise stem from soaring crude prices.

Bank of England, European Central Bank bide time

As expected, both the Bank of England and the European Central Bank maintained their key interest rates at 5.75 percent and 4 percent respectively. Both continue to assess the risk from ongoing market chaos on their economies while trying to accommodate liquidity needs. Both the UK and EMU are watching as their currencies climb against the dollar to new or multi-year records and at the same time are trying to evaluate the impact of their higher valued currencies on the economy as a whole as well as on export and exchange rate reliant industries such as manufacturing and tourism.

In the UK, the Bank of England left its key interest rate at 5.75 percent, the highest among the G7 countries. Interest rates were last increased in July. The economy is expected to slow from the third quarter’s preliminary GDP estimate of 3.3 percent when compared with the previous year as past rate increases take hold and the Bank continues to evaluate the impact of the global credit crunch. Higher borrowing costs and tame house price gains along with the tight credit are expected by analysts to dampen consumer spending. Manufacturers are also finding it harder to compete in world markets as the pound soars in value against the dollar and makes exports more expensive. At the same time, record oil prices are squeezing profits margins.

The European Central Bank also stayed in a holding pattern and left its key interest rate at 4 percent. The ECB is in a difficult position with inflation rising and growth weakening. Flash harmonized index of consumer prices jumped 2.6 percent in October. The ECB inflation target ceiling is just under 2 percent. While higher prices would normally point to a rate increase, slowing growth could eventually put pressure on the ECB to lower rates. Another issue is the strength of the euro; but German Finance Minister Peer Steinbrueck on Thursday stressed the positive effect of the elevated currency — it lessens the impact of higher oil prices.

During his post-meeting press conference, ECB President Jean-Claude Trichet said he expected a short-term inflation spike coupled with still-solid growth. But he also stressed that rising oil prices and continuing market volatility could dampen the expansion. European concerns about the impact of the falling dollar came when Mr. Trichet said recent exchange rate moves had been “undoubtedly sharp and abrupt,’ adding that brutal moves are never welcome. His comments echoed language he used when the euro was strengthening rapidly at the end of 2004 and suggests the ECB believes exchange rates are constraining its maneuvering room in setting interest rates.

Asia/Pacific

Asian/Pacific indexes were down last week — investors were nervous thanks to the continuing uncertainties arising from the U.S. subprime crises. Japanese shares declined for the sixth consecutive day on Friday. The Topix lost 6.6 percent while the Nikkei lost 5.7 percent on the week. The crisis is causing U.S. and European banks to become more stringent in extending loans — not just to those with poor credit but to businesses as a whole. Sell orders placed by overseas investors continued to outnumber buy orders, suggesting a receding near-term confidence in the Japanese market. Significant losers have been in banking, consumer finance, mining and pharmaceutical shares. Exporters’ stocks were also hurt by the rising yen which results in higher prices in export markets and cuts into repatriated profits.

The Hang Seng lost 5.5 percent on the week. A major sell-off occurred Monday when a Chinese official said that China would delay a plan for mainland Chinese individual investors to buy Hong Kong equities directly. The Hang Seng plunged 1,526.02 or 5 percent, its steepest decline since September 2001. The Hang Seng China Enterprises Index, which tracks 43 so-called H shares of Chinese companies listed in Hong Kong, lost 6.4 percent. The government said that it needs to study the risks, increase knowledge among Chinese investors and prepare regulations to protect the stock markets in Hong Kong and at home before allowing individual investors to buy Hong Kong shares. China's currency regulator said on August 20 that individuals holding accounts at Bank of China Ltd.'s branch in Tianjin city's Binhai economic zone would be allowed to invest foreign currency in Hong Kong stocks for the first time. No timing was given on the plan.

Reserve Bank of Australia increases key interest rate

As expected, the Reserve Bank of Australia increased its key interest rate for a second time in four months to combat ever increasing inflationary pressures and despite a looming national election in which the level of interest rates has been an issue. The RBA’s key interest rate is now 6.75 percent after the 25 basis point increase. The central bank had little choice. The case for an increase was very strong with data showing consumption accelerating, while looser fiscal policy would add to the upward inflationary pressures. Core consumer prices jumped by the most in 16 years in the third quarter, pushing annual inflation to 3.1 percent and breaching the 3 percent limit of the inflation target band. The economy is in its 16^th year of expansion, spurred by demand for commodities from China and India. Australia is the biggest shipper of coal, iron ore and wool. Even as inflation accelerates, the Australian economy, which expanded 4.3 percent in the second quarter from a year earlier, is being buffeted by the worst drought on record and slowing global growth sparked by the U.S. housing recession.

In its statement, the RBA said that inflationary pressures have increased with expectations that both headline and underlying measures of inflation are likely to be above the 3 percent ceiling of their inflation target range. They said that demand growth and output also increased with few signs that this strength is diminishing as yet —reports of high capacity usage and shortages of suitable labor persist. While the increase in the exchange rate will help to contain pressure on prices, growth in aggregate demand will need to moderate if inflation is to be kept within the 2 to 3 percent target range in the medium term.

The reserve policy board also evaluated international financial market developments and concluded that conditions have improved over the past couple of months, but confidence remains fragile. Funding costs for intermediaries remain elevated relative to official interest rates, and capital market conditions are still difficult in several major countries. They noted that the tightening in credit conditions resulting from the global turmoil has been less pronounced than elsewhere. The spread between the Australian interest rates and the U.S. widened to 2.25 percent while the spread with the UK is now 1 percent and with the eurozone, 2.75 percent. With Japan the spread is 6.25 percent!

Currencies

The dollar’s decline last week began in earnest when on early Wednesday Cheng Siwei, vice-chairman of a standing committee of China's National People's Congress, said that China should add strong currencies to its reserves and sell weak ones. The foreign exchange markets took him at his word and sold dollars — despite a retraction later that day saying he didn’t mean China should buy more euros. (Later, analysts said that Cheng has a history of speaking out on a range of financial market and economic developments and his comments are not always accurate.) The dollar fell to a record against the euro and the lowest since 1981 against the pound sterling. It also declined to its lowest level against the Canadian dollar since the end of a fixed exchange rate in 1950 and a 23-year low against the Australian dollar. The sell-off was triggered by fears that foreign central banks might diversify away from dollar assets. International investors sold a record amount of U.S. securities in August as soaring credit costs sparked an exodus from stocks.

The yen jumped as risk-aversion, fueled by the melt-down in U.S. equities, spurred a strong rally, allowing the Japanese currency — until recently a funding favorite for carry trades — to surge dramatically. Traders reminded investors that in carry trades, where a low-yielding currency is sold to fund purchases of higher-yielding assets, the reason for the trade can unravel if the sold currency (in this case the yen) appreciates sharply in value.

Indicator scoreboard

EMU — September retail sales were up 0.3 percent and 1.6 percent when compared with last year. Essentially all of the gain in the headline reflected the unexpected strength of retail demand in Germany (2.3 percent) which was well out of line with the other larger EMU states. Hence, in France sales managed a modest 0.3 percent gain while in Spain demand fell 0.9 percent. Purchases of food, drink & tobacco (0.4 percent) were slightly ahead of non-food products (0.3 percent).

September producer price index was up 0.4 percent and 2.7 percent when compared with last year. Energy prices, up 1.0 percent, were a key driving force behind the monthly advance. Excluding energy prices the PPI was up a much more modest 0.2 percent but up a strong 3.1 percent on the year. Intermediate goods were flat on the month (4.1 percent on the year) while capital goods and consumer durables both rose 0.1 percent (1.6 percent and 1.9 percent on the year respectively). Non-durable consumer goods advanced 0.5 percent monthly lifting year-on-year growth to 3.0 percent.

Germany — September manufacturing orders sank 2.5 percent after climbing a revised 1.9 percent in the previous month. When compared with the same month a year ago, orders were up 4.5 percent. Third quarter orders dropped 1.7 percent when compared with the previous quarter. Both domestic and foreign orders declined — 2.9 percent and 1.9 percent respectively. Declines were broad-based among the various sectors with basic goods down 0.9 percent on the month, capital goods down 3.7 percent and consumer and durable goods down 1.4 percent. 

September total industrial output was up 0.3 percent and 6 percent when compared with last year. Excluding construction, the ECB’s favored measure, output was up 0.2 percent and 6.6 percent on the year. The main contributors to the increase were energy and construction, which were up 1.0 percent and 0.7 percent respectively. Manufacturing output edged up 0.1 percent after jumping 2.1 percent in August. Consumer goods output dropped 0.3 percent while durables plunged 4.4 percent on the month after soaring by 7.5 percent in August.

September merchandise trade surplus expanded to €17.9 billion from €15.6 billion in August. Exports were up 0.7 percent while imports sank by 2.6 percent. Over the first nine months of the year exports have risen 10.5 percent — well ahead of imports at 6.3 percent. Within this export total, shipments to non-EU nations were up 7.4 percent compared with a 1.3 percent decline in imports from the same bloc.

France — September industrial production excluding construction was down 1.1 percent but up 1.1 percent when compared with last year. Weakness was apparent in most of the major categories with declines in the previously robust auto industry (3.1 percent) leading the way. There were also significant drops in output in food and agriculture (1.5 percent), consumer goods (1.2 percent), and semi-finished and capital goods (both 1.0 percent). The only gain was in energy which built upon a 0.5 percent increase in August with another increase of 0.3 percent. Total manufacturing was down a disappointing 1.3 percent while construction was flat.

September merchandise trade deficit increased to €3.1 billion, up €0.3 billion from August. Exports declined 0.3 percent while imports were up 0.7 percent. For September alone, the largest European bilateral deficit was recorded with Germany (€1.6 billion), followed by Belgium/Luxembourg (€0.6 billion). The most significant surplus was achieved with the U.K. (€0.8 billion), just ahead of Spain (€0.6 billion). Net exports with the U.S. were essentially in balance while with Asia, the shortfall remained little changed and high at €2.4 billion. 

Italy — September industrial output slumped 1.0 percent but was up 0.3 percent when compared with last year. The monthly drop was the largest since a 1.2 percent decline at the start of the year and while holidays always complicate the seasonal adjustment process for August/September, the underlying profile is clearly soft. Outside of the capital goods sector (up 0.7 percent), weakness was apparent across all of the major sectors with the key consumer goods area down 4.2 percent, intermediates down 1.2 percent and energy down 1.9 percent.

United Kingdom — September industrial production was down 0.4 percent and down 0.2 when compared with last year. Weakness in September was broad-based across the market sectors with durables off 1.5 percent on the month, non-durables and intermediates both down 0.3 percent and capital goods 0.5 percent lower. Manufacturing output sank a hefty 0.6 percent, leaving mining & quarrying (0.4 percent), electricity, gas & water (1.0 percent) and oil & gas extraction (0.9 percent) to provide a partial cushion for headline industrial production. The data collection for this month’s report coincided with a national postal strike, making for a lower response rate than usual and boosting the likelihood of revisions next time. Production of chemicals & fibres was down 0.6 percent, metals down 0.4 percent, engineering down 1.1 percent and textiles & clothing down 0.7 percent. The only sectors to register gains were coke & petrol (1.3 percent) and food & drink (0.1 percent).

September merchandise trade deficit widened to a record £7.8 billion as exports fell 1.0 percent and imports jumped 2.4 percent. Excluding oil and erratics, the red ink also grew sharply, from £6.1 billion to £7.0 billion and just below July’s all time high. Nearly all of the £0.8 billion increase in the global deficit could be attributable to trade with the non-EU bloc which saw a sharp increase in its shortfall to a record £4.7 billion as imports of cars and other consumer goods picked up sharply. Total imports from this area were up almost 4 percent. Net trade with the EU countries was essentially flat at £3.0 billion.

Asia/Pacific

Australia — October employment was up by 12,900 jobs and the unemployment rate edged up to 4.3 percent. Unemployment increased by 15,700 to 478,500. The number of persons looking for full-time work increased by 7,400 to 316,300 and the number of persons looking for part-time work increased by 8,300 to 162,200. The participation rate remained unchanged at 65 percent.

Americas

Canada — September merchandise trade surplus declined to C$2.6 billion from C$4.3 billion in August. The surplus is the lowest since December 1998. Exports dropped 2.3 percent while imports were up 2.2 percent. Canada's surplus with the United States dropped from C$6.9 billion to C$6.2 billion. The deficit elsewhere expanded to C$3.5 billion. Leading the decline in exports was machinery & equipment which slumped 7.2 percent to its lowest level since May last year on the back of a nosedive in aircraft & other transportation equipment (31.5 percent). Industrial goods and materials dropped 3.6 percent, in part due to continued weakness in prices for base metals caused by soft activity in the U.S. housing market. Agricultural and fishing products eased 3.6 percent and autos fell 2.3 percent. Exports of energy products, however, were up thanks to increases in petroleum & coal. Imports were bolstered by a 13.5 percent jump in energy and received further support from both industrial goods (2.6 percent) and autos (1.6 percent). However, there were declines in both imports of machinery equipment (1.9 percent) and agriculture & fishing products (0.5 percent).

Bottom line

The week’s economic news was dominated by central bank meetings along with Fed rhetoric. Of the three central bank meetings, only the Reserve Bank of Australia increased interest rates while the Bank of England and the European Central Bank left their interest rates unchanged at 5.75 percent and 4.0 percent respectively. In the financial markets, equities sank as did the U.S. dollar while the euro, pound sterling and Canadian dollar to mention a few hit new all time or multi-year highs against the beleaguered currency. International trade data dominated with only Germany and Canada scoring surpluses — and with Canada’s much reduced in size.

Next week brings a plethora of third quarter flash gross domestic product estimates for the third quarter. The Bank of Japan will meet and is expected to maintain the status quo. And of course investors will be watching stocks and the dollar with a wary eye.

Looking Ahead: November 12 through November 16, 2007

Central Bank activities
November 12,13	Japan	Bank of Japan Monetary Policy Meeting
The following indicators will be released this week...
Europe
November 12	UK	Input and Output Producer Price Indexes (October)
November 13	EMU	Industrial Production (September)
	Germany	ZEW Business Survey (November)
	Italy	Gross Domestic Product (Q3.07 flash)
	UK	Consumer Price Index (October)
November 14	EMU	Gross Domestic Product (Q3.07 flash)
	Germany	Gross Domestic Product (Q3.07 flash)
	France	Gross Domestic Product (Q3.07 flash)
	UK	Average Earnings (September)
		Claimant Count Unemployment (October)
November 15	EMU	Harmonized Index of Consumer Prices (October)
	UK	Retail Sales (October)
November 16	EMU	Merchandise Trade Balance (September)
	Italy	Merchandise Trade Balance (September)
Asia/Pacific
November 12	Japan	Corporate Goods Price Index (October)
November 13	Japan	Gross Domestic Product (Q3.07 first estimate)
November 15	Japan	Tertiary Index (September)
Americas
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