Global Markets

Easy come and easy go. The ‘relief rally’ on Monday was short lived — it lasted one day — after the U.S. Treasury rescued financially strapped Fannie Mae and Freddie Mac. But investors were far from convinced that the problems facing the U.S. financial system are over. The rally that followed the Treasury’s bail-out quickly lost steam, with investors experiencing renewed panic over the health of financial institutions less than a day after the rescue. Investor concerns shifted to the investment bank Lehman Brothers, commercial bank Washington Mutual and insurance company American International Group. All plunged on concerns over mounting mortgage losses and difficulties raising fresh capital.

Investors appear increasingly fearful. While the Federal Reserve and the U.S. Treasury have undertaken dramatic financial market interventions including emergency interest rate cuts, the Bear Stearns bailout and the Fannie/Freddie government takeover, a plan is needed to address the market’s problems as a whole and to tackle broader systemic challenges. Equity and credit markets suffered wild swings, while the dollar continued to attract buyers and commodities sank as an uncertain outlook for global growth triggered a wave of risk aversion.

On the week, six of 13 indexes gained in the Asia/Pacific area. The Kospi rebounded with a 5.2 percent gain while the Jakarta Composite plummeted by 10.8 percent. In Europe and the UK, the three indexes tracked here were up on the week, with the FTSE gaining 3.4 percent. In North America, the Dow, Nasdaq and S&P 500 were up. The dollar barely edged up on the week against the euro but the yen gained against a host of other currencies.

Global Stock Market Recap

Europe and the UK

Despite declining for three of five days, the FTSE, DAX and CAC managed to recoup some of the previous week’s heavy losses. After rallying Monday on the Fannie/Freddie news, the three indexes slumped as concerns for Lehman Brothers rose to fever pitch and downgrades put further pressure on other financial stocks. One of the reasons stocks were down on Wednesday was that the European Commission downgraded eurozone growth prospects (see below). Banking stocks again were under pressure as the Lehman Brothers saga unwound throughout the week. On the week, the FTSE was up 3.4 percent, the DAX was up 1.8 percent and the CAC gained 3.2 percent.

On Monday, a technical glitch brought trading on the London Stock Exchange to a halt for seven hours, wiping out most of the trading day on what should have been one of the busiest sessions of the year. The outage happened just after 9 AM London time and trading did not resume until 4 PM. Less than half of Friday’s total and well below the daily average were traded as a result. The worst outage since early 2000 was caused by a failure in the electronic connections that link the systems that receive and display orders to buy and sell shares and the market.

Below the line

The European Commission revised its growth forecasts for the eurozone last week. They cut the growth rate in half for 2007 to 1.3 percent and said that inflation would be much higher because of financial turmoil, soaring commodity prices and housing market shocks. Eurozone growth as measured by gross domestic product was 2.6 percent in 2007. For Germany, the largest Member State, the EU expects a recession with at least another quarter of contracting growth. Spain is also expected to fall into recession in the second half of the year. GDP contracted in the second quarter of 2008 in both France and Italy, but they are expected to stagnate rather than decline for the rest of the year. The Commission raised its inflation estimate for this year to 3.6 percent from 3.1 percent previously. That is almost twice the European Central Bank’s target of keeping inflation below, but close to 2 percent. The Commission does not see the eurozone economy falling into a technical recession, defined as two consecutive quarters of negative growth, as it forecast stagnation rather than contraction of quarterly growth in the third quarter after a 0.2 percent contraction in the second.

Asia/Pacific

Several Asian/Pacific stock indexes managed to pull victory from the jaws of defeat and were up last week, thanks to positive trading on Friday. However, others including the Hang Seng, Shanghai Composite, Sensex, Jakarta and KLSE Composites had fallen too far earlier and were down over 2.5 percent on the week. Friday’s positive tone was the result of reports that indicated the U.S. investment bank Lehman Brothers had put itself up for sale. Asian banking stocks rallied on optimism that Lehman would find a suitor by the weekend. This helped take the edge off the very negative sentiment that swirls around the financial sector.

After declining for three days, the Nikkei rebounded on Friday as investors were cheered by a potential buyout Lehman — but the upside was capped by lingering uncertainty over the firm’s fate. The gains came despite the downward revision of second quarter gross domestic product data. The Japanese economy contracted at an annual rate of 3 percent in the second quarter. While some analysts think that once a Lehman buyout is a done deal credit fears will ease a bit, others think that other firms will become targets. The Tokyo market has been going through swings based on the Lehman news, brokers said, referring to how Tokyo stocks would rise on news of a possible buyout of Lehman at one point only to drop later on news of failed efforts to raise capital.

Japanese financial institutions, which own more than 15 trillion yen in securities issued by Fannie Mae and Freddie Mac, breathed a sigh of relief at the U.S. government's decision to rescue the mortgage giants, but they remain cautious about their future.

The Shanghai Composite continues to tumble — it declined another 5.6 percent on the week as relatively sluggish industrial output data triggered new concerns about slowing economic growth. However, the industrial production data could be distorted because it also reflects plant closures before and during the Olympics to cleanse the atmosphere. The Hang Seng continued to tumble as well, losing 2.9 percent on the week. While the Shanghai Composite has dropped 60.5 percent so far in 2008, the Hang Seng has lost a hefty 30.4 percent. Chinese stock declines have also been led by financial stocks while developers’ and resource company shares have dropped on fears of slowing demand.

Reserve Bank of New Zealand

The Reserve Bank of New Zealand cut its policy interest rate at the second meeting in a row as expected. It was the size of the cut surprised. The official cash rate (OCR) is now 7.5 percent as spending slows amid a recession, easing pressure on inflation. The RBNZ cut borrowing costs in July for the first time in five years and said further reductions are likely as the economy slows. The Treasury Department said this week the economy was in a recession in the first half of 2008 and may also contract in the third quarter thanks to a slump in housing investment and rising unemployment. Construction was down by 5.8 percent in the second quarter while retail sales dropped 1.4 percent, the most in 13 years. Second quarter GDP is not yet available but in the first quarter, it declined 0.3 percent on the quarter.

In its post-meeting statement, the RBNZ said that the economy was experiencing a marked slowdown that was being led primarily by the household sector. It also noted that the global outlook had deteriorated further in the wake of continued financial market turmoil. In addition, the business sector was coming under pressure from both rising costs and falling demand. While the Bank expects domestic activity to pick up late this year as a result of personal tax cuts, increased government spending and rising rural incomes, they expect a prolonged period of household sector adjustment and below-average growth. The New Zealand dollar (Kiwi) sank to a two-year low after the Bank’s aggressive interest rate cut, triggering further gains for the yen and U.S. dollar.

Bank of Korea

As expected, the Bank of Korea left its seven-day repurchase interest rate at 5.25 percent, an eight year high. The Bank said that it expects inflation to remain elevated for a significant period and could exceed the Bank’s forecast of 5.3 percent in the second half of the year. Prices are being stoked by a combination of a weaker currency, the won, and higher power costs. The Bank of Korea is also caught between a rock and a hard place with inflation rising and evidence of a deepening economic slowdown. The won's slump of about 16 percent this year against the U.S. dollar has fanned inflation pressures by driving up the cost of imported goods. The currency has declined as investors sold the nation's stocks and bonds because of the dimming outlook for economic growth and signs of increased overseas debt. The economy grew 4.8 percent in the second quarter from a year ago, the slowest pace in more than a year. Household spending fell for the first time in four years as rising living costs prompted consumers to cut discretionary purchases.

Currencies

After soaring to $1.39 per euro on Wednesday, the dollar fell from a one-year high after U.S. retail sales declined and so did producer prices. The dollar faded as traders increased their bets that the Federal Reserve would cut interest rates again by the end of the year because of the weak data. Some saw the dollar’s strength while others saw the euro’s weakness as growth slows perceptively in the eurozone. The dollar has gained almost 13 percent since touching the all-time low of $1.6038 per euro on July 15 as the European economy then slumped and crude oil dropped more than 30 percent from its peak. The euro rose against the dollar after Luxembourg Finance Minister Jean-Claude Juncker was reappointed to represent eurozone finance ministers and said he doesn't expect a prolonged recession and ECB Vice President Lucas Papademos said that the economy is likely to escape a recession. Despite the machinations, the euro ended the week slightly below last week’s close.

Risk aversion was evident in the currency markets as the yen benefited from a continued unwinding of carry trades, in which investors sell low-yielders such as the Japanese unit to fund purchases of riskier, high-yielding assets. Japan’s economic fundamentals have not changed. A recession is expected and there is little prospect that the Bank of Japan will increase its policy interest rate, which currently stands at 0.5 percent. The yen had played the low-yielding part in carry trades. Carry trade investors sold the yen heavily to fund the purchase of higher-yielding assets elsewhere. Now those positions are being reversed as investments are liquidated across a range of asset classes and regions across the globe.

Selected currencies — weekly results

Indicator scoreboard

EMU

July industrial production declined 0.3 percent and was down 1.5 percent when compared with last year. The latest monthly drop — the third in a row — was spread across all the main sectors with the exception of energy which posted a modest 0.2 percent gain. The steepest decline occurred in durable consumer goods which slumped 0.9 percent, just ahead of a 0.8 percent slide in capital goods. Non-durable consumer goods were down 0.3 percent from June while intermediates dropped 0.3 percent. However, there were significant differences in the performances of the EMU states. Output declined in Germany (1.8 percent), Ireland (0.8 percent), Italy (1.1 percent), the Netherlands (2.2 percent) and Slovenia (5.4 percent) contrasted with gains in France (1.2 percent), Spain (2.0 percent), Greece (0.4 percent), Portugal (2.1 percent) and Finland (0.2 percent). Other members failed to provide any data.

Germany

July merchandise trade surplus narrowed sharply to just €11.8 billion, well below June’s €18.2 billion outcome and easily the smallest surplus seen so far in 2008. The slide was mainly attributable to imports which posted a surprisingly robust 7.4 percent monthly jump to easily eclipse their June dip. However, the import effect on the bottom line was compounded by exports which saw a 1.7 percent drop on the month. Over the year to July, imports were up an impressive 15.7 percent, with purchases from the EMU bloc expanding by 15.4 percent and from non-EU countries by 19.6 percent. Exports climbed a much more modest 7.0 percent on the year, again led by non-EU countries (10.0 percent) which comfortably outpaced shipments to other EMU states (4.1 percent).

France

July industrial output excluding construction jumped 1.2 percent but is still down 2.0 percent when compared with last year. The monthly gain was led by manufacturing where output rose an even stronger 1.5 percent. Within this sector there were solid increases in all of the main sub-categories — consumer goods were up 1.3 percent, autos surged 5.1 percent, capital goods increased by 0.5 percent and semi-finished goods gained 1.1 percent. Energy output slipped 0.2 percent with fossil fuels especially weak (5.1 percent).

July merchandise trade deficit narrowed to €4.8 billion from €5.4 billion in June. However, over the first seven months of the year, the cumulative gap stands at some €28.6 billion, up more than 46 percent from the same period a year ago. The July improvement reflected a 0.3 percent increase in exports combined with a 1.0 percent drop in imports. In unadjusted terms, the bilateral deficit with Germany was essentially unchanged at €1.6 billion and little different with the EMU bloc as a whole at €2.3 billion.

Italy

Second quarter gross domestic product was down 0.3 percent and declined 0.1 percent when compared with the same quarter in the previous year. This was the worst annual performance since the third quarter of 2003. The first look at the expenditure components of real GDP confirms the anticipated weakness of consumption which dropped 0.3 percent from the previous quarter. The decline here was almost matched by capital investment which slipped 0.2 percent on the back of a 0.9 percent contraction in construction, and exceeded by exports which fell 0.7 percent.

July industrial production sank 1.1 percent and was down 3.9 percent when compared with last year. The monthly declines were broad-based and led by consumer goods, down 2.7 percent where activity has contracted in four of the last six months. Intermediates dropped 1.2 percent and capital goods fell 0.6 percent, the third consecutive monthly decline. Energy output was off 1.0 percent. Total manufacturing slumped 1.5 percent on the month with fabric & clothing (down 4.6 percent) easily the weakest performing sub-sector ahead of coal & petroleum (down 3.6 percent) and transport (down 2.9 percent). The only category to register an increase in production was machines & machinery appliances (0.1 percent).

United Kingdom

July producer output prices dropped 0.6 percent and eased to an increase of 9.7 percent when compared with last year from 10.3 percent in June. The drop was due to a sharp reversal in petrol prices which slumped 4.8 percent on the month. The only other monthly declines occurred in electrical & optical goods (0.1 percent) and other products (2.1 percent). Meantime, the largest monthly gains were posted by food (0.9 percent), chemicals (0.9 percent) and metals (0.7 percent). Core output prices which exclude food, drink, tobacco & petroleum products declined by 0.1 percent on the month, enough to reduce its annual rate from 6.8 percent to 6.4 percent. Producer input prices plummeted 3.6 percent on the month and reduced annual growth to 26.0 percent from 29.3 percent. The drop was largely attributable to crude oil — it nosedived 11.0 percent on the month and reduced the overall index by some 3.0 percentage points alone. There were also drops in the costs of fuel (2.0 percent), imported food (0.6 percent), imported metals (1.8 percent) and other imported materials (0.7 percent). Other home-produced materials (0.4 percent) registered the most significant gain but the few increases seen were very mild in comparison with previous months.

July industrial production was down 0.5 percent and dropped 1.9 percent when compared with last year. The latest monthly decline reflected declines in all areas except electricity, gas & water (up 0.9 percent). The steepest drop occurred in oil & gas extraction (4.4 percent), but there was also a hefty contraction in mining and quarrying (3.8 percent). Manufacturing output declined 0.2 percent and was down 1.4 percent on the year. Over the May through July period, output of durable goods fell 2.5 percent, non-durables dropped 1.4 percent, capital goods was down 1.0 percent and intermediates declined 0.8 percent. With the exception of textiles & clothing (up 0.7 percent), there were monthly output declines in all of the major production categories.

July merchandise trade deficit narrowed to Stg7.7 billion from a deficit of Stg8.0 billion in June. Exports were up 3.1 percent while imports were up 1.2 percent. Excluding oil and erratics, the underlying position showed a more substantial improvement with the red ink shrinking from Stg7.2 billion to Stg6.5 billion, the best performance since January 2007. The oil gap deteriorated by Stg0.6 billion — from Stg0.8 billion to a record Stg1.3 billion deficit — and was the main constraint limiting the improvement in headline. However, a 7.1 percent nosedive in oil exports was probably in large part a function of rig maintenance in the North Sea in which case coming months should see a rebound. Net exports to non-EU countries showed a deficit of Stg4.7 billion, essentially unchanged from June, while the shortfall with the EU narrowed slightly to Stg2.9 billion from Stg3.2 billion in the previous month.

Asia/Pacific

Japan

August corporate goods price index edged down 0.1 percent but soared 7.2 percent when compared with a year ago after jumping by 7.3 percent in July. This is very high in the Japanese context, and higher than any other month with the exception of July. Companies have virtually no pricing power due to weak consumer demand so it is unlikely that these prices will feed into consumer prices. Prices for manufacturing products were up 0.3 percent and 7.2 percent on the year. Although processed foods edged down 0.1 percent they were up 5.9 percent on the year. The biggest monthly decline was for nonferrous metals which dropped 2.5 percent and are down 2.3 percent on the year. The largest monthly increase was for chemicals & related products. They were up 0.9 percent on the month and 8.1 percent on the year.

Second quarter gross domestic product was revised to a decline of 0.7 percent from the original estimate of a 0.6 percent drop when compared with the previous quarter. When compared with the same quarter a year ago, GDP was up 0.8 percent. GDP declined at an annualized rate of 3.0 percent. On the quarter, domestic demand was down 0.7 percent with private demand (down 0.6 percent) accounting for most of the decline. This is a turn around from the first quarter when domestic demand was up 0.3 percent. Household consumption was down 0.5 percent after rising 0.7 percent in the previous quarter. Private non-residential investment declined for the second quarter in 2008. It was down 0.5 percent after edging down 0.2 percent in the first quarter. Gross fixed capital formation was down 1.7 percent after increasing by 0.6 percent in the previous quarter. Private residential investment sank 3.5 percent on the quarter after gaining 4.3 percent in the first quarter. Exports fell by 2.3 percent while imports dropped by 2.8 percent.

Australia

July retail trade trends were up 0.1 percent and 3.1 percent when compared with the same month a year ago. The trend estimate was also revised upward to 0.1 from flat for the prior three months. Food retailing was up 0.2 percent on the month while department stores edged up by 0.1 percent. Household good retailing was up 0.6 percent and other retailing increased by 0.3 percent. However both restaurants & takeaway food services and clothing & soft good retailing were down 0.7 percent and 0.3 percent respectively. From July, the ABS has changed the retail trade report. It will now be retail trade trends, putting the focus on the trend indicator rather than the seasonally-adjusted monthly data as previously. Changes to the survey mean that the seasonally-adjusted data are no longer valid except on a quarterly basis. Sales have been slowing sharply on an annual basis. This reflects the impact of tight monetary policy, higher gasoline prices and slowing employment growth that are all hitting consumer confidence and household expenditure.

August employment was up by a more than expected 14,600 to 10,744,300. The gains in full time and part time employment were almost equal. Full time employment increased by 7,500 to 7,729,700 and part time employment increased by 7,200 to 3,014,600. The unemployment rate also surprised. It dropped by 0.2 percentage points to 4.1 percent from 4.3 percent in June. The male unemployment rate decreased by 0.1 percentage point to 3.8 percent, and the female unemployment rate decreased by 0.3 percentage points to 4.4 percent. The number of unemployed declined by 22,900 to 457,300. The number of persons looking for full-time work was down by 4,000 to 321,900 and the number of persons looking for part-time work dropped by 18,900 to 135,500. The participation rate edged down to 65.2 percent from 65.3 percent in the previous month.

China

August consumer prices edged down 0.1 percent and eased to an increase 4.9 percent when compared with a year ago. This is the lowest reading since June 2007. July’s CPI was up 6.1 percent on the year. Food prices were up 10.3 percent on the year while non-food prices were up 2.1 percent on the year.

August producer price index was up 0.6 percent and 10 percent when compared with a year ago. Details suggest that although crude oil price inflation has moderated following the recent correction in global prices, PPI for various oil products, including gasoline, diesel, kerosene and fuels, continued to inch up reflecting the lagged impact of the latest energy price hikes.

August industrial production slowed to 12.8 percent from 14.7 percent in July when compared with last year. While this reflects in part the disruption of industrial activities due to the closure of factories during Olympics game, inventory declines in certain sectors may have also exerted a drag on industrial production. Seasonally adjusted, August industrial production contracted by 0.6 percent after declining by 1.7 percent in July.

Americas

Canada

July merchandise trade surplus narrowed from C$5.6 billion in June to C$4.9 billion. The slide reflected a 4.6 percent monthly jump in nominal imports that more than offset an otherwise respectable 2.2 percent gain in exports. The real trade surplus also narrowed as imports volumes rose a solid 3.6 percent, more than twice the pace of exports (1.7 percent). The bilateral surplus with the U.S. weighed in at C$8.9 billion, down from C$9.7 billion last time. Export gains were led by industrial goods & materials, which were up 5.0 percent, and machinery & equipment which surged 6.6 percent, mainly due to drilling, excavating & mining machinery and aircraft. However, energy exports dropped 1.5 percent as weaker volumes exceeded higher prices. There was also a decline in agriculture & fishing products (2.1 percent). Imports were up across the board. Automotive products (up 9.5 percent) reached their highest level since July 2007 and were compounded by a strong showing by industrial goods and materials (up 6.1 percent). Machinery & equipment imports rose 2.9 percent, energy goods by 2.4 percent and other consumer goods by 3.0 percent.

Bottom line

Activity in the financial markets swirled around the government takeover of Fannie Mae and Freddie Mac and other beleaguered financial institutions. The U.S. dollar rallied to $1.39 to the euro during the week but faded after retail sales disappointed, showing no carry through from the rebate checks issued in the spring. And producer prices eased to remove some inflationary pressures from the Federal Reserve.

Both the FOMC and the Bank of Japan Monetary Policy Board meet this week. No policy change is expected from either bank. In the UK, consumer price data will be released along with the all important labour market report. Given the dire predictions for the UK economy, both reports will be followed closely by market participants.

Looking Ahead: September 15 through September 19, 2008

Anne D Picker is the author of International Economic Indicators and Central Banks.