Global Markets

Economic data were left in the dust last week as financial market players focused on the demise of a venerable old firm and the saving of another along with a series of moves that opened the floodgates to an infusion of money to bail out everyone. In enough moves to leave this writer breathless, the U.S. moved from letting Lehman fail, to bailing out American International Group, to initiating a whole host of banking changes. The credit markets became paralyzed because no one would loan while equities gyrated wildly worldwide. Each day presented a new problem and in the end, the Treasury and Federal Reserve caved in to market demands. At this writing, little has been done to address the real cause of the current crisis.

Central banks are called lenders of last resort for good reason — and they have truly become the last resort as a generalized panic has festered, one not seen since the 1930s. Nobody trusts any credit other than the governments’. The world’s central banks understand this very well and on Thursday, they announced an emergency $180 billion injection of dollar liquidity in an attempt to halt the panic. The Federal Reserve is making available the extra funding to overnight and longer-term money markets. The European Central Bank, Banks of Japan, Canada and England and Swiss National Bank also pledged to take appropriate steps in addressing the issue. In essence, the world is witnessing an extreme shift in liquidity preference. People want to hold cash or securities only in the most secure and most accessible form — government liabilities. And government, the beneficiary of this shift in liquidity preference, must respond by engaging in a recycling operation and convince markets that sound businesses will not be allowed to disappear for lack of funding.

Treasury and Fed officials discussed the idea of creating a government-sponsored vehicle to deal with toxic assets, but they had been reluctant to put a plan forward unless they were confident it would pass Congress. However, the terrifying events of the past week appear to have changed the political landscape profoundly, enough to make a new Resolution Trust Company possible.

The graph on the left shows the long term performance of five major equity indexes — FTSE, Nikkei, Dow, Nasdaq and S&P/TSX Composite — indexed to the end of 1999. Of the five, only the S&P/TSX is up about 60 percent while the Dow is unchanged and the other three lag their beginning of the millennium level.

On the week, two indexes gained in the Asia/Pacific region and four were up in North America.

Global Stock Market Recap

Europe and the UK

A one day rally was not sufficient to offset a string of four daily losses and the FTSE, CAC and DAX all ended down for the week despite Friday’s gains of 8.8 percent, 5.6 percent and 9.3 percent respectively. UK stocks were invigorated after the Financial Services Authority said it would ban short selling of financial shares for 29 companies until January 16, 2009. (Short selling is where traders borrow shares from their broker that they then sell. If the price drops, they buy back the stock, return it to their broker and keep the difference.) The FTSE surged the most since October 21, 1987 when the index rallied 7.9 percent according to FTSE Group. This followed the previous day of stock market collapses in what became known as Black Monday.

Shares — and especially bank shares — jumped after U.S. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke proposed removing troubled or toxic assets from banks' balance sheets and the Securities and Exchange Commission (SEC) joined the UK in banning short sales of financial firms. U.S. Treasuries and European government bonds fell on speculation that the proposed plan would increase the demand for stocks over bonds. The Treasury also announced a $50 billion program to insure the holdings of money-market mutual funds for a year.

Friday’s announcement was preceded on Thursday by a coordinated effort by major central banks to stem the worsening global credit crisis. The Federal Reserve, European Central Bank, the Banks of England and Japan and the Swiss National Bank injected as much as $180 billion into global money markets. The emergency measure followed a week of chaos that saw Lehman Brothers collapse, Merrill Lynch get taken over and American International Group Inc. get bailed out.

Swiss National Bank

As expected, the Swiss National Bank left the target range for its three-month Libor rate unchanged at between 2.25 percent and 3.25 percent on Thursday. According to the SNB, it intends on keeping its rates at current levels for the time being. The SNB also noted its “generous and flexible provision of liquidity” to the Swiss money market. In its monetary assessment, the SNB said that the economy was developing as expected, with growth rate having slowed in the first half of 2008. The SNB also noted that inflation could reach 2.7 percent this year, assuming that the Libor remains at 2.75 percent, before slipping to 1.9 percent in 2009.

Asia/Pacific

Asian/Pacific stocks surged Friday as central banks pumped cash into money markets and worked on plans to shore up banks and insurers. But as was the case later in Europe, the gains were not enough to change the overall direction for the week. Only Indonesian stocks were up significantly — gaining 4.9 percent on the week — while India’s Sensex managed to eke out a 0.3 percent increase. Losses ranged from 0.1 percent for the Hang Seng to 6.9 percent for the Philippine PSEi.

The Nikkei added 3.8 percent Friday while the Hang Seng Index jumped 9.6 percent. All markets in the region advanced while U.S. Treasuries and Japanese bonds declined on speculation that the plan will increase demand for stocks over bonds. The Bank of Japan participated with the other major central bank effort and offered up to $60 billion to local and overseas financial institutions to ease the credit squeeze. According to the Ministry of Finance, for the week ending September 13, foreign residents were net sellers of Japanese stocks for the second straight week, having sold a net ¥401.2 billion worth of stocks. However, foreigners were net purchasers of Japanese bonds and notes for the week, having bought bonds worth a net ¥878.5 billion.

China’s Shanghai Composite, led by bank shares, surged by a record 9.3 percent Friday after the government scrapped a stock-trading tax and the sovereign wealth fund announced plans to buy shares in state-owned banks. The index had declined for the previous three days (Monday was a holiday). The Shanghai composite spent most of the week below the 2,000 level — Tuesday’s drop below this level was the first since November 29, 2006. The People’s Bank of China’s decision to lower the one-year lending rate by 27 basis points, to 7.2 percent, had little impact. It was the first rate lowering after years of gradual increases aimed at fighting inflation and reining in what some saw as an overheating economy.

RBA minutes

The Reserve Bank of Australia said in their September meeting minutes that monetary policy will have to remain on the restrictive side of normal for some time. They said the choice to cut by 25 basis points to 7.00 percent, the first easing in seven years, was to avoid weakening in demand, and that inflation numbers may not fall back into the bank's target range of 2 percent to 3 percent for some time. They also said external stimulus to the economy will likely not be strong and that domestic consumption is weak. Turning to the labor market, they said conditions are easing and that capacity has fallen but is still high. They said business investment plans could possibly be scaled back over the course of the year.

Bank of Japan

As expected, the Bank of Japan kept its key interest rate at 0.5 percent. Second quarter gross domestic product dropped at an annual rate of 3 percent putting the economy in jeopardy of recession. While the corporate goods price index soared and the consumer price index continues to rise, most if not all the price increases stem from food and energy. The CPI excluding those items hovers around zero. The BoJ held its meeting amidst financial market upheaval in the aftermath of the Lehman Brothers failure. The BoJ announcement follows the FOMC announcement on Tuesday in which no change was made to the 2 percent fed funds target rate. On Tuesday, the Bank of Japan injected ¥2.5 trillion yen ($24 billion) into the banking system following the collapse of Lehman Brothers. The BoJ injected ¥2 trillion more into the market on Wednesday. Japanese stocks sank to a three year low while the yen surged. The monetary policy board headed by governor Masaaki Shirakawa will want more evidence that weakening global growth will derail the world's second-largest economy before deciding about the impact of the global slowdown on the economy before changing its interest rate.

Peoples Bank of China

The Peoples Bank of China surprised analysts and cut interest rates for the first time in six years and reduced reserve requirements as worsening credit-market turmoil and weakening export demand dimmed the outlook for economic growth. The PBoC reduced the one-year lending rate to 7.20 percent from 7.47 percent and lowered the reserve ratio at the nation's smaller banks by 1 percentage point to 16.5 percent effective from September 25. However, the reserve requirement cut does not apply to five large banks and China Postal Saving Bank. The PBoC emphasized that the purpose of the cuts is to maintain “steady and fast” economic growth. Notably, the Bank did not mention any tightening bias for the first time since late last year. Many analysts think that this is the first in a series of monetary easings against the tumultuous backdrop of slower world growth and financial turmoil.

Currencies

The yen was up against the U.S. dollar but down against the euro on speculation investors will resume carry trades after the U.S. Treasury and the Federal Reserve proposed cleaning up financial firms' balance sheets. On Friday, Japan's currency dropped the most against the Australian dollar since August 1993. Treasury Secretary Paulson said that the U.S. government will spend “hundreds of billions of dollars” to cleanse banks of troubled assets and halt an exodus of investors from money markets. Congressional leaders said they intend to pass legislation within days. But the dollar declined Friday as investors sold the dollar and bought back high-yielding currencies.

On Thursday, the dollar declined as coordinated action from global central banks to ease liquidity tension in the world’s money markets dented its newly found status as a safe-haven currency. Analysts said the dollar had previously benefited as worries over the global financial system heightened risk aversion, prompting U.S. investors to repatriate funds that had been invested in foreign equities while lower inflation expectations had supported demand for U.S. bonds. The dollar’s losses were largest against the high-yielding Australian and New Zealand dollars, which had been the worst hit among leading currencies during the recent market turmoil.

Selected currencies — weekly results

Indicator scoreboard

EMU

August harmonized index of consumer prices edged down 0.1 percent and were up 3.8 percent when compared with last year. The annual rate still remains close to double the ECB inflation target of close to but not exceeding 2 percent. Excluding food, drink, tobacco and gasoline, the HICP was up 1.9 percent on the year. Excluding only seasonal food and energy, it was up 2.7 percent on the year. Simply omitting energy, the index was up 2.7 percent. Food prices were up 6.2 percent, both housing and transport were up 6.3 percent and education climbed 3 percent on the year. Among the larger nations, inflation fell in Germany (3.3 percent from 3.5 percent), France (3.5 percent from 4.0 percent) and Spain (4.9 percent from 5.3 percent). However, prices accelerated in Italy (4.2 percent from 4.0 percent).

Germany

September ZEW reading improved to minus 41.1 from minus 55.5. The current conditions index climbed to minus 1.0 from minus 9.2 but this still constituted its second weakest reading since April 2006 and did little to dent a combined 46.8 point fall in July/August. Significantly, the survey was conducted before the collapse of Lehman Brothers which seriously impacted financial markets so there is every chance the next survey could be more pessimistic. This report suggests that there are no strong fears of rising inflation over the next six months.

United Kingdom

August consumer prices were up 0.6 percent and 4.7 percent when compared with last year — a new series high. The Bank of England’s inflation target is 2 percent. The formerly targeted retail price index excluding mortgage interest payments (RPIX) was up only 0.3 percent on the month to reduce its annual rate from 5.3 percent to 5.2 percent. Core CPI was up 0.6 percent but was up only 2.0 percent on the year. Dominating the acceleration in both the latest monthly and annual CPI increases were sharply higher prices in the housing, utilities and fuels sector. A 2.1 percent leap here saw the sector’s annual inflation rate surge from 7.6 percent to 10.1 percent. Electricity prices were up 4.3 percent on the month and gas prices 11.5 percent. Changes introduced earlier in the year on the way in which hikes in tariffs made by utilities companies are captured in the data mean that all of the latest increase was essentially put into one month rather than being spread over four. This makes the August data look especially poor. Among the other major sectors annual inflation rates climbed significantly in food & beverages (13.0 percent from 12.3 percent), furniture & household equipment (3.2 percent from 2.8 percent) and miscellaneous goods & services (3.4 percent from 2.8 percent). Against this, lower fuel costs saw the annual rate slow appreciably in transport (7.3 percent from 8.0 percent) while other sectors saw their rates essentially unchanged. Annual inflation in the goods sector increased to 5.1 percent from 4.7 percent and in the services sector to 4.3 percent from 4.1 percent.

July headline average earnings growth edged just up a notch to 3.5 percent. Excluding bonuses, the headline rate was unchanged at 3.7 percent. Annual growth in the year to July alone rose to 3.7 percent from 3.4 percent. The July data reflect a small pick-up in wage rates in the public sector where headline earnings moved a tick higher to 3.3 percent from 3.2 percent last time. In the private sector, the rate held steady at 3.5 percent. Pay rates in the service sector were steady at 3.7 percent and actually dipped a notch in manufacturing to 2.8 percent.

August claimant count unemployment was up 32,500 for the largest gain since December 1992. The claimant jobless rate edged up to 2.8 percent, its highest level since early 2007. Vacancies sank a hefty 56,900 over the latest quarter. For the three month to July, the International Labour Organisation (ILO) jobless jumped by 81,000, its steepest gain since the second quarter of 2006. The jobless rate increased to 5.5 percent from 5.3 percent in the pervious quarter. Employment fell for the first time since the first quarter of 2007, declining 16,000 from the previous three months. The employment rate also dropped to 74.7 percent.

August retail sales were up 1.2 percent and 3.4 percent when compared with last year. The latest monthly rise in volumes was led by a surge clothing & footwear (4.1 percent) which helped to boost overall non-food purchases to a 2.1 percent advance over July. However, within this sector all of the other major categories registered gains too with purchases of household goods (1.7 percent), non-specialized goods (1.4 percent) and non-store retailing (2.4 percent) especially robust. Food sales were down 0.2 percent on the month.

Asia/Pacific

Japan

July tertiary index was up 1.2 percent and 0.7 percent when compared with last year (original index). The following industries increased: wholesale & retail trade (up 2.0 percent), services (up 2.1 percent), electricity, gas, heat supply & water (up 6.0 percent), medical, health care & welfare (up 1.0 percent), and transport (up 0.6 percent). The following industries declined: information & communications (down 1.1 percent), finance & insurance (down 0.8 percent), real estate (down 0.5 percent), learning sport (down 2.8 percent), eating & drinking places & accommodations (down 0.2 percent), and compound services (down 0.3 percent).

Americas

Canada

July factory shipments jumped by 2.7 percent for the fourth monthly gain in succession and, with 17 of the 21 reporting industries registering advances, boosted annual growth to almost 6 percent. The performance of nominal shipments has been deceptive in recent months as high commodity prices have provided a major boost to the bottom line. However, in July volume shipments also posted a solid and surprisingly robust 2.0 percent increase over June. This lifted real orders to their highest level since November 2007. The nominal monthly advance was led by durable goods with a 4.0 percent jump accounting for around three-quarters of the headline increase. Primary metals were especially firm, up fully 10.1 percent for their largest gain since September 2003. Transportation (2.3 percent) also fared well with both motor vehicles (3.1 percent) and parts (2.0 percent) staging a recovery. There was also a firm showing by machinery manufacturers (4.0 percent) thanks in large part to higher sales of agricultural, construction & mining equipment. New orders were unchanged on the month and up 1.3 percent on the year while unfilled orders were down 0.4 percent but up 14.1 percent on the year.

Bottom line

There is no likely historical precedent to the events of the last week. The events included the collapse of Lehman Brothers, Merrill Lynch’s fire sale to Bank of America, the weakness of AIG and its bailout and the threats to other institutions. Today’s crisis is right at the heart of the financial system and threatens a complex pattern of credit guarantees and insurance backstops that were touted as making the financial system failsafe.

Investors will play close attention to the developing plan to secure the U.S. financial system systemically. While the prospective plan elated investors on Friday, there is no guarantee the enthusiasm will continue over the weekend as U.S. taxpayers assess the prospective costs in increased taxes going forward.

On Monday, the Japanese political party, LDP, will hold an election for a new president. According to a survey conducted at the end of last week by The Nikkei, the party’s Secretary General, Taro Aso, appears certain to succeed Yasuo Fukuda as party president. Because the LDP holds a majority in the lower house which has the final say over the selection of the prime minister, the winner in Monday's election will be named the next prime minister.

Oh yes. There will be a spate of new economic information especially in Japan where the latest inflation numbers will be released along with the merchandise trade balance.

Looking Ahead: September 22 through September 26, 2008

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