Global Markets

Two main themes dominated securities markets this past week: 1) the unfolding of the European Union’s rescue package for Greece, Spain and Portugal and its fallout particularly for the European Central Bank and the euro; 2) the election in the UK and the swoon of the pound sterling. However, the May 6^th flash crash and how it happened remains a mystery and a concern.

On Monday, market euphoria over the EU pact was palpable — equities soared and the euro, which had been under attack, managed to climb to about $1.30, but not for long. The euro began to slide again as investors fretted over the U-turn by the ECB. At the post governing council meeting press conference on Thursday, May 6^th, Bank President Jean Claude Trichet said that there was no discussion on the purchase of bonds. Yet just a few days later on Sunday the ECB said it would purchase bonds even though they categorically denied that this would result in the printing of money or any form of quantitative easing.

The results of the May 6^th UK national election left no party with a clear majority to rule. But after five days the conservatives and liberal democrats managed to form a government. However, the pound sterling dropped anyhow. While the new government has pledged to take measures to cut the country’s fiscal deficit which had been a concern, market players fretted that paring government expenditures could cut growth. Investors were already concerned that the stiff austerity measures in Europe — the UK’s major export market — would reduce demand for British products and curtail growth. (For more information about the rescue plan, see this week’s Short Take entitled “EU/IMF/ECB 'gallop' to the rescue”.)

Equities rode a roller coaster with a euphoric beginning to the week and a swoon at the end as the implications of the various financial plans were assessed. Investors were distracted and paid little attention to economic data including UK industrial output data and unemployment data which were better than anticipated. Both Spain and Portugal presented their austerity packages. It should be noted that Spain inched out of recession in the first quarter while Portugal grew at the fastest rate of any member state within the EMU. On the week, all Asian/Pacific equity indexes followed here were up as were those in Europe and North America.

Gold!

On Friday, London spot gold surged to a fresh nominal all-time high of $1,248.95 a troy ounce. But adjusted for inflation, gold prices are a long way from their real all time high of more than $2,300 per ounce achieved in 1980. Gold in euro terms breached the €1,000 an ounce level for the first time and traded as high as €1,002.69 an ounce. Gold bugs have been snapping up coins — particularly in Germany and Switzerland — amid fears over the potential inflationary impact of the ECB’s decision to buy eurozone government bonds.

Gold’s latest rally still lags in magnitude behind the 2,200 percent run of the inflationary 1970s. Dollar denominated gold prices tend to move inversely to the U.S. currency's strength. But so far this year, they have risen along with the dollar's appreciation against the euro and pound sterling. Investors seem to have dispensed with the idea that gold and the dollar should trade in opposite directions as the two have done over the past several years in an environment of dollar depreciation. Now both are moving higher in tandem thanks to their appeal as safe haven assets.

Global Stock Market Recap

Europe and the UK

After Monday’s euphoric reaction to the rescue package, investors sobered up and most markets retreated. That is not surprising. For the package to truly serve its purpose, sustained eurozone growth must return. Yet the fiscal adjustment required to meet its conditions may shut off the very growth it is designed to inspire. And while Eurostat data suggest that Ireland, Spain and Portugal should grow modestly in 2011, one questions the forecasts as possibly too optimistic given the scale of fiscal adjustment required to reduce their budget deficits, not to mention their ratios of debt to output, which admittedly are far more favorable than Greece’s. On the week the FTSE, DAX and CAC were up 2.7 percent, 6.0 percent and 4.9 percent respectively.

ECB beleaguered

Investors warned that the ECB would have to introduce quantitative easing to stave off the worst crisis in the eurozone’s brief history. The Bank resisted following the Bank of England and the Federal Reserve in expanding money supply by buying government bonds because it feared that it could stoke inflation. Although eurozone central banks bought eurozone government bonds this week for the first time as part of the international rescue plan, this is not QE as the ECB is funding this by selling German bunds or using commercial bank deposits.

Axel Weber, Bundesbank president, has voiced concern over the decision to buy government bonds and other ECB governing council members fear the blurring of fiscal and monetary policies could undermine the ECB’s independence and credibility, fuelling inflation risks. But analysts said the ECB should put its worries about future inflation on the backburner as the austerity measures that many eurozone economies will have to introduce to cut their deficits will hold back growth.

ECB governing council members promised a fuller picture of their bond purchase operations although they will not disclose the volume they intend to buy. President Jean Claude Trichet said Friday that the ECB will “withdraw the liquidity that we will inject mainly through tendering term deposits.” Trichet did not specify potential supplementary draining methods but assured that sterilizing the government bond purchases “does not present technical difficulties.”

Bank of England holds fast

As expected, the Bank of England kept its key interest rate at 0.5 percent and at the same time, left its total amount of quantitative easing unchanged at Stg200 billion. The meeting was delayed until Monday in order to avoid any danger of politicizing its decision during the general election which was held on May 6^th. There was no accompanying statement which is normal operating procedure when policy remains unchanged.

On Sunday evening the Bank of England participated with the Federal Reserve, Bank of Canada, European Central Bank and the Swiss National Bank in reestablishing temporary U.S. dollar liquidity swaps to help improve liquidity conditions in U.S. dollar funding markets and to prevent the spread of strains to other markets and financial centers stemming from the Greek debt crisis.

The Inflation Report released Wednesday showed a slightly softer profile to the CPI over the medium term. Inflation is still seen well below the 2 percent target in two years time on both unchanged official interest rates (1.8 percent) and market discounted rates (1.4 percent). The inference is that the BoE is not in a hurry to tighten any time soon. However, the Bank acknowledged considerable uncertainty surrounding its latest projections and there was a range of views among the MPC members on where the CPI was headed. There appeared to be a growing concern about the downside risks to growth stemming from the UK's own budgetary problems and the more general global fiscal woes. Efforts to address these issues are expected to have a potentially significant impact upon the speed at which the domestic economy recovers.

In an accord to form the first coalition government in 65 years, the conservative and liberal democrat parties agreed to give the Bank of England overall responsibility for both regulation and monitoring risk to the entire financial system, known as macro-prudential supervision. The FSA will undertake day-to-day supervision of individual lenders, and report directly to the BoE.

Asia/Pacific

All equity indexes followed here were up last week. All soared on Monday exhilarated by the EU and IMF rescue package. But they quickly fell to earth Tuesday as vestiges of doubt began to permeate market players. And on Friday, most major indexes dropped again as worries about slower growth sent investors to safe havens. Traders said investors appear to be worried about the potential drag on eurozone growth as governments there take measures to bring swelling fiscal deficits under control. Only four days after the mega European bailout package was announced, the market finds itself pondering the medium-term impact of Europe's massive debt burden.

Additional pressures in markets here are concerns that China might further tighten measures to cool its growing economy after new data revealed that April inflation surged by 2.9 percent. Fresh concerns about the implementation of the $1 trillion package to revive the European markets from debt crisis also affected market sentiment. Before the Greek crisis intensified last week, policy makers in China and elsewhere in Asia said too much growth and an abundance of capital inflows were pushing real estate and other asset prices dangerously high. While Asian markets welcomed the bailout plan, analysts warned that the rescue package could end up bringing even more capital to Asian markets.

Gains for the week ranged from 6 percent for the PSEi — the results of the national election may have influenced the gain here — to 0.3 percent for the Shanghai Composite. The SET, despite the ongoing political woes in Thailand, managed to inch up less than 0.1 percent.

Bank of Japan holds an extraordinary meeting

The Bank of Japan's monetary policy board held an extraordinary policy meeting Monday morning local time and voted to re-open its temporary U.S. dollar swap agreement with the Federal Reserve and resume injecting dollar liquidity into financial markets. The meeting was held amid international efforts to contain the impact of the Greek debt crisis. The BoJ also voted unanimously to maintain the target for the overnight lending rate among commercial banks at 0.1 percent.

The BoJ joined the Banks of Canada and England, the European Central Bank, Federal Reserve, and the Swiss National Bank in reestablishing the temporary U.S. dollar liquidity swap facilities. The BoJ said it acted “in view of recent liquidity pressure in the international financial markets and the possible impact of those on liquidity in the yen monetary market.” The facility will last until January 31, 2011.

Bank Negara Malaysia increases rates for second time

Bank Negara Malaysia increased its overnight policy interest rate to 2.5 percent from 2.25 percent. The March rate increase had been the first in almost four years. Malaysia was among the first Asian countries to withdraw monetary stimulus this year. Gross domestic product increased 10.1 percent in the three months ended March 31 from a year earlier and the most in a decade. The ringgit is Asia’s best performer this year and has climbed 7.4 percent against the dollar after depreciating significantly in 2008 and part of 2009.

The Bank of Korea left rates unchanged for a 15^th month this week. Bank Indonesia has refrained from raising borrowing costs even as its economy expanded at the fastest pace in more than a year last quarter. India and Vietnam have raised interest rates to contain inflation, while China has ordered banks to set aside more reserves three times this year.

Currencies

The euro had only a brief respite and then continued to swoon after the rescue plan was announced. At this writing, the euro is now down over 13 percent this year as sovereign woes continue to depress the currency. The new austerity measures in Greece, Spain and Portugal failed to assuage market fears, and instead the measures have only heightened concerns about social unrest and a weakening growth outlook.

The euro took the brunt of the pain doled out by investors after the ECB executed one of the sharpest policy U-turns in its 12-year history. But in the process it raised concerns about its politicization in the wake of Europe’s financial crises. Purchases of eurozone government bonds on an undisclosed scale or the ‘nuclear option’ began just hours after the ECB’s announcement of a package of measures to shore-up the EMU’s stability. (It was not a unanimous decision by the governing council.) At the same time, the ECB reintroduced unlimited offers of three and six month funds and teamed up with the Federal Reserve and other central banks to provide extra dollar liquidity. The action effectively ended the ECB’s exit strategy. It had been gradually undoing the exceptional measures it had taken since the collapse of Lehman Brothers in September 2008.

Another beleaguered currency is the pound sterling. Sterling jumped after Gordon Brown resigned as prime minister Tuesday but relief was short lived even though investors got what they wanted — David Cameron at the helm of a Conservative led government. But the Bank of England’s dovish inflation report suggested that interest rates would remain lower for longer. Sterling resumed its decline while gilts rose. And if the new government follows through on Mr Cameron’s promise to reduce the deficit faster than Mr Brown had planned, that could hurt sterling by slowing economic growth. The new chancellor of the exchequer, George Osborne, has promised a new budget within 50 days that will lay out plans to reduce the deficit. The new government faces the worst peacetime deficit in history and an untested new form of government (the coalition between the conservative and liberal democratic parties). This will be a tricky balancing act. There has to be enough fiscal tightening to retain confidence in sterling but not so much that it plunges the country back into recession.

Selected currencies — weekly results

Indicator scoreboard

EMU

First quarter flash gross domestic product edged up 0.2 percent after remaining flat in the fourth quarter of 2009. On the year, GDP was up 0.5 percent when compared with the same quarter a year ago. In keeping with its usual practice, Eurostat did not provide any details behind the first quarter economic performance but the monthly data point to growth primarily in the goods producing sector. It is likely that most of the increase in output stemmed from stronger overseas demand and possibly some rebuilding of business inventories. Indicators for household spending have remained frustratingly sluggish while fixed investment continues to struggle. Regionally, France grew just 0.1 percent on the quarter, Germany 0.2 percent, Italy a surprisingly firm 0.5 percent and Spain 0.1 percent. Among the larger states, only Spain’s current total output is still below its year ago level (1.3 percent). GDP in Greece sank 0.8 percent on the quarter.

March industrial production (excluding construction) climbed 1.3 percent on the month and was up 6.9 percent on the year. Capital goods output was up 1.5 percent from February. There was an unusually large advance in nondurable consumer goods (1.2 percent) and decent increases in both durable consumer goods (0.6 percent) and intermediates. The only decline was in the energy sector where production dropped 0.6 percent. By state, industrial output surged 2.6 percent on the month in Germany and 2.1 percent in Spain. France (1.0 percent) also enjoyed a strong period but Italy saw output slip 0.1 percent after a no gain in February. Portuguese production jumped 7.2 percent, in sharp contrast to Ireland where output dropped 2.6 percent.

Germany

March seasonally adjusted merchandise trade surplus widened out to €13.3B in March from an unrevised €12.1B in February. Nominal exports were up 10.7 percent on the month while imports climbed an even steeper 11.0 percent. Exports have now expanded for six of the last seven months and imports have grown in every month since November 2009. Annual growth of exports now stands at 23.3 percent while imports were up 18.3 percent on the year. Exporters have clearly benefited from the slide in the value of the euro as sales to non-EU countries were 34.7 percent higher on a year ago compared with a relatively modest 15.1 percent gain in purchases by the other EMU states.

First quarter flash gross domestic product was up 0.2 percent and 1.6 percent on the year. Total output has now risen every quarter since a 3.5 percent slump in the first quarter of 2009. However, the start of this year marked the first period of positive annual growth since the third quarter of 2008. As usual with the flash GDP report, the Federal Statistics Office provided few details. However, it did signal advances in exports and fixed investment as well as an increase in business inventories and higher government spending. On the downside, construction and household consumption once again appear to have been a drag on growth.

France

March industrial production excluding construction expanded by 1.0 percent and was 6.2 percent higher on the year. A 0.8 percent monthly gain in manufacturing output was boosted by a 13.7 percent jump in the coke & refined petroleum products area and there were respectable increases in both electrical & electronic equipment (0.8 percent) and in other manufacturing (1.2 percent). However, food & beverages declined 0.4 percent and transport equipment dropped 2.2 percent with autos down 1.6 percent. Production in the mining & quarrying, energy & waste management sector spiked 2.7 percent after a 2.8 percent slide in February while construction grew 0.1 percent.

First quarter gross domestic product inched up 0.1 percent and was up 1.2 percent on the year. The main culprit was gross fixed investment, which slumped 0.8 percent on the quarter on the back of declines in businesses (0.9 percent), households (0.7 percent) and public administration (1.2 percent). Another negative to hit the bottom line was destocking which subtracted 0.1 percentage points. Final domestic demand slipped 0.1 percent thanks to a flat performance from household consumption. Public sector spending current edged up 0.1 percent. But for a 3.9 percent jump in export volumes, the economy would not have grown at all last quarter.

Italy

March industrial production inched down 0.1 percent but was up 6.4 percent on the year. March would have been worse but for a 0.7 percent monthly bounce in energy output. Intermediates expanded just a modest 0.3 percent but even this looked good compared with a minimal 0.1 percent advance in capital goods and a 1.5 percent drop in consumer goods output. Despite the disappointingly weak results in February and March, first quarter industrial production still shows a respectable 1.4 percent increase from the previous period thanks to a strong January (1.9 percent).

First quarter gross domestic product was up 0.5 percent and up 0.6 percent when compared with the same quarter a year ago. ISTAT provided no details on the expenditure components of real GDP but the first quarter advance was probably largely accounted for by exports and business inventories.

United Kingdom

March industrial production jumped by 2 percent on both the month and the year while the manufacturing sector posted a 2.3 percent monthly gain to boost its annual growth to 3.3 percent. The monthly jump in the manufacturing sector was the steepest since July 2002. Twelve of the 13 industries that comprise the sector saw output expand including basic metals and metal products (up 3.9 percent on the month), printing & publishing (up 2.7 percent) and machinery & equipment (up 4.2 percent). In the more volatile sectors, oil & gas extraction increased by 2.4 percent and was almost matched by a 2.2 percent increase in mining & quarrying. By contrast, utilities posted a 0.9 percent decline.

April claimant count unemployment dropped by 27,100 and was sufficient to bring down the jobless rate to 4.7 percent — its lowest level since May 2009 and its third consecutive monthly drop. However, somewhat surprisingly, the ILO unemployment measure showed a 53,000 increase in joblessness in the quarter ending in March. This left its jobless rate unchanged at 8.0 percent. The bullish picture painted by the clamant count figures found support in the average earnings report which showed a sharp jump in its headline rate to 4.0 percent, a 1.5 percentage point increase on its February pace. The surge here reflected a 6.1 percent headline rate in manufacturing, up from 4.3 percent last time and largely a function of a sharp increase in bonus payments from an especially weak 2009 base. Service sector pay accelerated to 3.5 percent, up from 2.0 percent in mid-quarter. Significantly, total earnings growth excluding bonuses was just 1.9 percent or only 0.2 percentage points faster than last time and still historically weak.

March merchandise trade gap widened back out to a larger than expected Stg7.5 billion from Stg6.3 billion in February. The deterioration was due to a 5.2 percent monthly jump in nominal imports, the largest increase since September 2009. The advance here was easily more than enough to offset a 1.0 percent rise in exports. The real trade balance also worsened as import volumes rose 2.8 percent while exports declined 0.5 percent. The increase in red ink on the overall goods balance was essentially matched by the underlying measure which excludes oil and erratics. Here the shortfall widened to Stg7.4 billion from Stg6.2 billion in February. Regionally net trade deteriorated with both the EU bloc and non-EU countries.

Asia/Pacific

Australia

April employment increased by 33,700 to 11.025 million. The increase in employment was driven by a rise in full-time employment which was up 37,500 to 7.736 million. This was offset by a fall in part-time employment, down 3,900 people to 3.290 million. This was the eighth consecutive month that the number of people employed full-time has increased. March's employment gain was revised to 27,700 from the previously estimated 19,600. The unemployment rate was 5.4 percent for the second month. The number of people unemployed increased by 6,500 people to 628,100. The participation rate was 65.2 percent, unchanged from March.

Americas

Canada

March merchandise trade surplus narrowed sharply to C$0.25 billion. Nominal exports swooned 0.7 percent while imports increased by 2.0 percent. The fall in exports ended a run of six consecutive monthly gains but was purely a reflection of weaker prices as volumes rose a solid 2.3 percent. Imports on the other hand reached there highest level since December 2008 and would have been stronger still but for a fall in prices. Thus, volumes were up 3.5 percent from February while prices declined 1.5 percent. Within the overall fall in nominal exports, purchases by the U.S. dropped 2.5 percent on the month. Taken together with a 0.6 percent fall in imports, the bilateral surplus with the U.S. duly retreated to C$3.8 billion from C$4.3 billion last time. By product, exports were dragged lower by monthly declines in energy (6.6 percent), machinery & equipment (1.9 percent), autos (0.9 percent) and other consumer goods (1.8 percent). However, there were gains in industrial goods & materials (4.7 percent) and forestry products (3.0 percent). Imports were boosted by a 10.4 percent jump in purchases of industrial goods & materials and a 10.1 percent jump in energy products. The main decline was in autos (5.8 percent).

March manufacturing sales were up 1.2 percent and are now 10.2 percent higher than a year ago. Significantly, the improvement in nominal shipments was exceeded by volumes which climbed 1.7 percent from their mid-quarter level and their seventh consecutive monthly gain. Within the total monthly rise in cash sales, there were particularly strong performances in food manufacturing (3.5 percent), textile products (6.1 percent), wood (4.9 percent) and non-metallic minerals (7.7 percent). Other gains of note were recorded in machinery (3.7 percent), fabricated metals (2.0 percent) and primary metals (1.9 percent). Transportation saw a more modest 0.7 percent increase but within this motor vehicles jumped an impressive 3.6 percent. Excluding motor vehicles and parts, sales were up 0.9 percent on the month and 10.5 percent on the year. Underperformance was most marked in petroleum & coal where shipments were down 1.5 percent on the month alongside computer & electronics (down 5.3 percent), leather (down 11.1 percent) and aerospace (down 9.6 percent). New orders however, dropped 0.7 percent from February while backlogs dropped 0.4 percent. However, inventories declined 1.1 percent, mainly due to sharp declines in aerospace and petroleum products.

Bottom line

There was a spate of good economic news that was largely ignored last week including a jump in UK industrial and manufacturing output and a decline in claimant unemployment. But flash GDP data verified what we already knew — growth is anemic in the eurozone. Investors focused on the ‘what ifs’ of the rescue plan and the new government’s budget plans for the UK. The big question is how much will the proposed cuts in spending cut into already weak growth.

The Bank of Japan meets again — but this time it is an already scheduled two day meeting on Thursday and Friday (local time). No policy move is anticipated. Economic data however does include the preliminary estimate of first quarter GDP growth. And in Europe, the spotlight will be on the two important German surveys — the ZEW and Ifo.

Looking Ahead: May 17 through May 21, 2010

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