Global Markets

The relief rally that wasn’t — Most market pundits expected a relief rally after Congress agreed to a budget ceiling package. But that didn’t happen. Equities dropped and the declines fed upon themselves with losses accelerating to send many equity indexes into correction territory. The reasons for the decline are many. The long drawn out wrangling in Washington over the debt ceiling eroded investor confidence. The possibility of a debt downgrade for the U.S. after a compromise was finally reached kept traders in a dour mood. A string of weaker than anticipated economic reports globally renewed fears of a possible recession. The shifting of sovereign debt concerns to Italy and Spain brought the spectre of dreaded contagion to larger eurozone member states.

Volatility in the currency markets reflected investors’ flight to safety. The U.S. dollar was up against its major counterparts with the exception of the Swiss franc. The soaring values of the yen and Swiss franc triggered intervention by the Bank of Japan and the Swiss National Bank. The twin actions drove up the value of the dollar while at the same time put sharp pressure on crude oil prices and industrial commodities as well as the companies that rely on those prices to meet their earnings expectations. However, the impact of the SNB’s actions proved short-lived as investors continued to seek safe havens.

On the week, every index followed here declined. Only four indexes are up in 2011 — Jakarta Composite and SET (up 5.9 percent), PSEi (up 5.6 percent) and the KLCI (up 0.4 percent). Losses so far this year range from 4.8 percent (Shanghai Composite) to 15.6 percent (Sensex). The All Ordinaries, Bolsa, Taiex and Topix are down 14.0 percent, 12.6 percent, 12.5 percent and 10.9 percent respectively.

Global Stock Market Recap

Europe and the UK

The sell off in Europe and the UK continued amid growing fears that the eurozone’s debt woes could intensify. Investors were worried that the global economy was slowing dramatically thanks to Europe’s ongoing debt saga and U.S. economic weakness. European stocks dropped to their lowest in more than two years Friday, ending their worst week since May 2010. The FTSE was down for its sixth consecutive day while the DAX was down for its eighth and the CAC was down for its 10th. On the week, the FTSE, DAX and CAC sank 9.8 percent, 12.9 percent and 10.7 percent respectively.

Focus was on the European Central Bank amid the worries about Italy and Spain. ECB President Jean-Claude Trichet acknowledged the risks to growth in the region, saying economic risks "may have intensified" and that recent data showed the growth pace in Europe has decelerated. Mr. Trichet also said the bank would hold more liquidity operations to give euro area banks more cash, a technique the central bank had used at the height of the 2008 global financial crisis to ensure that banks could guarantee to keep themselves liquid if they lost access to wholesale funding markets.

But while the ECB resumed purchases of government bonds for the first time in five months, investors were unnerved that it was only buying Portuguese and Irish government bonds, a decision that Mr. Trichet acknowledged wasn't unanimous. Both countries, as well as Greece, have received international bailouts after their ability to borrow through the bond market essentially closed. Yields on Spanish and Italian bonds have been climbing in recent weeks, fueling worries that they could run into funding problems, and market participants had been hoping that the ECB would step in and buy their bonds in the open market.

In late U.S. trading, Italy announced that it will speed up its fiscal consolidation timetable and introduce a balanced budget amendment in its constitution as part of an agreement with European Union authorities according to Italian Prime Minister Silvio Berlusconi. Mr. Berlusconi made the announcement during a news conference called in an effort to quell market concerns that Italy's economy will be dragged into the continent's escalating sovereign debt crisis.

European Central Bank

As widely expected, the European Central Bank left its key interest rates unchanged having raised them by 25 basis points last month. The key interest rate on the main refinancing operations was held at 1.5 percent around which the deposit rate stays at 0.75 percent and the marginal lending rate at 2.25 percent. The meeting was attended by a number of senior central bank officials whose holiday plans have been usurped by the ongoing eurozone fiscal crisis. The vote came amidst mounting evidence of an economic slowdown, not just in the periphery but, crucially, in the key French and German economies as well. The Bank may not be happy with the current level of inflation — at 2.5 percent in July — but any policy move that undermines growth would simply fuel mounting speculation about possible default in some member states.

To this end, ECB President Jean Claude Trichet again omitted the key words ‘‘strong vigilance'' when discussing the policy stance going forward and, as such, seemingly ruled out any increase in official interest rates in September. Trichet indicated that, in addition to the central bank's regular refinancing operations, which will continue to be on a full allotment fixed rate basis, an additional six-month tender would be introduced with a view to addressing the ongoing tensions in financial markets. This move may well help to dampen speculation about any possible hike in key rates next quarter.

The general economic picture was not regarded as being significantly different from last time and while underlying M3 growth remains only moderate, the stock of liquidity is still seen as high enough to be a potential threat to price stability. The bottom line is that monetary policy is still officially viewed as accommodative and the ECB would almost certainly like to raise rates again soon. However, recent economic developments have reduced pressures for a rate hike and the evolving fiscal crisis has significantly reduced their room for maneuver.

Swiss National Bank

In an effort to curtail the relentless rise of the Swiss franc, the Swiss National Bank announced that it would reduce the target range for 3-month CHF LIBOR by 50 basis points from zero to 0.75 percent to zero percent to 0.25 percent. Moreover, having previously sought to keep money rates around the 0.25 percent mark, it will now aim to hold rates as close to zero as possible. At the same time, the SNB indicated that it would increase significantly the supply of liquidity in domestic financial markets over the next few days. The authorities will seek to expand banks' sight deposits held at the SNB by around CHF30 billion to some CHF80 billion. The SNB said the currency was ‘massively overvalued.’ The franc, considered a haven in times of turmoil, has surged 10 percent against the euro over the past two months as Europe’s debt crisis worsened, hurting Swiss exports and economic growth. The Organization for Economic Cooperation and Development’s measure of purchasing power parity suggests the franc is 49.5 percent overvalued against the dollar and 42 percent overvalued against the euro.

The emergency measures reflect official concerns that the downward pressure on Swiss consumer prices caused by the excessive strength of the local currency might translate into a period of deflation. However, with the currency still a favorite safe-haven vehicle for investors during times of economic and financial uncertainty, it is far from clear that today's actions will have the desired effect.

Bank of England

As expected, the Bank of England left its key bank rate at 0.5 percent where it has been since March 2009. It also left its quantitative easing ceiling at £200 billion. No statement was released with the announcement. Rather, bank watchers will have to wait for the minutes which will be released on August 17^th for any signs of a slight softening in the position of the hawks. Insight into the monetary policy committee’s thinking however, will be available on August 11^th when the next quarterly Inflation Report will be released. Recent growth data have been very weak with second quarter GDP edging up 0.2 percent on the quarter. However, inflation remains over double the BoE’s inflation target of 2 percent.

Asia Pacific

The region was not immune to shedding risk. All indexes followed here dropped last week with losses ranging from 1.5 percent (PSEi) to 9.2 percent (Taiex). Investors reacted to the massive sell offs in the U.S. and Europe as fears escalated over slowing global economic growth. Fear took a heavy toll on investor confidence, prompting a flight to safety. Worries about growth in Europe and the U.S. — the region’s primary export markets — sent traders to the sidelines. Weak economic data from the U.S., Europe and even Australia raised worries about the possibility of another recession. An uncertain demand outlook for commodities weighed on mining and energy stocks. Investors here were also concerned about the seemingly never ending eurozone sovereign debt situation which despite containment efforts continues to spread. Concerns about Europe's financial struggles and rising Italian and Spanish bond yields suggest that the debt issues, if not handled properly, could lead to yet another crisis.

Reserve Bank of Australia

As expected, the Reserve Bank of Australia left its key interest rate at 4.75 percent where it has been since November 2010. Indicators for the economy are mixed. Business and consumer confidence have dropped and inflation accelerated in the second quarter to the fastest annual rate in three years. However, the July purchasing managers’ survey released on August 1^st plunged to a reading of 43.4 from 52.9 in June indicating that the sector is contracting. At the time of the meeting, the Australian dollar was at a record high against the U.S. dollar. The high value of the dollar has curtailed tourism and sapped manufacturing. The RBA noted the acute sense of uncertainty in global markets. It noted that it is concerned about the inflation outlook but also has to consider growth. The RBA’s decision not to raise the developed world’s highest rates reflects concern about slowdowns in the U.S. and China, and Europe’s debt crisis.

In its quarter monetary policy statement, the RBA slashed its 2011 growth forecast and raised the outlook for inflation, signaling it may extend an interest rate pause into a second year on concern the global economy may stall. The RBA forecast 2011 growth in 2011 to average 2 percent, down from its May 6 estimate of 3.25 percent. In 2012, GDP growth is expected to accelerate to 4.5 percent, stronger than the prior estimate for a 4.25 percent expansion. Consumer prices are expected to rise 3.5 percent on the year through to the final quarter of 2011 from a previous prediction of 3.25 percent while core inflation will quicken to 3.25 percent from 3 percent.

Bank of Japan

The Bank of Japan on behalf of the Ministry of finance followed the Swiss move on Wednesday and intervened on behalf of the yen in the foreign exchange markets. The BoJ then cut short its previously scheduled two day meeting to one following the intervention to announce expansion of its asset buying program. At the meeting the board voted unanimously to keep its policy interest rate range from zero to 0.1 percent. It also agreed to additional easing steps because of the strong yen. It increased its asset buying program by ¥5 trillion yen to ¥15 trillion. It also increased the size of its long term JGB buying by ¥2 trillion to ¥4 trillion. It increased its corporate bond buying to ¥2.9 trillion from ¥2 trillion.

Yoshihiko Noda, Japan’s finance minister has increasingly threatened to intervene in the currency market but this is the first time since the G7-backed coordinated intervention soon after the earthquake that the Ministry of Finance has given the go ahead for the BoJ to sell yen. Mr Noda told reporters on Thursday that the yen’s recent moves had been too one-sided and that he had been in contact with both U.S. and European authorities, pointing to unilateral intervention.

Currencies

Currencies were volatile during a week that was punctuated by moves in Switzerland and Japan to lower the value of their respective currencies. The currencies have been experiencing escalating value in the current flight to safety. Demand for currencies like the Japanese yen and Swiss franc, seen as relatively safe assets to hold in turbulent times, have surged in recent weeks, driving up their value as investors shed dollars and euros because of debt worries in the U.S. and Europe.

Japan’s Ministry of Finance moved on Thursday to reverse the trend just a day after the Swiss National Bank unexpectedly cut interest rates in an effort to weaken the franc. A strong currency might sound like a validation of investor confidence in the performance of an economy. But for trade dependent countries like Japan and Switzerland, a sudden jump in the value of their currencies can wreak havoc by making their exports uncompetitive. Both countries also devalued their currencies last year. South Korea and Brazil intervened in foreign exchange markets earlier this year. And China has long purchased dollar and yen denominated assets in an effort to keep its renminbi weak enough to sustain its export economy.

On Thursday, Japanese authorities decided to act. First, the Finance Ministry said it had begun selling yen and buying dollars. Then the Bank of Japan announced that it had further expanded its program to buy government and corporate bonds, a form of monetary easing aimed at increasing liquidity and helping to dilute the value of the yen. On March 18, a week after an earthquake, tsunami and subsequent nuclear crisis, the Group of Seven industrialized economies came to Japan’s aid by staging a joint intervention, coordinating efforts to sell the Japanese yen on global currency markets. Traders had attributed the yen’s surge to Japanese companies repatriating funds to finance recovery back home at that time.

But since then, the dollar has again slumped against the yen as investors, wary of the debt impasse in the United States, fled to other currencies. Even after lawmakers in Washington struck a deal on Tuesday to avert a default or downgrade of United States debt, fresh concerns over the economy again weighed on the dollar.

Selected currencies — weekly results

Indicator scoreboard

EMU

June unemployment rate was 9.9 percent for the fourth month. The number of unemployed was up 18,000 after jumping 41,000 in May. The number of people without jobs now stands at 15.640 million. Among the big four economies, the unemployment rate held steady at 6.1 percent in Germany and edged down 0.1 percentage point to 8.0 percent in Italy. The French rate edged up 0.1 percentage points to 9.7 percent while the Spanish rate rose another 0.2 percentage points to 21.0 percent. The Spanish rate remains at the top of the Eurozone jobless table, nearly 7 percentage points above the occupant of the number two slot, Ireland (14.2 percent). Austria (4.0 percent) held on to the bottom rung of the ladder, just below the Netherlands (4.1 percent).

July manufacturing PMI was 50.4, down 1.6 points from June and at its weakest level since October 2009. Manufacturing output grew at its slowest pace during the 24-month recovery period and largely reflected a second consecutive drop in new orders. Both the domestic and overseas markets declined, the latter especially steeply in Germany. Moreover, backlogs saw their sharpest fall since August 2009. Employment bucked the general trend with its 15th gain in as many months but even here growth hit its lowest mark since October last year. Among the big four members, slower activity rates were widespread. However, while France (down 2.5 points from June to 50.5) and Germany (down 2.6 points to 52.0) at least signaled further expansion, Italy (up 0.2 points to 50.1) essentially stagnated and Spain (down 1.6 points to 45.7) contracted even more sharply than in June.

June producer prices were unchanged on the month and up 5.9 percent on the year and a five month low. Energy prices were down 0.3 percent from May and played a major role in keeping the total index in check. Excluding energy, the PPI edged just 0.1 percent higher on the month to stand 4.4 percent higher on the year. Capital goods prices were up 0.2 percent on the month. Nondurable consumer goods were up 0.1 percent as were intermediates while durable consumer goods were unchanged.

Germany

June manufacturing orders were up 1.8 percent and 9.5 percent on the year. This follows a revised increase of 1.5 percent in May. The latest monthly increase was wholly attributable to a 5.0 percent surge in capital goods. The jump here more than offset a 2.4 percent decline in consumer & durables and a 2.1 percent slide in basics. The June advance left total orders for the second quarter as a whole up 3.2 percent on the previous period when they rose 2.4 percent. Domestic orders dropped 10.8 percent on the month reflecting a 15.1 percent drop in capital goods and smaller declines in both basics (7.2 percent) and consumer & durables (1.3 percent). By contrast, overseas orders were up 13.7 percent on the month within which capital goods soared 20.8 percent. Basics posted a 4.3 percent increase but consumer & durables were off 3.4 percent. Foreign demand was led by the other eurozone members (16.4 percent) but non-EMU countries (11.9 percent) also easily more than reversed their May decline.

June industrial production dropped 1.1 percent on the month but was up 6.7 percent on the year. Excluding construction, output dropped 0.8 percent and was up 6.8 percent on the year. With construction falling 4.5 percent, manufacturing output was down a slightly smaller 0.9 percent from May which left production in the sector 1.0 percent higher over the last two months. Within manufacturing, intermediates expanded 0.3 percent on the month but there were declines in both capital goods (2.0 percent) and consumer goods (1.0 percent). Energy production was up 0.7 percent.

France

June seasonally adjusted trade deficit shrank from a narrower revised €6.4 billion in May to a smaller than expected €5.6 billion at the end of last quarter. The June improvement reflected a 2.0 percent monthly decline in nominal imports while exports were flat. However, the second quarter gap still widened out from €18.6 billion in the first three months of the year to €18.9 billion. For the first half of the 2011 the red ink stood at €37.5 billion or nearly 50 percent larger than over the same period of 2010. The rise in the price of oil has had a major impact on the French external accounts but the expanding deficit will still underpin worries about the damage to competitiveness being caused by the strength of the euro versus its U.S. counterpart.

Italy

June industrial output dropped 0.6 percent but edged up 0.2 percent on the year. Output was depressed by a 1.1 percent monthly drop in consumer goods. This followed a 0.7 percent drop in mid-quarter and reflected a 2.3 percent slump in durables and a 1.0 percent decrease in nondurables. The other sub-sectors were mixed with intermediates off 0.2 percent but capital goods output expanding 0.3 percent. Energy was down 0.2 percent from May.

Second quarter flash gross domestic product edged up 0.3 percent and was up 0.8 percent when compared with the same quarter a year ago. Apart from indicating that a contraction in agricultural output was more than offset by gains in both the industrial and service sectors, Istat as usual offered no breakdown of the flash data.

United Kingdom

July producer output prices were up 0.2 percent and 5.9 percent higher on the year. Input prices jumped 0.6 percent and 18.5 percent on the year. Output prices were supported by a 0.5 percent gain in food prices and a 0.6 percent increase in the cost of clothing which together were worth more than half of the overall monthly rise. Other sub-sectors showed smaller increases and tobacco & alcohol prices were flat while petrol was 0.1 percent cheaper. As a result, the core factory gate index was up a slightly firmer 0.3 percent from June and 3.3 percent on the year. Input costs were boosted by a 1.6 percent increase in crude oil which alone added more than 0.4 percentage points to the monthly headline advance. Most of the rest of the damage was done by the other imported materials category where prices surged 3.8 percent. However, there were partially offsetting declines in home food materials (3.6 percent) and fuel (0.9 percent).

Asia Pacific

Australia

June retail sales were down 0.1 percent on the month after a revised decline of 0.6 percent in May. On the year, sales were up 1.4 percent. Sales were down 3.2 percent in department stores while both the household goods and cafes, restaurants & takeaway food services sectors slid 0.7 percent. Sales were up for other retailing (1.2 percent), food retailing (0.4 percent) and clothing, footwear & personal accessory retailing (0.2 percent). Sales were down in New South Wales, South Australia, Victoria and the Australian Capital Territory. Tasmania was relatively unchanged. Sales were up in Western Australia, Queensland and the Northern Territory.

June seasonally adjusted balance on goods and services was a surplus of A$2,052 million, a decline of A$647 million from May’s surplus of A$2.700 million. Exports slipped 0.1 percent. Non-monetary gold dropped 55 percent and net exports of goods under merchanting dropped 6.0 percent. Non-rural goods were up 4.0 percent while rural goods were up 3 percent. Services credits rose A$5 million. Imports were up 2.6 percent. Intermediate and other merchandise goods were up 4 percent, capital goods gained 7 percent and non-monetary gold was up 6 percent. Consumption goods declined 1.0 percent. Services imports rose A$8 million.

Americas

Canada

July employment was up 7,100 while the unemployment rate slipped to 7.2 percent from 7.4 percent in June. The decline in the jobless rate essentially reflected a declining participation rate. Full time jobs were up 25,500 offsetting an 18,400 drop in part time positions. Moreover, with public sector payrolls shrinking by 71,500, it was the private sector that was responsible for providing a 94,500 boost to overall employment. The number of self employed declined nearly 16,000. Employment growth in July was concentrated in the goods producing sector where a 17,100 advance was heavily skewed by a 30,800 bounce in construction. Manufacturing was up 10,100 but there were declines in natural resources (11,300), agriculture (9,400) and utilities (3,200). Services saw their headcount drop 10,000 despite healthy increases in both trade (27,500) and transportation & warehousing (27,700). The bulk of shrinkage here was caused by health care & social assistance (down 29,400) and educational services (down 30,000), the latter possibly in part due to problems with the seasonal adjustment process. There were also significant declines in business, building & other support services (14,000) and public administration (11,800).

Bottom line

The Reserve Bank of Australia, Bank of England and European Central Bank met and kept their policy interest rates unchanged at 4.75 percent, 0.5 percent and 1.5 percent respectively. The Bank of Japan increased its asset purchase programs. The Swiss National Bank held an unscheduled meeting and lowered its interest rate target range to zero to 0.25 percent as part of its effort to bring down the value of the Swiss franc. Economic data mostly disappointed although U.S. employment did increase more than anticipated.

The main focus this week will be on the slew of monthly data from China but especially its consumer price index. In Australia, labor force data for July are on tap. In Europe, international trade and industrial production data will be posted by several countries. In the U.S., investors will hone in on the FOMC statement at the conclusion of its one day meeting on Tuesday.

Looking Ahead: August 8 through August 12, 2011

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