Global Markets

Investors continued to focus on the European debt situation despite a slew of earnings reports and several potentially market moving economic indicators. Early in the week, flash purchasing managers’ indexes from China, the Eurozone, France, Germany and the U.S. received attention. This was followed by provisional second quarter growth estimates from the UK and U.S. However after a bit of nerves, risk became stylish again as investors became more confident that the European Central Bank would act to alleviate stress in the bond markets and the Federal Reserve perhaps would extend its quantitative easing programs.

Equities began the week in a decidedly negative mood as yields climbed for Spanish and Italian debt putting greater pressure on the governments of the two countries to fund it. However, equities made an abrupt turn Thursday after European Central Bank President Mario Draghi vowed unconditional support for the euro and the Eurozone and boosted speculation that the ECB may unveil some concrete plans when its governing council meets on Thursday.

During a speech in London, Draghi sent out strong signals that the ECB is much more open now to policy action. Markets interpreted his comments to mean that the ECB will soon purchase Italian and Spanish government bonds. He said that the ECB would do what was necessary within its mandate to protect the Eurozone including fighting high bond yields — a measure ECB officials had not previously suggested. The ECB president said that if high sovereign yields hurt the transmission channels for monetary policy, keeping risk premiums under control would come within the bank's mandate. Mr Draghi's remarks were later underscored by ECB governing council member Christian Noyer. The comments were made against a backdrop of climbing Spanish bonds yields, which reached a euro-era high of 7.7 percent on Wednesday, creating worries that the bank bailout agreed on in June might not be sufficient to stabilize Spain's ailing economy. Government bond yields dropped both on Thursday and Friday while the euro rallied on both days as well.

However, Germany's Bundesbank reiterated its opposition both to any further government bond purchases by the ECB and to allowing the bloc's rescue funds access to ECB financing. The Bank regards further ECB bond buying as "problematic" and "not the most sensible" instrument for overcoming the debt crisis, a spokesman said. The Bundesbank's resistance to further ECB bond purchases suggests discord within the ECB over how to rein in soaring Spanish and Italian borrowing costs. While the Bundesbank is the central bank of the Eurozone’s biggest economy —and arguably the most influential of the bloc's central banks — it has only one vote on the ECB's 23-member governing council and could therefore be overruled on the issue.

Global Stock Market Recap

Europe and the UK

Equities on the continent rebounded on Thursday and Friday and recouped the heavy losses incurred earlier in the week. Friday’s advance came after German Chancellor Angela Merkel and French President Francois Hollande said they would do anything to protect the euro, the U.S. economy grew more than forecast and companies posted earnings that topped estimates.

The DAX, CAC and SMI advanced 0.9 percent, 2.7 percent and 1.2 percent respectively. The FTSE’s rebound was not enough to offset earlier losses and retreated 0.5 percent on the week after provisional GDP data indicated that the economy contracted for a third consecutive quarter. As one would expect, equities in Italy and Spain rebounded the most after Mr Draghi’s comments on Thursday and the reassurance from Germany and France Friday. The MIB jumped 4.1 percent while the IBEX soared 5.9 percent for the week.

Mr Draghi's comments raised hopes that the ECB would support Spain and Italy by buying their sovereign bonds — as the ECB did when the two countries came under attack from markets last summer. Prior to Mr Draghi’s remarks, ECB Governing Council member Ewald Nowotny said there were arguments in favor of giving the European Stability Mechanism a banking license. If the ESM were granted a banking license, it would gain access to the ECB's lending. Currently, the facility has a lending capacity of €500 billion. But he added that he was not aware of specific discussions within the ECB at this point.

Late on Monday, Moody's revised its credit rating outlook on Germany, the Netherlands and Luxembourg — three of the Eurozone’s strongest members — to negative from stable. It pointed to increased uncertainty regarding the Eurozone’s prospects and a higher chance that Greece will exit the euro bloc.

Asia Pacific

Equity indexes were mixed on the week. On Friday, Asian shares rallied on speculation that the ECB and Federal Reserve will announce additional steps to spur global growth after European Central Bank President Mario Draghi vowed unconditional support for the beleaguered euro.  It boosted expectations that the ECB may unveil some concrete plans after its governing council meeting on August 2^nd. Despite a lack of specifics in the minutes of the most recent FOMC meeting, investors still remain hopeful and betting on further easing from the U.S. Federal Reserve as it holds a two day policy meeting starting July 31^st. Despite rallies on Friday, the Nikkei sank 1.2 percent and the Hang Sang lost 1.9 percent while the Shanghai Composite dropped 1.8 percent on the week. The All Ordinaries and Kospi managed to eke out gains of 0.1 percent and 0.3 percent respectively.  

Early in the week, stocks pared losses after the release of improved Chinese manufacturing data. With earlier easing measures starting to work, China's manufacturing contracted at a slower pace in July according to the flash PMI estimate. The PMI reading came in at 49.5 in July, up from 48.2 in the previous month, suggesting the slowest contraction in manufacturing activity in five months.

Reserve Bank of New Zealand

As expected, the Reserve Bank of New Zealand left its official cash rate (OCR) unchanged at a record low of 2.5 percent where it has been since March 2011 when it cut its OCR by 50 basis points as an insurance against the negative economic impact of the Christchurch earthquake. The RBNZ has an inflation target range of 1 percent to 3 percent. Inflation was up 1.0 percent on the year in the June quarter and below the inflation range mid-point. In his statement, RBNZ Governor Alan Bollard noted that economic conditions in the country’s major trading partners remains poor while the currency — the New Zealand dollar — remains high. Domestically, the rebuilding in Canterbury is expected to boost the economy.

Currencies

The euro strengthened against the U.S. dollar after ECB’s Draghi said that policy makers will do whatever is needed to preserve the currency. The euro’s gain was reinforced after German Chancellor Angela Merkel and French President Francois Hollande said they will do “everything” necessary to protect the single currency. Only three days earlier the euro sank to $1.2043, the weakest since June 2010 after reports that the Valencia and Catalonia regions would seek financial help from Spain's central government. The euro’s climb means the market is pricing in some probability of real action from the ECB.

The U.S. dollar was unchanged against the yen for the week after economic growth slowed less in the second quarter than forecast, dampening bets the Federal Reserve will take more stimulus action when they meet Tuesday and Wednesday. But the yen was down Friday against most of its major peers after government data showed Japan’s consumer price index declined — evidence that the nation continues to struggle to defeat deflation. Earlier in the week, the yen soared to its highest level against the euro in over 11 and a half years, triggered by potential default risks at debt ridden regional governments in Spain.

Selected currencies — weekly results

Indicator scoreboard

EMU

July flash manufacturing PMI dropped to 44.1 from June’s 45.1 for the lowest level in 37 months. Output declined at its steepest rate since May 2009 while new orders were down for the 14th month running and at their second sharpest pace since last November. Backlogs, likewise, were down more steeply than at any time since June 2009 and employment contracted for the sixth month in a row and at an accelerated pace. Weakness in economic activity was reflected in a softer inflation picture which saw input costs fall at their fastest rate since August 2009 with deeper discounting in output prices. Regionally there was more poor news. The German national PMI slid to a 37-month low of 43.3 while in France the activity rate declined 1.6 points to just 43.6, its weakest level in 38 months. The EMU composite output index was unchanged from June (46.4) but still signaled the sixth consecutive contraction in total output. Overall production has now fallen in 10 of the last 11 months.

June M3 money supply edged up to 3.2 percent from 3.1 percent on the year. The three month moving also edged upward to 3.0 percent from 2.9 percent last time when compared with the same three months a year ago. Total credit extended to general government picked up 0.3 percentage points to a 9.4 percent annual rate, but the private sector saw a 0.4 percent contraction, down from a 0.2 percent decline last time. Bank lending to the private sector was 0.2 percent lower than in June 2011 after a 0.1 percent drop in May. Within this, borrowing by households was steady at a 0.3 percent 12-month rate with loans for house purchase similarly unchanged at 0.8 percent. However, borrowing by non-financial corporations dropped to a minus 0.6 percent annual rate from unchanged in May. Loans to non-monetary financial institutions (excluding insurance companies and pension funds) grew 0.1 percent having fallen 1.9 percent in the year to May.

Germany

July Ifo sentiment index was down 1.9 percent to 103.3 for its weakest level since March 2010. The latest slide reflected additional losses in both the current conditions and expectations components. The former easily more than reversed June's 0.7 point gain with a 2.3 point drop to 111.6 while the latter declined 1.6 points to 95.6, its fourth fall in a row. Among the major sectors, morale was worst hit in manufacturing which posted a 6.7 point slump to minus 1.9. But there were losses too in wholesale (1.1 points to 3.9), construction (2 points to minus 6.7) and services (5.6 points to 15.7). However, it was not all bad news as retail sector confidence was surprisingly firm, rising nearly 5 points to 5.1.

United Kingdom

Second quarter provisional gross domestic product contracted 0.7 percent on the quarter and was down 0.8 percent below its year ago level. However, the ONS noted that the figures are particularly prone to revision and subject to potentially sizeable distortions associated with both the Queen's Jubilee celebrations and record rainfall in April and June. However, at this stage no official estimate of the impact of either special factor has been made available. As usual with the first release, there were no details of the GDP expenditure components but the output figures confirmed expectations that the quarterly decline would be led by the goods producing sector. Therefore, industrial production was down 1.3 percent from the first three months of the year (down 3.2 percent from Q2 2011) while service sector output slipped just 0.1 percent. Within the former, the key manufacturing sector contracted a quarterly 1.4 percent and there were sizeable declines too in mining & quarrying (5.9 percent) and water supply (2.1 percent). Construction plunged 5.2 percent but electricity, gas & steam expanded 5.9 percent. The minimal dip in services was largely attributable to a 1.4 percent drop in transport, storage & communication. Distribution, hotels & catering fell 0.4 percent but business services & finance grew 0.1 percent and the government sector 0.3 percent.

Asia/Pacific

Japan

June merchandise trade surplus was Y61.7 billion – analysts expected a deficit of Y113.2 billion. On the year, exports were down 2.3 percent while imports were 2.2 percent lower. Exports declined for the first time in four months while imports dropped for the first time in 30 months. Exports to the U.S. jumped 15.1 percent but dropped on the year to Asia (down 4.4 percent), China (down 7.3 percent) and the EU (down 21.3 percent). Imports were down from Asia (2.5 percent), China (4.5 percent), the U.S. (down 3.5 percent) and the EU (down 3.4 percent). On a seasonally adjusted basis, the June deficit was Y300.8 billion. On the month, exports were down 1.4 percent and down 3.5 percent on the year. Imports plummeted 6.5 percent on the month and slipped 0.1 percent from a year ago.

June consumer prices were down 0.5 percent on the month and 0.2 percent on the year. The key core CPI excluding fresh food declined 0.3 percent and also 0.2 percent on the year. Excluding both food and energy, the CPI dropped 0.2 percent and 0.6 percent from a year ago. This was the second consecutive month that prices declined on the year. Consumer durable goods prices dropped 10.4 percent on the year. Refrigerator prices plunged 29.1 percent while television prices slid 6.1 percent. Energy prices were up 2.0 percent on the year after increasing 3.7 percent in May.

June retail sales were up 0.2 percent from a year ago. It was the seventh consecutive increase. Retail machinery sales plunged 32.3 percent after sinking 23.9 percent the month before while car sales soared 37.0 percent after jumping 47.2 percent in May from a year ago. Fuel sales were down 6.1 percent after increasing 2.4 percent on the year last time. Sales also declined for general merchandise, food & beverage and fabrics, apparel & accessories.

Australia

June quarter final stage producer prices were up 0.5 percent and were up 1.1 percent from the same quarter a year ago. The quarterly price increases were due primarily to increased prices received for other agriculture (up 10.9 percent), petroleum refining (up 4.3 percent) and other manufacturing (up 2.4 percent). These increases were partially offset by declines in the prices received for commercial fishing (down 12.2 percent) and accommodation (down 5.6 percent). Intermediate or stage two commodities were up 0.7 percent and 1.4 percent on the year. Prices were up for electricity, gas & water supply (4.9 percent), oil & gas extraction (2.6 percent) and petroleum refining (2.4 percent). However, prices for commercial fishing (down 17.5 percent) and basic non-ferrous metal manufacturing (percent 2.5 percent) offset some of the increase. Preliminary (stage 1) commodities were up 0.9 percent on the quarter and 1.4 percent on the year. Higher prices received included electricity, gas & water supply (4.2 percent), oil & gas extraction (2.6 percent) and basic chemical manufacturing (4.4 percent). These increases were partly offset by drops in the prices received for grain, sheep, beef & dairy cattle farming (down 2.5 percent) and basic non-ferrous metal manufacturing (down 2.5 percent).

June quarter consumer price index was up 0.5 percent after increasing 0.1 percent in the March quarter. On the year, the CPI was up 1.2 percent after increasing 1.6 percent in the previous quarter. The most significant price increases on the quarter were for medical & hospital services (2.8 percent), rents (1.1 percent), vegetables (5.2 percent) and furniture (4.5 percent). The most significant offsetting price declines were for domestic holiday travel & accommodation (down 4.0 percent), audio, visual & computing equipment (down 3.8 percent) and cakes and biscuits (down 2.8 percent). The Reserve Bank of Australia has an inflation target range of 2 to 3 percent. In the June quarter, the two analytical measures that the RBA monitors closely are the trimmed mean and weighted mean. The former was up 0.5 percent on the quarter and 2.0 percent on the year while the latter was up 0.7 percent and 1.9 percent.

Americas

Canada

May retail sales were up 0.3 percent after slipping 0.3 percent in April. On the year, purchases were up 3.1 percent. Volumes performed better, registering a 0.7 percent gain over their April level. Only six of 11 reporting sectors saw nominal sales advance on the month and among these, the most notable increases were in food & drink (1.6 percent), sporting goods & hobbies (1.9 percent) and clothing & accessories (1.6 percent). General merchandise stores (0.8 percent) and furniture & home furnishings (0.7 percent) also fared well. However, gains here were almost offset by declines elsewhere, particularly at gasoline stores (1.4 percent) but also in electronics & appliances (0.8 percent), miscellaneous stores (0.7 percent) and health & personal products (0.6 percent). Motor vehicles were down 0.4 percent and excluding this sector and gasoline, purchases were up 0.8 percent on the month.

Bottom line

Equities rebounded at week’s end after ECB President sent strong signals that the Bank was prepared to act to alleviate Spanish and Italian pain stemming from high debt yields. Economic data were mixed.

The Federal Reserve, Bank of England and the European Central Bank announce their policy decisions this week. The Bank of England increased the ceiling of its asset purchase program last month and is not anticipated to announce further policy changes this month. The ECB, after Draghi’s comments on July 26^th, is expected to take some action to alleviate Spanish and Italian debt yield woes. Views are split as to whether the Fed will take new policy action before or after the presidential election in November.

Looking Ahead: July 30 through August 3, 2012

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