Global Markets

Investors focused on two main events last week — the German court ruling and the FOMC announcement. They were barely distracted by disappointing economic data from China at the beginning of the week. Most equity indexes were higher with only the Shanghai Composite down 0.2 percent on the week. Gains ranged from 0.3 percent (SMI) to 4.4 percent (Sensex).

On Wednesday, Germany's Federal Constitutional Court in Karlsruhe cleared the way, as expected, for the ratification of the European Stability Mechanism (ESM), but with conditions including capping Germany's ESM liability. The Court said Germany must cap its bailout fund liability at €190 billion and that further expansion of the country's ESM share needs to get the backing of Parliament. Both houses of Parliament must be informed of any decisions on the ESM in future. With the ruling, the Eurozone now will be able to move ahead with the establishment of the European Stability Mechanism, — something like a Continental version of the International Monetary Fund. The mechanism will handle bailouts and work in tandem with the European Central Bank to buy the bonds of countries like Italy and Spain that are straining under high interest rates. Although the ruling is unlikely to quell Europe’s economic crisis entirely, a rejection could have unleashed new waves of instability and thrown the march toward European integration into question.

At its two day meeting on Wednesday and Thursday, the Federal Reserve left its federal funds interest range at zero to 0.25 percent but extended its guidance to at least to mid-2015 from the end of 2014. The FOMC also initiated another round of quantitative easing or QE3. The Fed said it will purchase additional agency mortgage backed securities at a pace of US$40 billion per month. The end of the program is conditional on improvement in the economy. The interesting issue here is that the Fed is not buying US Treasuries but rather mortgage backed securities. The Fed also will continue to reinvest pay down on agency debt and mortgage backed securities. Operation Twist also continues as earlier planned through December of this year. In its analysis, the FOMC pointed to labor market problems along with the sovereign debt situation in Europe as reasons for the move. Once again, Richmond Fed President Jeffrey Lacker voted against the statement.

The Fed said it would continue easing until the labor market outlook improves "substantially." Investors cheered the Fed's commitment to action. The Fed, which was under pressure to act amid the sagging economies of Europe and the United States, has succeeded in conveying a consistent message that investors can count on low interest rates and accommodative monetary policy for a considerable time. The Fed's latest action came a week after the European Central Bank announced bond buying measures to check volatility in sovereign bonds of troubled European countries. It is now widely expected that the Bank of Japan would eventually follow the Federal Reserve on easing monetary policy, when the policy board meets next week.

Global Stock Market Recap

Europe and the UK

The European markets rallied strongly Friday after the Federal Reserve delivered the hoped for third round of quantitative easing. The economic stimulus had been expected. On the week, the FTSE was up 2.1 percent, the CAC was 1.8 percent higher, the DAX gained 2.7 percent and the SMI was up 0.3 percent. Equities were muted at the beginning of the week with investors reluctant to take positions prior to the German court ruling and the FOMC announcement.

Investors were awaiting a court ruling in Germany on Wednesday regarding the legality of the ESM. The ruling could have potentially jeopardized the bond purchase plan announced by the European Central Bank on September 6^th, which sparked the strong rally in stocks. But European markets ended the day with mixed results after the highly anticipated German court ruling was announced. Investors then shifted their focus to the FOMC announcement and the subsequent press conference from Fed Chairman Ben Bernanke. Nervousness over the Federal Reserve policy meeting kept European investors in a cautious mood on Thursday. Markets here were closed prior to the Fed’s announcement.

Although financial markets were buoyant Friday, worries about the Eurozone’s more fragile economies are never far from investors' minds as the region's leaders and finance ministers began their informal meetings in Cyprus, with Spain and Greece likely to be high on the agenda. Investors are becoming increasingly impatient with Spain's Prime Minister Mariano Rajoy, who remains defiant despite being under pressure to seek a full Eurozone bailout. Data earlier Friday showed Spanish government debt had risen to 75.9 percent of gross domestic product in the second quarter, hitting new highs as the government struggles to finance a towering budget deficit.

Swiss National Bank

The Swiss National Bank's latest Monetary Policy Assessment contained few surprises and suggests that the Bank has made no changes to its policy stance since its last quarterly update in June. The target range for three month Swiss Libor remains 0.0 percent to 0.25 percent with a point objective at the lower end of the band and the official floor to EUR/CHF stays at CHF1.20.

Since the June Assessment, the SNB has successfully prevented EUR/CHF from falling beneath the 1.20 level. Following the ECB's bond buying announcement on September 6^th, the euro moved significantly above this level for the first time since March. SNB reserve figures have suggested that intervention by the Bank has become less aggressive in recent weeks but this could easily prove short lived should sentiment turn against the euro again. The revised economic outlook was a little softer than the one delivered in June. Real GDP growth is now put at 1.0 percent this year, down 0.5 percentage points from last time while inflation has been shaved to a decline of 0.6 percent from a drop of 0.5 percent.

Asia Pacific

Equities here rallied Friday joining those in the U.S. after the Federal Reserve announced a $40 billion a month open-ended program of mortgage backed security purchases while also committing itself to keep interest rates exceptionally low until at least 2015 to aid the U.S. recovery. All indexes covered here were higher on the week with the exception of the Shanghai Composite which slipped 0.2 percent.

The Fed’s announcement heightened expectations that the Bank of Japan, at its policy meeting next week, will ease as well to support the export reliant economy. Hinting at possible yen intervention, Japan's Finance Minister Jun Azumi urged the BoJ to act at the right time. He said at a press conference that he would not rule out any policy options to fight excessive moves in the yen.In addition, traders said that the BoJ carried out a rate check with several banks during New York trading hours, the first since early June. After checking the yen exchange rate with several banks, the BoJ could immediately follow with actual intervention, making it one of the strongest signals it can send.

August Chinese data released on September 9^th and 10^th disappointed. In particular, merchandise trade data showed that imports were down 2.6 percent from a year earlier while exports grew a less than expected 2.7 percent, in the latest sign of weakness in China’s economy. Much of the weakness came from Europe, which is China’s biggest trading partner. Exports to the EU dropped 12.7 percent from a year earlier. Exports to Japan also disappointed, registering a decline of 6.7 percent in August, while shipments to the US rebounded with 3 percent growth. At the start of the year Beijing set a target of 10 percent growth in overall trade — but with year to date growth of just 6.2 percent by the end of August that target looks unrealistic.

Other economic indicators released on Sunday showed that a general slowdown in the Chinese economy had continued into August. (See Indicator Scoreboard below for more detail.) Data pointed to falling factory output and investment and rising inflation. In China, massive stimulus measures would be “detrimental” to sustainable economic growth, the official Xinhua News Agency wrote in a commentary. That came after Premier Wen Jiabao on September 11^th signaled there’s more room for fiscal and monetary policy to support growth.

Reserve Bank of New Zealand

The Reserve Bank of New Zealand kept its overnight cash rate (OCR) at 2.5 percent where it has been since March 2011. The decision was Governor Alan Bollard’s last after serving a 10 year term before he steps down September 25^th. He will be succeeded by former World Bank co-managing director Graeme Wheeler. While the RBNZ signaled little need to raise borrowing costs until the second half of 2013 because of risks from Europe’s fiscal crisis and the outlook for New Zealand’s trading partners including China, economists are waiting to gauge Wheeler’s interpretation of conditions before agreeing.

Sluggish domestic demand and a rising currency are helping to keep inflation within the Bank’s 1 percent to 3 percent target range but at the same time, is hurting exporters. Bollard has left the cash rate at 2.5 percent since March 2011 to allow the economy to recover after the nation’s deadliest earthquake in 80 years. The February 2011 temblor struck Christchurch and the surrounding Canterbury province. Reconstruction is expected to accelerate next year.

Currencies

The U.S. dollar declined against most of its major counterparts last week. The decline picked up pace after the Federal Reserve announced that it would begin a third round of asset purchases to bolster the economy. The move is raising concerns that the measure will debase the value of the U.S. currency. The U.S. currency weakened to a four month low against the euro after the Fed announcement. European Central Bank President Mario Draghi said last week that policy makers had agreed on an unlimited debt buying program for the region.

The euro was up for a fourth day on Friday as Europe’s finance ministers and central bank officials gathered in Cyprus for a two day meeting to discuss the next steps in addressing the region’s sovereign debt crisis. The currency jumped to an 18-week high against the dollar Tuesday ahead of a key ruling on the constitutionality of the Eurozone's bailout fund. The euro has rallied 6 percent against the dollar since early August on firming optimism that the European Central Bank can relieve financial stresses in countries like Spain and Italy. Last week, the ECB unveiled a new proposal for unlimited bond buying in peripheral countries if they ask for help.

Selected currencies — weekly results

Indicator scoreboard

EMU

July industrial production was up 0.6 percent to reverse June's unrevised 0.6 percent decline. However annual workday adjusted growth declined 2.3 percent after dropping 2.1 percent last time. Energy production was down 1.2 percent from June. However, capital goods output climbed 2.4 percent and intermediates edged 0.1 percent higher, durable consumer goods fell 0.5 percent and nondurables were off 0.6 percent. Regionally, there were solid monthly gains in output in Germany (1.3 percent), Greece (1.8 percent), Ireland (1.0 percent), Portugal (1.5 percent) and Slovakia (1.5 percent). France also managed a small advance (0.3 percent). However, Italy (down 0.2 percent) and Spain (down 0.2 percent) again performed poorly and there were hefty declines in the Netherlands (0.8 percent) and Slovenia (2.3 percent). Indeed, of the 12 member states providing data, only five (Ireland, Malta, Finland, Slovenia and Slovakia) showed positive annual growth rates.

August final harmonized index of consumer prices was up 0.4 percent and 2.6 percent on the year. Regionally, annual inflation accelerated in most EMU states and in three of the four larger members. France saw its national rate gain 0.2 percentage points to 2.4 percent while Germany was up 0.3 percentage points at 2.2 percent and Spain, 0.5 percentage points higher at 2.7 percent, its fastest pace since November last year. Inflation in all four countries is now above the ECB's near-2 percent target. The only economy not breaking the target last month was Greece (1.2 percent). The disappointingly high headline figures continue to reflect the recovery in energy prices seen since June. Excluding food, drink, tobacco & petrol prices were up only 1.5 percent on the year. Similarly, the rates for both the HICP without seasonal food & petrol and without unprocessed food & petrol eased from 1.9 percent to 1.7 percent.

France

July industrial output excluding construction was up 0.2 percent after remaining flat in June. On the year, production was down 3.1 percent. The manufacturing sector performed even better, registering a 0.9 percent monthly advance although even this still left an annual drop of 2.8 percent. Outside of food & agriculture where production was down 1.9 percent on the month, all of the main manufacturing sub-sectors made renewed headway. In particular, activity in refining expanded 4.3 percent, transport equipment was up 3.4 percent and electronics & machines advanced 2.3 percent. The other goods category was 0.5 percent higher. Elsewhere, energy registered a 3.4 percent slump and construction was off 0.1 percent.

Italy

Second quarter revised gross domestic product contracted 0.8 percent and was down 2.6 percent from the same quarter a year ago. Household consumption dropped 1.0 percent on the quarter and alone subtracted 0.6 percentage points from the change in total output. Capital investment was even worse, dropping 2.3 percent and subtracting a further 0.4 percentage points from quarterly growth. Government spending crept up 0.2 percent but, with inventories flat over the period, the main positive stimulus came from the foreign trade sector. With exports up 0.2 percent on the quarter and imports off 0.4 percent, net overseas trade added 0.2 percentage points to the bottom line.

United Kingdom

July merchandise trade deficit narrow to Stg7.2 billion following an almost certainly heavily distorted record level in June. The underlying balance, which excludes oil and erratics, also showed a marked improvement with the deficit here shrinking from Stg8.4 billion to Stg6.7 billion. Total exports climbed 9.3 percent on the month (core 6.4 percent) and so more than reversed June's 9.0 percent slump, which had been impacted by the extra holidays associated with the Queen's Jubilee celebrations in June. Oil and diamonds were especially strong. However, imports were down 2.1 percent (core minus 1.7 percent), their fourth consecutive monthly decline and now stand at their weakest level so far in 2012. Most of the headline gain reflected a reduction in the deficit with the non-EU bloc which narrowed by more than Stg2 billion to Stg2.9 billion, the smallest since October 2005. Exports to this region were up 11.0 percent from June. Net trade with the rest of the EU was in the red by Stg4.3 billion after a Stg5.0 billion shortfall last time.

August claimant count unemployment was down a steep 15,000 on the month — the largest drop since June 2010 — after a notably steeper revised 13,600 decline in July. The jobless rate on this basis was unchanged at the 4.8 percent level to which the previous month's rate was downwardly revised. The ILO data were less optimistic, showing a decline in joblessness over the three months to July of just 7,000 and an unemployment rate of 8.1 percent, but at least they told a consistent story. The Olympics probably helped to flatter the headline figures and a 5,500 drop in the London claimant count could just reflect temporary hiring caused by the games.

Asia/Pacific

Japan

The second estimate of second quarter gross domestic product was revised down to 0.2 percent on the quarter from the first estimate of 0.3 percent. On an annualized basis, GDP was up 0.7 percent, down from the previous estimate of 1.4 percent and the forecast of 1.0 percent. On the year, GDP was revised to an increase of 3.3 percent from the original 3.6 percent. On the quarter, both domestic demand and private demand were revised down to a gain of 0.2 percent from the original 0.4 percent estimate. Private consumption was unrevised at an increase of 0.1 percent. Capex was revised to a slightly lower advanced of 1.4 percent from 1.5 percent and higher than a forecast of a much deeper revision of 0.8 percent. Exports were unchanged at 1.2 percent.

August corporate goods price index was up 0.3 percent on the month but down 1.8 percent from a year ago. The CGPI was down 2.2 percent on the year in July. This was the fifth consecutive month that the annual change has declined. Among components, food, beverages, tobacco & feedstuff prices were 0.3 percent lower on the year, the same as in July. Prices for both lumber & wood products and chemicals & related products were down 3.5 percent on the year. Petroleum & coal dropped 5.1 percent. Nonferrous metals swooned 10.5 percent as did information & communication equipment.

July tertiary industry index, which measures spending in the services sector, was down 0.8 percent on the month in July, posting the first decline in three months after a revised 0.2 percent increase in June. On the year, the index was up 0.2 percent after increasing 1.4 percent in June. The monthly decline was led by wholesale trade in food & beverages and appliances, trucking services and finance & insurance.

July seasonally adjusted core private sector machinery orders were up 4.6 percent but down 1.9 percent on the year. On the year, unadjusted core orders were up 1.7 percent. Core orders exclude volatile demand from electric utilities and for ships. The sharp increase was led by a rebound in orders from the manufacturing sector including steel mills and electric machinery makers. However, orders from non-manufacturers declined 2.1 percent. Offshore orders, which are not part of core orders, increased 3.0 percent from the previous month in July after a 9.8 percent drop in the previous month.

China

August consumer prices were up 0.6 percent on the month and 2.0 percent from a year ago. For the first eight months the CPI was up 2.9 percent when compared with the same months a year ago. Food prices jumped 3.4 percent after climbing 2.4 percent in July from a year ago. Non-food prices were up 1.4 percent on the year after increasing 1.5 percent. Most categories were up on the year with the lone exception of transportation & communication which was down for the fourth consecutive month with this time’s decline of 0.8 percent. Increases included clothing which was up 3.1 percent, tobacco & alcohol was up 3.0 percent and housing which was 2.2 percent higher. The urban CPI was up 2.1 percent while the rural index was up 1.8 percent.

August producer price index dropped 3.5 percent from a year ago. On the month, the PPI slid 0.5 percent. For the eight months through August, the PPI was down 1.3 percent. Prices were down for all categories with the exception of consumer goods (up 0.2 percent from a year ago) which recorded gains. Within consumer goods, only prices for durables were down 1.2 percent while clothing & related products were up 1.7 percent on thee year. Other consumer goods categories recorded minimal gains. Production material prices dropped 4.6 percent while raw materials procurement swooned 4.1 percent from a year ago. Ferrous metals and non-ferrous metals dropped 9.8 percent and 9.9 percent respectively.

August industrial production was up 8.9 percent from a year ago after increasing 9.2 percent in July. On the month, output was up 0.69 percent. For the first eight months of the year, it was up 10.1 percent when compared for with the same months a year ago. All categories gained from a year ago. Gains aside, the data suggest that the economy is slowing further in the third quarter, despite a widely anticipated recovery during the second half of the year. Electricity output improved for a second straight month, rising 2.7 percent on the year from 2.1 percent in July and zero growth in June.

August retail sales were up 13.2 percent on the year while sales were up 1.28 percent from July. For the first eight months, sales were up 14.1 percent about the same as in July. Urban retail sales were up 13.1 percent from a year ago, the same as in July while rural retail sales were up 14.3 percent after increasing 13.6 percent last month. Auto sales have been weakening since April when they were up 8.2 percent. August sales were up 2.4 percent after increasing 4.7 percent in July and 6.2 percent in June.

August merchandise trade surplus was $26.66 billion. Imports were down 2.6 percent from a year ago while exports were up 2.7 percent. The year to date trade surplus was $120.61 billion, up 30 percent on the same period last year. Exports were up 7.1 percent on the year during January through August period while imports were 5.1 percent higher. The July and August trade surplus this year stood at $214.71 billion, well above the $168.94 billion in the same two months a year ago and nearly double the $126.14 surplus for the full second quarter this year. On a seasonally adjusted basis, exports declined 3.3 percent on the month compared with July's 4.2 percent drop while imports were down 4.6 percent compared with the previous drop of 5.8 percent.

Americas

Canada

July seasonally adjusted trade deficit was C$2.34 billion, its fourth consecutive monthly shortfall. The July deterioration reflected a 3.4 percent monthly drop in exports that more than offset a 2.2 percent decline in imports. Within these figures, sales to the U.S. market were off 5.0 percent while imports were down a relatively small 2.1 percent. This combination in turn provided for a bilateral surplus with the U.S. of C$2.11 billion, well short of the C$3.02 billion excess recorded last time. The real trade position also worsened as export volumes declined 2.0 percent from their June level and imports slipped a more modest 1.2 percent. Weakness in exports was particularly marked in energy products which saw an 8.5 percent monthly decline but there were also sizeable drops in machinery & equipment (5.5 percent), autos (5.3 percent) and agricultural & fishing products (3.2 percent). Indeed, the only categories to register gains of any note were industrial goods & materials (2.1 percent) and other consumer goods (2.7 percent). Imports were similarly hit hard by the energy sector (down 12.3 percent), with the next steepest decline being in machinery & equipment (3.7 percent). A number of other areas saw smaller declines and the strongest gain was limited to 1.7 percent in forestry products.

July manufacturing sales dropped 1.5 percent after sinking 0.8 percent in June. Compared with a year ago, sales were up just 2.3 percent. Constant dollar sales performed even more poorly, dropping a sizeable 2.0 percent from the end of last quarter led by a 2.7 percent plunge in durables. Within the monthly drop in total nominal shipments, eleven of the twenty-one reporting industries posted declines. Transportation suffered a 6.4 percent contraction, in large part courtesy of a 22.1 percent slump in aerospace products & parts. Autos were down 3.2 percent but even excluding vehicles, parts & accessories, headline sales would have dropped 1.4 percent. The other main area of weakness was machinery equipment, which recorded a monthly 2.4 percent slide, but there were marked declines too in computer & electronic products (2.0 percent), paper manufacturing (2.4 percent) and beverage & tobacco (1.4 percent). Primary metals & non-metallic minerals (both down 1.1 percent) struggled as well. Solid growth was only seen in textiles (10.7 percent) and wood (1.5 percent) and, to a lesser extent, plastics & rubber products (0.7 percent). New orders were down 5.6 percent on the month and backlogs were off 1.2 percent.

Bottom line

Stocks soared on news that the Federal Reserve is launching another round of quantitative easing. Whether profit taking will follow the beginning of this week remains to be seen. Besides the Fed action, the German Constitutional Court ruled in favor of the ESM — but with caveats. Data from China disappointed, showing weakness — especially in the country’s bilateral trade with the EU.

This coming week appears to be calmer. The Bank of Japan meets. Expectations now are that the BoJ will expand its easing program, following the Fed. The major data are the flash purchasing managers’ indexes that will be released Thursday for China, Germany, France, the Eurozone and the United States. Investors also will be watching Japan’s merchandise trade data for new clues to global growth.

Looking Ahead: September 17 through September 21, 2012

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