Global Markets

Most equity indexes declined last week. A combination of weaker than expected Chinese manufacturing data and Fed speak injected doses of uncertainty into the markets — and markets do not like uncertainty. Early in the week, traders focused on what Fed Chairman Ben Bernanke would say when he testified to the Joint Economic Committee of Congress. Afterward, they painfully parsed not only Mr Bernanke’s words, but those of District Bank presidents’ speeches as they looked for clues to future Fed policy. The problem for the markets appeared to be the wide range of views that are being aired. Even positive U.S. economic data including reports on housing, employment and durable orders were virtually ignored. However, disappointing data sent alarm bells ringing especially in the Asia Pacific region.

Flash PMI surveys disappoint

Flash PMI estimates are available only for China, the Eurozone, France, Germany and recently, the United States. The May data show that only the U.S. was above the 50 breakeven point that separates expansion and contraction. China’s PMI for manufacturing slipped back into contraction in May with a reading of 49.6, down from 50.4 in April — a seven month low. However the manufacturing output index was virtually unchanged from April at 51.0, a three month low. The cooling manufacturing sector reflected slower domestic demand along with continuing headwinds from abroad. The report sent equities lower.

In Europe, the economy was still struggling to gain any real traction. At 47.7, the composite output index which includes both manufacturing and services was up 0.8 points from its April reading but still well short of the key 50 growth threshold. Neither the manufacturing and nor service sector showed any real life with the PMI for the former (47.8) and the latter (47.5) similarly making insufficient gains to breach the 50 mark.

Among the core Eurozone countries, the French composite output index was unchanged at a lowly 44.3 while in Germany it was up 0.7 points to 49.9. Both the overall softness of the core countries and, in particular, the marked weakness of French economic activity continues to be a real issue for policymakers.

Though above 50 unlike its Chinese and European counterparts, the U.S. manufacturing PMI slipped to a reading of 51.9 and was virtually unchanged from April’s 52.0 reading. The manufacturing sector continues to expand albeit at a marginally slower rate.

Bank of Japan on hold

As expected, the Bank of Japan monetary policy board left its key interest rate range at zero to 0.1 percent. It also left its asset purchases unchanged after having already pledged in April to double its bond holdings in two years to expand the supply of money at an annual pace of ¥60 trillion to ¥70 trillion. The vote was unanimous.

In its statement, the BoJ said that the economy has started to pick up. Exports have stopped declining as overseas economies are gradually heading toward a pickup. Business fixed investment continues to show resilience in nonmanufacturing and appears to have stopped weakening on the whole.

The BoJ also said that it will continue with quantitative and qualitative monetary easing, aiming to achieve the price stability target of 2 percent as long as it is necessary for maintaining that target in a stable manner: “It will examine both upside and downside risks to economic activity and prices, and make adjustments as appropriate.”

At his press conference immediately following the monetary policy board meeting, BoJ Governor Haruhiko Kuroda played down concerns about recent volatility in the domestic bond market, insisting there would be no sharp interest gains going forward while promising to buy Japanese government bonds in a flexible manner in response to any yield increases that may occur. Mr Kuroda acknowledged that volatility in the JGB market is "a bit high" compared with the past, but he added that while climbing yields warrant close monitoring, he said that at this point, he was not expecting them to have any significant impact on the real economy.

The policy meeting was the third held under the leadership of Mr. Kuroda, the main architect of the easing steps that aim to reverse Japan's deflation and generate 2 percent inflation in about two years. Mr. Kuroda made it clear he has no intention to change the bank's plan to double the amount of cash it pumps into the financial system in two years — the centerpiece of which is buying roughly ¥50 trillion worth of JGBs a year.

Global Stock Market Recap

Europe and the UK

Equities declined for the first week since April 19^th on concerns about Asian growth and the potential scaling back of U.S. monetary stimulus. After three days of increases, the declines on Thursday and Friday were driven by a downbeat manufacturing PMI from China and concerns about the status of U.S. quantitative easing. It should be noted that indexes here initially rallied on Fed Chairman Bernanke’s testimony to Congress. Markets here were closed before the release of the FOMC minutes and before Bernanke’s testimony was finished that included comments which prompted profit taking on equity indexes trading at multi-year highs. Some analysts have suggested that the markets may be reading too much into Mr Bernanke’s comments as they parse every word. The FTSE was down 1.0 percent, the CAC and DAX each lost 1.1 percent and the SMI retreated 1.3 percent.

A rebound in consumer spending helped the German economy — the Eurozone’s engine of growth — thwart recession in the first quarter of 2013. However, the continued decline in fixed asset investment and extreme weather conditions stifled the recovery. Gross domestic product edged up just 0.1 percent in the first quarter and declined 0.2 percent from a year ago. The increase followed a sharp 0.7 percent quarterly drop in the previous quarter.

Asia Pacific

Most equity indexes here were down on the week in extremely volatile trading. Shares in Australia and Japan were particularly affected by both the disappointing Chinese manufacturing PMI index and Fed policy uncertainty. An example of the volatility that plagued investors is the Nikkei. The index swung over 1,000 points on both Thursday and Friday before ending higher Friday on optimism over earnings growth and the economy. However, the index plunged 3.5 percent on the week after sinking 7.3 percent Thursday. Thursday’s decline was the worst since the March 2011 earthquake and tsunami. The index ended the week 3.5 percent lower. The All Ordinaries continued to struggle after Thursday’s weak Chinese manufacturing PMI, given the key role exports to China play in Australian growth. The index dropped 3.8 percent on the week.

The selloff on Thursday was prompted by the release of data that pointed towards a contraction in Chinese manufacturing activity along with renewed concerns that the U.S. Federal Reserve could start to roll back its bond buying program. Though Japan led the declines that day, the rest of Asia also dropped. The volatile trading on Friday suggests that Thursday's sharp moves were not just a one-time event. It called into question the strength of the Japanese rally, which has seen the Nikkei soar 40.6 percent so far this year.

Investors’ fear that Japanese shares may have climbed too far, too fast appears largely to blame for the Nikkei’s plunge Thursday and not because of a turn for the worse in Japan's fundamentals. Most market watchers polled by The Nikkei said the correction will be short, taking the stock index down only to around 14,000. The Nikkei soared 80 percent from November to Wednesday. After breaching 14,000 on May 7^th it had enjoyed a nearly unbroken run upward. To some market watchers, the sight of Nikkei futures and individual stocks with little earnings support being bid up ever higher sets off alarms.

Thursday’s plunge came after a surge in Japanese government bond yields, which forced the Bank of Japan to offer ¥2 trillion in funds to calm investor nerves. The central bank announced the fund supplying operation after 10-year JGB yields soared to their highest level in more than a year, citing “the unreasonable increase” in volatility. The day’s intraday jump in JGB yields comes a day after BoJ Governor Haruhiko Kuroda played down concerns about recent volatility in the domestic bond market.

Currencies

The U.S. dollar was up against the commodity currencies — the Canadian and Australian dollars — but down against the euro, yen and Swiss franc last week. It also advanced against the pound sterling. During the week, the U.S. currency declined against its major counterparts on Monday and Thursday but advanced against all on Tuesday and Wednesday while on Friday, it was mixed as traders assessed the week’s volatile trading in equity markets ahead of the long weekend in both the U.S. and UK.

The dollar declined Friday in Asian trading before rebounding slightly after April durable goods orders growth exceeded expectations. That report meshed with the idea that the U.S. economic recovery is still on track. The euro climbed against the dollar in European hours Friday on better than expected Ifo sentiment data for May, but it ran into selling pressure ahead of $1.30 to the euro as traders were unwilling to push the common currency any higher ahead of the three day weekend. The better than expected U.S. data also weighed on the euro.

Selected currencies — weekly results

Indicator scoreboard

Germany

April producer prices slipped 0.2 percent on the month and were just 0.1 percent higher on the year. The third decline in as many months (and fifth decline in the last six) was in part shaped by a 0.3 percent drop in energy costs, but in general prices were subdued. While capital and consumer goods charges both edged up just 0.1 percent from March, basics recorded a sizeable 0.4 percent drop. Excluding energy, prices were 0.1 percent lower on the month and only 0.4 percent higher than a year ago.

First quarter GDP growth was confirmed at an anemic 0.1 percent after contracting 0.7 percent in the fourth quarter of 2012. On a workday adjusted basis, real GDP was down 0.2 percent from a year ago after having increased 0.3 percent in the previous period. This was the first time that annual growth has been negative since the fourth quarter of 2009. Private consumption rebounded 0.8 percent after declining 0.3 percent in the fourth quarter. It was strong enough to offset a drop in gross capital investment (down 2.4 percent). With exports falling 1.8 percent and imports down 2.1 percent, foreign trade was still able to add 0.1 percentage point after subtracting 0.7 percentage points in the previous quarter. Construction investment dropped 2.1 percent, reflecting the poor winter weather.

The May Ifo survey rebounded from April’s reading of 104.4 but remained below March’s 106.7. The headline business climate index gained more than 2 points to 105.7 after two consecutive monthly declines. Current conditions contributed to the increase, rising 2.7 points to 110.0 from 107.3 last time. Business expectations remained unchanged at 101.6. The readings within sectors were mixed. Manufacturing rebounded to a 6.1 reading from 3.4 last time. However, the construction sector eased to 1.2 from 2.8 in April and 7.1 in March. Retail edged up to 0.1 from a negative 1.1 in April. The overall industry reading improved to 4.1 from 1.5 the month before.

United Kingdom

April consumer prices were up 0.2 percent on the month and 2.4 percent on the year. Core CPI edged up 0.1 percent and 2.0 percent from a year ago. Lower petrol prices knocked more than 0.1 percentage points off the total annual inflation rate but outside of health (2.5 percent after 2.3 percent) and food (4.6 percent after 3.7 percent), 12-month rates in all the other sectors were either steady or, as in most cases, lower than in March.

April producer output prices slipped 0.1 percent following a smaller revised 0.2 percent increase in March. Annual growth of factory gate charges declined fully 0.8 percentage points to 1.1 percent, the slowest pace since September 2009. Core output prices were equally soft, also edging 0.1 percent lower on the month to reduce their 12-month rate to just 0.8 percent. At the same time, input prices slumped 2.3 percent from March to stand 0.1 percent below their year ago level. The latest decline followed a revised 0.1 percent monthly increase last time and made for an annual decline of 0.1 percent, the first negative 12-month rate since November 2012.

April retail sales dropped 1.3 percent following a slightly shallower revised 0.6 percent decline in March. Excluding fuel, purchases were down 1.4 percent after a 0.7 percent drop last time. Compared with a year ago, total volumes were still up 0.5 percent thanks to an even sharper decrease in April 2012 while non-fuel sales were 0.2 percent higher. The failure to see any recovery in household goods spending after what was the second coldest March on record will inevitably raise concerns about the health of the sector. However, the April drop was heavily biased by developments in the food sector where sales slumped 4.1 percent on the month as persistent cold weather took its toll of summer-related products. Non-food sales actually increased a solid 1.9 percent from March. Within this latter category, household goods jumped 3.8 percent, clothing & footwear was up 0.8 percent and other stores 1.6 percent. Non-store retailing was off 5.5 percent but this essentially just unwound the weather-inspired 5.2 percent jump last time.

First quarter gross domestic product was up an unrevised 0.3 percent on the quarter and 0.6 percent on the year. The first look at real GDP expenditure components revealed a disappointingly modest 0.1 percent quarterly gain in household spending, its weakest performance since the third quarter of 2011. The sluggishness here is likely to be in part due to the particularly bad weather but it makes the second quarter performance all the more important. Elsewhere, fixed capital investment contracted 0.8 percent on the quarter after a 0.2 percent drop in the previous period while government consumption was unchanged. Consequently it was renewed stock building that provided the additional boost needed to lift total domestic expenditure to a 0.4 percent quarterly rate. Exports were down a quarterly 0.8 percent and imports 0.5 percent. As a result, the net trade deficit was £6.3 billion which, following a £6.0 billion shortfall in the fourth quarter, was enough to shave a 0.1 percentage point off total output.

Asia/Pacific

Japan

April unadjusted merchandise trade deficit was ¥879.9 billion. Analysts had been expecting a deficit of ¥594.3 billion. Exports were up 3.8 percent from a year ago while imports jumped 9.4 percent. Exports were up for a second consecutive month while imports were up for the sixth month. Exports to China edged up 0.3 percent on the year for the first increase in three months. Exports to the U.S. jumped 14.8 percent for the fourth consecutive increase. However, exports to the EU were down for the 19th straight month, this time by 3.5 percent. On a seasonally adjusted basis, the April merchandise trade deficit was ¥764.4 billion after recording a revised ¥922.0 billion in March. Exports were virtually unchanged on the month while imports declined 2.4 percent. Exports here continue to reflect weak global demand.

Americas

Canada

March nominal retail sales were unchanged on the month and up 1.1 percent from a year ago. However, the steady headline reading masked a solid 0.7 percent monthly increase in volume purchases which now stand 1.6 percent higher than in March 2012. Within the cash data, there were monthly increases in six of the 11 reporting subsectors. The largest gain was in clothing & accessories which recorded a 3.1 percent advance. Elsewhere, the auto & parts category expanded 0.7 percent, largely on the back of a 6.1 percent increase in the other motor dealers' area. Furniture stores were up 1.2 percent. Otherwise performances were generally lacklustre. The steepest monthly decline was at gasoline stations (1.3 percent) but miscellaneous stores (down 1.2 percent) fared little better and additional declines were posted by food & beverages (0.1 percent) and electronics & appliances (0.9 percent).

Bottom line

Last week was all about the intentions of the Federal Reserve. Markets had difficulty parsing the Chairman Bernanke’s Congressional testimony along with several FOMC members. Markets seemed to push the panic button whenever a hint of a possible change in the Fed’s bond buying program is mentioned, despite the caveats that were offered at the time. The bottom line here is that the Fed has always been data driven in its assessment of when it might ease its bond purchases — in this respect nothing new was said.

Next week is a holiday shortened one in the U.S. and UK. Key monthly data for April including unemployment, consumer spending and industrial output will be released in Japan. Investors will be looking for signs that Abenomics is working. The Bank of Canada holds a monetary policy meeting. It will be the last for Governor Mark Carney — he will move to London to become Bank of England governor beginning July 1.

Looking Ahead: May 27 through May 31, 2013

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