Global Markets

Equities continue to evaluate each U.S. economic data release as they attempt to forecast exactly when the Federal Reserve will begin cutting back on its bond buying programs. Part of the anxiety stems from the delayed releases due to the government shutdown for the first half of October. Two key releases on Thursday and Friday — advance third quarter gross domestic product and the October employment situation report — beat expectations.

Another central bank proved that it can also surprise markets — the European Central Bank caught traders off guard when it lowered its key refinance rate by 25 basis points to 0.25 percent. The main reason was the precipitous decline in Eurozone inflation over the past several months to only 0.7 percent on the year in October. Elsewhere, both the Reserve Bank of Australia and the Bank of England left policy unchanged for now.

Most equity indexes retreated on the week. Losses ranged from 0.1 percent (Nasdaq) and 0.2 percent (All Ordinaries) to 3.0 percent (Bolsa) 3.5 percent (PSEi). Gains ranged from 0.2 percent (SMI) to 1.0 percent (Jakarta Composite).

Reserve Bank of Australia

As expected, the Reserve Bank of Australia left its key interest rate at 2.5 percent where it has been since August. The Board made it clear that no imminent move can be expected. At the October meeting Board members agreed that the Bank should again neither close off the possibility of reducing rates further nor signal an imminent intention to reduce them.

In Governor Glenn Stevens’ statement he noted that inflation data were consistent with the RBA’s medium term target and that it will remain that way over the next one to two years. In addressing the strong Australian dollar, the Board noted that while it is weaker than earlier in the year, the currency is still uncomfortably high. A lower level of the exchange rate is likely to be needed to achieve balanced growth in the economy. Regarding the economy, the Bank noted that growth has been a bit below trend and the unemployment rate has edged higher. It said that private demand excluding mining is expected to improve.

In its quarterly Statement on Monetary Policy, the RBA forecast below trend growth and rising unemployment in 2014 as resource investment drops and renewed currency strength drags on the economy, leaving open the chance of lower interest rates. The RBA projected gross domestic product will increase by between 2 percent and 3 percent in the year to December 2014, sharply lower than its previous 2.5 to 3.5 percent forecast three months earlier. The outlook for inflation is expected to remain consistent with the 2 to 3 percent target range. The forecast “reflects the substantial decline in mining investment, planned fiscal restraint and the still high level of the Australian dollar.” The Bank said it has already delivered a ‘substantial degree’ of policy stimulus and the effects still have further to run. It reiterated concerns about the Australian dollar, which has climbed after the Federal Reserve’s recent decision to postpone unwinding record stimulus.

Bank of England

In line with expectations, the Bank of England announced no change to either the Bank Rate (0.5 percent) or its asset purchase program (£375 billion) at its November monetary policy committee meeting. With the economy proving surprisingly robust since the October meeting and inflation slowing gradually but, at 2.7 percent, still above the 2 percent target, there was neither the need nor room to ease. However, at the same time ILO unemployment (7.7 percent in August) is still well above the 7 percent level needed for a Bank Rate increase just to be contemplated, so a tightening was never even a possibility.

The Monetary Policy Board’s discussions probably centered on the Bank's updated economic forecasts due for release alongside the next Inflation Report on November 13. These will almost certainly acknowledge the pick-up in the pace of the recovery via a faster projected decline in the jobless rate. When the BoE launched its forward guidance plan three months ago, it said it would not raise rates until unemployment fell to 7 percent, something it predicted would not happen until well into 2016. With growth picking up, house prices rising at double the rate of inflation and signs that broader price pressures are building, many economists believe a rate increase could be warranted much sooner than the BoE is suggesting.

European Central Bank

Against the general consensus but in line with a significant and expanding minority of market participants, the ECB announced its first cut in the refinance rate since May. The 25 basis point reduction lowered the benchmark rate to just 0.25 percent, a new record low. The deposit rate, already at zero, was left unchanged and the marginal lending facility was trimmed by 25 basis points to 0.75 percent thereby narrowing the interest rate corridor to just 75 basis points.

The latest move reflects a combination of factors, most notably a surprisingly sharp decline in inflation which, at provisionally just 0.7 percent in October, was nowhere close to its near 2 percent medium term target and was still heading in the wrong direction. At the same time, emergence from recession has been painfully slow and GDP growth over the second half of the year looks certain to undershoot earlier hopes. Meanwhile, broad money M3 continues to expand only very sluggishly (annual 2.1 percent rate in September) while lending to the private sector is still almost 2 percent weaker on the year. In addition, policy has been effectively tightened in recent months as banks have sought to repay earlier borrowings.

To this end, while reaffirming the ECB’s current forward guidance mantra of keeping key interest rates at present or lower levels over an extended period of time, ECB President Mario Draghi's press conference only indicated that the Bank will consider all available instruments. Hopes for a new LTRO remain, at least for now, unfulfilled. Still, the ECB has clearly taken on board the widening inflation undershoot and seems less than convinced that it will return to target over the policy relevant horizon. Accordingly, monetary policy will continue to operate with an easing bias over the foreseeable future.

Global Stock Market Recap

Europe and the UK

The majority of the European markets ended the week in negative territory after S&P downgraded France's credit ratings. The stronger than expected growth in both October U.S. employment and headline GDP growth has investors worried that the Federal Reserve will begin to reduce its stimulus measures sooner rather than later. The FTSE lost 0.4 percent and the CAC retreated 0.3 percent. However, the DAX gained 0.8 percent and the SMI was 0.2 percent higher on the week.

Equities were caught unawares by the European Central Bank’s surprise interest rate cut. The immediate reaction was a rally after the ECB move but then weakened in late trading as traders shifted their concerns to doubts about the health of the Eurozone economy. In the UK, the FTSE was down. The decline was attributed to a rise in the pound sterling against the euro that could hit UK exporters. Italy’s MIB suffered heavy losses after the ECB move. While the rate cut will make it easier for businesses in the periphery, it is not the case for banks which will suffer a drop in net interest income.

On Friday, Standard and Poor's cut France's sovereign credit ratings by one notch, saying that the government's economic policies have failed to improve the country's growth prospects, which in turn, reduces the room for sound fiscal reforms. S&P is lowering the unsolicited long term foreign and local currency sovereign credit ratings to 'AA' from 'AA+'. The outlook is stable. The short term ratings, at the same time, were affirmed at 'A-1+'.

In its autumn forecast, the European Commission said that economic growth is expected to gather pace over the forecast horizon, but it is too early declare the crisis over. The return to solid growth would be a gradual process. EU economic growth is set to gather some speed next year. The commission underlined that risks and uncertainty remain elevated and unemployment would stay at its record level. As such the return to solid growth will be a gradual process. The European Union's executive arm forecasts 0.4 percent contraction in the Eurozone this year, which was unchanged from the previous estimate released in May. The EC significantly raised the growth projections for the UK economy, citing improvement in private consumption and investment as well as slowing inflation. The UK forecast was lifted to 1.3 percent for this year from 0.6 percent projected in May.

Asia Pacific

Equities retreated last week as fears that the Federal Reserve might cut back its $85 billion monthly bond purchase programs sooner rather than later overshadowed positive Chinese merchandise trade data. The reason for the renewed Fed fears is the better than anticipated third quarter growth data from the U.S. While the headline number beat expectations, several of the components looked wobbly as inventories boosted growth. Only the Jakarta Composite advanced on the week, up 1.0 percent. Among the weekly declines, the All Ordinaries lost 0.2 percent while the PSEi dropped 3.5 percent. The Kospi and Sensex were down 2.8 percent and 2.5 percent respectively.

Most of the economic data from this region came from Australia, where employment provided the biggest disappointment, increasing only by 1,100 instead of the 10,000 expected. However, the international trade deficit eased thanks to increasing exports but declining imports. The RBA as noted elsewhere, kept its key policy interest rate at 2.5 percent.

Investors spent most of the week evaluating a mixed platter of earnings reports as they waited for two important releases from the U.S. — advance gross domestic product for the third quarter and the October employment situation report. They also traded warily as they waited for China’s important leadership meetings. Equities gyrate on virtually every U.S. data release since the Fed said that its policy decisions would be data dependent.

The Communist Party of China’s plenum begins on Saturday (November 9). The third plenary session of the 18^th Congress of the CPC Central Committee will take place between November 9 and 12. The party leadership has hinted that Mr Xi will use this occasion to send a message to the world about his plans for the rest of his decade in power.

Currencies

The U.S. dollar advanced against its major counterparts with the exception of the pound sterling last week. The euro dropped more than 1 percent immediately after the ECB announced its decision to cut rates. Not helping sentiment towards the euro was Friday’s announcement by Standard & Poor’s that it was cutting France’s sovereign credit rating by one notch to “AA”.

For much of this year, the euro’s resilience has acted as a brake on the Eurozone’s nascent recovery and added to deflationary pressures. Now the question is whether the ECB’s action will be enough to send the euro on a sustained slide, relieving those pressures. Some analysts say the euro will not weaken significantly unless the ECB is willing to contemplate more radical action such as cutting the Eurozone’s deposit rate below zero or mounting a further round of longer term refinancing operations.

However, the biggest influence on the euro will be Federal Reserve policy as it prepares to start scaling back its vast stimulus programs. In recent months, the Fed’s continued expansion of its balance sheet while Eurozone banks were paying back loans extended during the crisis bolstered the euro. But now investors are starting to focus on the diverging paths of a tapering Fed and increasingly dovish ECB.

Selected currencies — weekly results

Indicator scoreboard

EMU

The October PMI was unrevised from the flash estimate at 51.3, up just 0.2 points from its final September reading and consistent with sluggish growth of business activity at the start of the quarter. On a positive note, all but two of the reporting EMU countries posted national PMIs above the key 50 growth mark. Ireland posted a 30-month high (54.9) and Austria a 28-month high (52.7). The two trailing countries were France (49.1) and Greece (47.3). The results generally imply only a very modest pick-up in overall activity. Aggregate production and new orders expanded for the fourth month in a row but employment contracted for the 21st straight month reflecting subdued demand growth and caution over input costs which rose for the second month in a row. Factory gate prices also climbed but only marginally and output price inflation remained historically weak.

September retail sales dropped 0.6 percent on the month and were up 0.3 percent on the year. The limited breakdown of the headline data showed a slightly firmer underlying picture with (excluding auto fuel) purchases of non-food products sliding just 0.1 percent on the month, their first decline since June. Food, drink & tobacco sales dropped 0.6 percent after a 0.2 percent decline in mid-quarter. Among the larger member states, Germany (down 0.4 percent) and Spain (down 2.5 percent) both endured monthly setbacks while sales in France were only flat. Elsewhere monthly declines were widespread and only Ireland (0.1 percent) and Portugal (1.6 percent) recorded increases.

Germany

September manufacturing orders jumped 3.3 percent on the month and were a workday adjusted 7.9 percent above their level a year ago. Export oriented industries benefited most as the entire monthly advance was attributable to demand from overseas which expanded 6.8 percent. Much less promising, a 2.3 percent plunge in capital goods and a 1.7 percent slide in consumer & durable goods saw the domestic component drop 1.0 percent, reversing almost half of the previous month's 2.1 percent gain. Within the headline advance, capital goods jumped 5.5 percent on the month (overseas 10.2 percent). However, strength here was complemented by a 2.7 percent increase in consumer goods and a more modest 0.2 percent increase in basics. Despite their latest setback, domestic orders are still more than 4 percent above their level at the start of the year while total orders are up in excess of 7 percent.

September industrial production dropped 0.9 percent on the month and was up 1.0 percent from a year ago. Manufacturing output declined 1.1 percent from August although this only wiped out half of that month's gain of 2.2 percent and its 2-month moving average still showed a 0.7 percent gain. Capital goods were particularly soft, dropping 2.1 percent on the month but only after a 4.6 percent surge last time. Intermediates slipped 0.2 percent while consumer goods were flat as a 0.9 percent increase in durables was offset by a 0.2 percent slip in nondurables. Energy grew 2.1 percent but construction was down 1.8 percent.

September seasonally adjusted trade surplus expanded from an already upwardly revised €15.8 billion in August to €18.9 billion, a new record. The unadjusted surplus stood at €20.4 billion, up from €13.3 billion last time. The sharp improvement in the adjusted headline reflected a 1.7 percent monthly increase in exports together with a 1.9 percent drop imports. The increase in the former followed a 1.0 percent increase in August and left exports at their highest level since August 2012 and 3.6 percent stronger on the year. The drop in imports was the first since June and only the second since February. Even so, compared with September 2012 purchases from overseas were down 0.3 percent.

France

September industrial production (excluding construction) dropped 0.5 percent on the month. However, August's increase was revised significantly stronger to 0.7 percent. However, annual output dropped 0.9 percent. Manufacturing contracted 0.7 percent on the month and reversing much of August's 0.9 percent advance. Food & beverages (down 2.0 percent), coke & refined petroleum products (down 2.1 percent) and transport equipment (down 3.4 percent) all performed very weakly and other manufacturing (down 0.7 percent) also struggled. The only subsector to see positive monthly growth was electrical & electronic equipment (2.8 percent). Elsewhere mining & quarrying, energy, water supply & waste management expanded 0.4 percent.

United Kingdom

September industrial production was up 0.9 percent on the month and 2.2 percent from a year ago. Manufacturing output fully offset its unrevised and surprisingly steep setback in August and was up 1.2 percent and 0.8 percent on the year. Within manufacturing, seven of the 13 subsectors posted monthly gains in output. Pharmaceutical products & preparations (9.4 percent) were especially robust and there were solid increases in transport equipment (3.4 percent) and computer, electronic & optical goods (0.5 percent). The main downward impact came from coke & refined petroleum products where production slumped 6.1 percent. Elsewhere, mining & quarrying expanded 1.5 percent, oil & gas extraction was up 1.7 percent and electricity, gas, steam & air conditioning flat. Water supply & sewerage was down 1.6 percent.

September shortfall on global trade in goods unexpectedly widened out by £0.2 billion to £9.8 billion, its worst performance since October last year. The deterioration masked a modest 0.2 percent monthly increase in exports while imports jumped 2.7 percent. The underlying picture was also disappointing as the deficit excluding oil and erratics increased by almost £0.5 billion to £8.7 billion. Core exports were only flat on the month while comparable imports climbed 1.6 percent. The increase in the headline deficit was wholly attributable to a worsening in trade with the rest of the EU. Here the bilateral shortfall expanded from £5.2 billion in August to £6.0 billion as exports dropped 2.5 percent on the month and imports increased 2.3 percent. By contrast net exports to the rest of the world strengthened with the deficit falling £0.5 billion to £3.8 billion.

Asia/Pacific

Australia

September retail sales were up a greater than anticipated 0.8 percent on the month and were 2.9 percent higher than a year ago. It was the fastest monthly advance since February. On the month, other retailing was up 1.6 percent, department stores were 2.8 percent higher, clothing, footwear & personal accessory retailing gained 2.5 percent, food retailing was up 0.4 percent and cafes, restaurants & takeaway food services were up 0.6 percent. These increases were partially offset by a decline of 0.4 percent in household goods retailing. Over the longer term, clothing, footwear & personal accessory retailing was the strongest contributor to growth, up 1.3 percent in trend terms.

The September trade deficit was A$284 million, a decrease of A$409 million on the A$693 million deficit in August. Exports were up 0.5 percent on the month and 15.0 percent from the same month a year ago while imports were down 1.0 percent and up 4.4 percent. Non-rural goods were up 1.0 percent while rural goods dropped 3.0 percent. The main component contributing to the rural goods decline was other rural. Contributing to the increase in non-rural goods were metal ores and minerals and other mineral fuels. Other manufactures, metals and coal, coke & briquettes partly offset these gains. Contributing to the decline in imports were consumption goods, capital goods and non-monetary gold. Intermediate and other merchandise goods however increased.

October seasonally adjusted unemployment rate was 5.7 percent. The unemployed increased by 9,100 to 709,300 in October. Employment increased by a meager 1,100 to 11,639,200. The increase in employment was due to increased part time employment which was up 28,900 to 3,544,500. This was offset by a decline in full time employment which was down 27,900 people to 8,094,700. The increase in total employment was mainly driven by an increase in male part time employment. The seasonally adjusted labour force participation rate was steady at 64.8 percent in October.

China

October merchandise trade balance was $31.10 billion, more than double September’s balance of $15.20 billion. Exports were up 5.6 percent on the year after slipping 0.3 percent last time. Imports were up 7.6 percent on the year after climbing 7.4 percent in September. For the ten months this year, the trade balance is $200.46 billion. The trade surplus with the U.S. was $5.54 billion after a deficit of $1.19 billion in September. Exports were up 8.1 percent from a year ago while imports were 13.9 percent higher. The trade surplus with the EU was $12.04 billion after a deficit of $1.1 billion the month before. Exports were up 12.7 percent while imports were up 14.0 percent. The trade balance with Japan edged up to $0.06 billion after recording deficits from February through September. Exports were up 5.6 percent while imports were 3.6 percent lower on the year.

Americas

Canada

October employment was up 13,200 while the jobless rate remained unchanged at 6.9 percent. The participation rate also stabilized at 61.8 percent. What employment growth there was came from a 16,000 increase in full time jobs while part time positions were down 2,700. However, private sector payrolls were down 22,100 and the number of self-employed declined 12,000. This left a 47,300 surge in public sector hiring to account for the entire headline gain. The goods producing sector lost 12,200 jobs within which manufacturing slipped 6,400. Construction (down 9,300) also declined as did agriculture (down 1,800). Partial offsets were provided by increases in utilities (4,700) and natural resources (500). By contrast, service sector employment gained 25,400 jobs led by solid increases in accommodation (29,900), health care & social assistance (19,900) and public administration (19,300). In addition, transportation & warehousing added 6,200 jobs, professional, scientific & technical services 8,100 and education 9,800. However, retail declined 19,700, business, building & other support services dropped 32,600 and finance, insurance, real estate & leasing was down 6,700.

Bottom line

The European Central Bank surprised the markets and lowered its key interest rate by 25 basis points to a record low of 0.25 percent. Both the Reserve Bank of Australia and the Bank of England left their monetary policies unchanged. Other surprises for investors were the better than expected U.S. growth and employment data. Investors reacted accordingly — first rallied, then sold as they worried that this would move a Federal Reserve curtailment of bond purchases to December.

Expectations are high as Communist Party leaders begin a four day conclave or plenum on November 9^th. History shows these kinds of introspective sessions can launch the big reforms that propelled China's growth. Deng Xiaoping's 1978 program was the most epochal. China also releases October economic data over the weekend for consumer and producer prices, industrial output and retail sales. In Europe, flash third quarter gross domestic product data for the Eurozone and member states will be monitored closely to see if the recovery is still in progress.

Looking Ahead: November 11 through November 15, 2013

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