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Global Markets

The Federal Reserve’s policy move Wednesday was a relief more than a surprise. It removed a good deal of uncertainty from the markets. It also was a two handed move. On the one hand, the Fed said it would reduce its bond buying programs by $10 billion beginning in January. On the other — in their forward guidance — they said that interest rates world remain at virtually zero well past the time that the unemployment rate declines below 6.5 percent, especially if projected inflation continues to run below the FOMC’s 2.0 percent longer-run goal.

Both the Reserve Bank of India and the Bank of Japan also met and announced their policy decisions. Both left monetary policy unchanged. And elsewhere, the Reserve Bank of Australia and the Bank of England each published minutes of monetary policy meetings that were held earlier this month. The minutes explained why both chose to leave their monetary policies unchanged.

Most indexes rallied last week with the notable exceptions of the Shanghai Composite (down 5.1 percent) and the Hang Seng (down 1.9 percent). Global gains ranged from 0.1 percent (Thai SET) to 4.5 percent (Spanish IBEX). In general European indexes mostly outperformed those in North America and the Asia/Pacific region.

Global Stock Market Recap

Europe and the UK

The major equity indexes advanced four of five days last week. Investor euphoria resulting from the Federal Reserve's decision late Wednesday to begin curtailing its bond buying programs lingered to end of the week. Investor sentiment also received a boost from strong German business sentiment and consumer confidence data and an unexpected upward revision to U.S. GDP. On the week, the FTSE was up 2.6 percent, the CAC advanced 3.3 percent, the DAX jumped 4.4 percent and the SMI gained 3.2 percent.

The positive economic data helped the markets shrug off the EU's loss of its coveted AAA rating on Friday. S&P lowered the sovereign ratings of the European Union from AAA, citing deterioration in overall creditworthiness of member states amid contentious EU budgetary negotiations to AA+. In reply, the European Commission said the credit rating of European Union should be assessed on its own merits, due to the special treaty based status of the EU budget. At the same time, S&P affirmed Britain's triple-A sovereign credit rating, citing "exceptional" monetary flexibility and bright economic prospects. However, the rating agency maintained a 'negative' outlook on the top notch ratings.

The Bank of England published minutes of its most recent monetary policy committee meeting. At that time, the MPC were unanimous in the decision to hold the interest rate and quantitative easing unchanged. They voted to retain the 0.50 percent record low interest rate and quantitative easing at £375 billion. At the meeting, all members agreed that neither of the price stability knockout conditions that would override the policy guidance provided in August had been breached. Moreover, a recovery in output appeared to be underway. Inflation had eased and was expected to remain close to the Bank’s 2 percent target. The minutes said no member thought it appropriate to tighten or to loosen the stance of monetary policy at this time.

Asia Pacific

Equities alternated between gains and losses as investors reassessed the impact of the Federal Reserve's decision to taper its stimulus program on interest rates and capital flows. Concerns about tight Chinese liquidity conditions had a negative effect on investors making them cautious. This sent both the Shanghai Composite and Hang Seng lower for the week. The indexes lost 5.1 percent and 1.9 percent respectively.

A cash shortage among Chinese lenders worsened Friday despite an injection of funds from the PBoC, raising fears over the health of the financial system which is grappling with a slowdown and rising bad debt. The interest rates banks charge each other for short term loans jumped to 8.2 percent, the highest level since the summer, when a crippling liquidity squeeze rocked global markets. The stress in the banking system is starting to spread elsewhere, with stocks in Shanghai declining for a ninth straight day to the weakest level in four months, while government bonds dropped, pushing the 10-year yield to near its highest level in eight years.

The turmoil has been sparked by a scramble for funds by banks as they near end of the year when they typically need extra cash to meet regulatory requirements and funding demands from companies. This year, many of the banks are already under stress as they struggle with rising defaults on loans and the slowest economic growth in 20 years. The interbank lending market in China has grown dramatically in recent years, in part because of demand from the country's surging shadow banking sector. Lending by shadow banks has increased as China has tried to limit lending from traditional banks in an attempt to control the country's rising debt levels.

The PBoC has also contributed to the squeeze by refraining from adding cash through regular injections over the past two weeks. But late Thursday, it said it is using a special type of short term liquidity operation to inject cash into the system. Another factor driving the stress in the interbank lending market is that many loans made by the PBoC aimed at easing the cash squeeze will mature at the end of the year, forcing borrowers to come up with the cash to pay them off.

In emerging markets, there was little sign of a repeat of the panic that hit stocks, bonds and currencies earlier in the year when the Fed first discussed winding down its stimulus. Rather, investors largely took the Fed’s decision in their stride which came earlier than most had expected. They were reassured by the Fed’s guidance to hold interest rates at record lows while the economy recovers.

Reserve Bank of India

In contrast to general expectations for another 25 basis point tightening, the RBI opted to keep policy unchanged. The key repurchase rate stayed at 7.75 percent while the reverse repurchase rate remains pegged at 6.75 percent and the marginal standing facility rate at 8.75 percent. There was also no move on the cash reserve ratio (4.0 percent). Speculation about another move on rates had been prompted by the surprisingly high November CPI (up 11.2 percent from a year ago) and WPI (up 7.5 percent on the year) inflation. However, while both acknowledging this and making some warning noises about signs of faster wage growth, the RBI also pointed to sluggish economic activity and a negative output gap that, combined with the effects of earlier monetary tightening, should ease price pressures in due course.

The announcement made it plain that the decision to maintain the status quo was very close and further bad news on inflation next month would most likely see official interest rates increased once more. Additionally, the monetary authority had a more than wary eye on the outcome of the FOMC meeting with domestic financial markets and the rupee potentially highly vulnerable to any Fed action to ease its stimulus. The RBI’s decision came prior to the Federal Reserve’s announcement that it would begin curtailing its monthly bond purchases. India is better prepared for the Fed to curtail stimulus than earlier this year according to governor Rajan. The rupee plunged in August amid an exodus of funds from emerging markets on concern that the purchases would end.

Bank of Japan

As expected, the Bank of Japan left its key interest rate range at zero to 0.1 percent. It also left its financial asset purchases unchanged. The goal of the Bank is to increase the monetary base at an annual pace of about ¥60 to ¥70 trillion yen. The monetary policy board maintained its view that the Japanese economy is recovering moderately. The MPB noted that growth overseas has been picking up moderately although it remains somewhat lackluster. However, exports have been picking up. It said that CAPEX has been picking up along with corporate profits.

Regarding the BoJ's aim to achieve 2 percent inflation in two years, the announcement said that the Bank will continue with quantitative and qualitative monetary easing with the aim of achieving its inflation target of 2.0 percent as long as necessary. It is expected that the conduct of monetary policy will support positive activity in the economy and financial markets. The BoJ thinks it will contribute to increased inflation expectations and lead Japan’s economy to overcome the deflation that has lasted nearly 15 years.

Prior to this meeting, Japan's third quarter GDP was revised downward to a much worse than expected 1.1 percent when compared with a year ago. Within that, private consumption is growing. However, there are fears that Japanese citizens are simply bringing purchases forward ahead of a consumption tax that will be introduced in April 2014.

Currencies

The U.S. dollar rallied against all of its major counterparts with the exception of the pound. The currency reached a five year high against the yen on optimism U.S. economic growth will outperform Japan’s next year. The yen retreated for an eighth week after the Bank of Japan retained its plan to add ¥60 trillion to ¥70 trillion a year to the monetary base.

The Canadian dollar plunged to the lowest level in three years in intraday trading Friday after the country’s inflation rate remained below the Bank of Canada’s target band for a second month. The currency extended a weekly drop after third quarter US GDP was revised up and two days after the Federal Reserve said it would begin trimming its stimulus. BoC Governor Stephen Poloz cited the risk of low inflation in dropping his bank’s bias to raise interest rates earlier this year. The Bank’s target band is 1 percent to 3 percent.

At the same time, the Australian dollar almost matched its worst weekly run of losses since before it was floated three decades ago after Reserve Bank Governor Glenn Stevens reiterated the currency is too high and the Federal Reserve pared its stimulus. The currency was freely floated in December 1983. Stevens said on December 18 that an exchange rate above 90 U.S. cents is probably not “sustainable.”

Selected currencies — weekly results

Indicator scoreboard

EMU

December flash composite PMI climbed to 52.1 from the November final of 51.7 and close to the 27-month peak seen in September. However, the index is still close enough to the 50 breakeven mark to suggest that growth of the Eurozone economy at year end is only quite modest. The manufacturing PMI was 52.7, up 1.1 points from its final mid-quarter reading and a 31-month high. However, service sector activity slowed somewhat as its headline index slipped to 51.0, a four month low. New orders climbed sharply in manufacturing with export demand proving particularly robust. By comparison, growth of new business in services was only sluggish as domestic demand remained lacklustre. Overall employment declined for the 24th consecutive month but the decline was only marginal. For the core countries, the composite output index slipped 0.2 points to a still solid 55.2 in Germany but declined a further point to a disappointingly weak 47.0 in France. The performance gap between the two economies continues to widen alarmingly. Elsewhere across the region output expanded at its fastest pace since April 2011. Outside of Europe, China’s flash manufacturing index disappointed and retreated to a reading of 50.5 from the November final of 50.8. And in the US, the manufacturing PMI slipped to 54.4 from 54.7 in November.

November harmonized index of consumer prices edged down 0.1 percent on the month and was up 0.9 percent from the same month a year ago. Among the core measures, excluding food, alcohol, tobacco and energy, prices were up 0.9 percent on the year. Excluding just seasonal food and energy and without only unprocessed food and energy inflation stood at 1.0 percent. Regionally, Estonia (2.1 percent) continued to occupy the top rung of the inflation ladder ahead of Finland (1.8 percent) and Germany (1.6 percent). At the bottom was Greece (down 2.9 percent) where the annual rate dropped a full percentage point. Cyprus (down 0.8 percent) also saw prices declining on the year.

Germany

December ZEW readings for current conditions were up 3.7 points at 32.4 and expectations gained 7.4 points to 62.0. The increase in the current measure was the first since September and left the index at its highest level since June 2012. More impressively, expectations were up for the fifth consecutive month and achieved their best posting since April 2006.

The December Ifo overall business climate index was 109.5, up a couple of ticks from November as the assessment of current conditions weakened slightly while expectations made fresh headway. The measure of current conditions was down 0.6 points to 111.6, its third small decline in the last four months. However, the December level was still 4.5 points above its year ago level. Meantime, expectations rose 1 point, its fourth monthly gain out of the last five, and in so doing reached their highest level (107.4) since March 2011. Among the major sectors, modest improvements in sentiment in construction, manufacturing and services contrasted with equally minor declines in retail and wholesale.

United Kingdom

November consumer prices edged up 0.1 percent on the month and were up 2.1 percent on the year and the lowest level in four years. Core CPI also was up just 0.1 percent on the month and was 1.8 percent firmer on the year. The main downward pressure on the CPI's 12-month increase came from weakness in the energy and food sectors. Lower fuel bills subtracted more than 0.1 percentage points off the overall annual increase while inflation in food and non-alcoholic drinks dropped 1.1 percentage points to 2.8 percent. Elsewhere annual inflation was little changed in most categories, the only real exception being restaurants and hotels which recorded a 0.5 percentage point decline to 2.3 percent.

November output prices dropped 0.2 percent and were up 0.8 percent on the year. Input prices also were down 0.2 percent and lost 0.9 percent on the year. In general the main components of the output price index saw little change on the month. However, a 0.3 percent monthly increase in paper & printing was easily more than offset by a 1.1 percent drop in petroleum products and a 0.5 percent slide in chemicals and pharmaceuticals. The core output price index was 0.1 percent lower on the month and 0.7 percent firmer on the year. Seven of the nine input cost categories posted monthly declines led by crude oil (2.9 percent) ahead of imported metals (1.1 percent), imported chemicals and other imported materials (both 0.5 percent).

November claimant count unemployment was down 36,700. The mid-quarter drop means that joblessness on this definition has declined every month since November 2012 and over the last three months alone, claims were down 124,200. The unemployment rate edged down to 3.8 from 3.9 percent in October and nearly a full percentage point below its year ago level. For the three months to October, the ILO data showed a surprisingly large 99,000 drop in unemployment and a jobless rate of 7.4 percent, down 0.2 percentage points from last time and now just 4 ticks above the BoE's tightening threshold. Annual average earnings growth in the three months to October was just 0.9 percent. Excluding bonuses the picture was still softer with annual growth here only 0.8 percent, unchanged from last time.

November retail sales were up 0.3 percent after dropping a steeper revised 0.9 percent in October. Annual growth of purchases was 2.0 percent. Excluding auto fuel volumes were up 0.4 percent on the month and were 2.3 percent above their year ago level. The underlying details were a little stronger than the headline data as excluding auto fuel, volumes were up 0.5 percent from the start of the quarter. By comparison food advanced only 0.2 percent. The best performing subsector was clothing & footwear (3.8 percent) ahead of household goods (0.9 percent) and non-store retailing (0.4 percent). However, non-specialized stores suffered a 3.1 percent monthly reversal and the other stores category was off 0.3 percent. Fuel sales were down 0.4 percent.

Third quarter gross domestic product was unrevised at 0.8 percent from the previous quarter but the annual increase in total output was adjusted 0.4 percentage points higher to 1.9 percent. The revision means that GDP is now only 2.0 percentage points below its pre-crisis peak as opposed to the 2.5 percentage points previously estimated. Among the key components of private sector demand household consumption was up 0.8 percent on the quarter as indicated previously while gross fixed capital formation was a tick stronger at 1.5 percent. Total domestic expenditure grew 1.9 percent from the second quarter and was 2.9 percent above its year ago level. However, probably the most striking aspect of the updated national accounts is the current account balance which, with a deficit of some Stg20.7 billion, was more than Stg14 billion larger than in the previous quarter. Moreover, at 5.1 percent, the red ink posted its largest percentage share of nominal GDP since the third quarter of 1989. However, only some of the damage was caused by the shortfall on trade which doubled to Stg10.0 billion.

Asia/Pacific

Japan

Sentiment among large manufacturers as measured by the Tankan survey climbed to its highest level in six years. Sentiment among large manufacturers was up 4 points from the prior quarter to 16, beating estimates at 15 with its highest reading since September 2007. Sentiment among large nonmanufacturers climbed 6 points to 20. Small manufacturers reading improved to plus 1 from minus 9 in September. Nonmanufacturers climbed to plus 20 in the latest survey, up from 14 previously. Small nonmanufacturing plus 4 topped last time’s minus 1. Tankan's capital expenditures survey came in at 4.6 percent, well below estimates at 5.5 percent and falling from the prior quarter's reading of 5.1 percent.

November merchandise trade deficit ballooned to ¥1.292 trillion from ¥1.091 trillion in October. The trade figures mark the 17th consecutive monthly trade gap, the longest-running series in decades. On the year, exports were up 18.4 percent (forecast was 18.0 percent) while imports jumped 21.1 percent (forecast was 21.3 percent). The weakening yen is helping Japan record higher exports, but it also makes the cost of imports more expensive, particularly for fuel and other resources. Exports to the EU were up for the 6^th consecutive month, climbing this time by 19.4 percent from a year ago. Exports to Asia were up 18.9 percent and those to China, 33.1 percent. Exports to the US jumped 21.2 percent. On a seasonally adjusted basis, the trade deficit was ¥1.346 trillion, up from ¥1.087 trillion in October. On the month, exports slipped 0.2 percent while imports were 3.5 percent higher.

Americas

Canada

October manufacturing sales were up 1.0 percent on the month for an annual growth rate of 2.6 percent. Volume sales were similarly robust, also advancing 1.0 percent from their September level to stand 1.5 percent higher on the year. Nominal shipments made monthly headway in 13 of the 21 reporting industries, led by food (6.9 percent) and chemicals (2.8 percent). However, autos were down 1.9 percent and aerospace products slumped 4.5 percent. Excluding motor vehicles, parts and accessories sales were up 1.3 percent from the end of the third quarter and 2.6 percent from October 2012. New orders jumped 5.9 percent on the month and backlogs gained 0.7 percent. However, inventories climbed 1.9 percent which was sufficient to add 0.02 months to the inventory/sales ratio which rose to 1.39 months, matching its year ago value.

October retail sales declined 0.1 percent following September's 1.0 percent increase. The decline left purchases 3.0 percent above their level a year ago, down from a 3.6 percent annual rise in September. Volume sales were firmer but a 0.2 percent monthly advance was still sluggish enough to suggest that consumers were in cautious mood. Within overall nominal sales, four of the eleven subsectors recorded monthly declines. Motor vehicle & parts (down 1.9 percent) were especially weak and without this category headline sales would have advanced 0.4 percent from September. Gasoline stations (down 1.6 percent) also struggled on the back of falling prices and furniture & home furnishings (down 1.9 percent) similarly endured a poor October. However, there were respectable monthly advances in food & beverages (1.7 percent), electronics & appliances (2.7 percent) and by miscellaneous store retailers (0.8 percent). Clothing & accessories were also up 0.4 percent and building material & garden equipment & supplies increased 0.2 percent.

November consumer prices posted no change on the month and a 0.9 percent increase on the year. The core measures were especially soft. Excluding just food and energy prices were down 0.3 percent on the month and recorded a 0.7 percent increase from November 2012. The Bank of Canada’s preferred measure which excludes eight volatile items slipped a monthly 0.1 percent for a 1.1 percent 12-month rate. Seasonal factors are negative in November and adjusted for these, the CPI was up 0.2 percent on the month. On the same basis, excluding food and energy the index slipped 0.1 percent and the BoC gauge was only flat. Within the adjusted basket the only monthly increase of any note was in shelter (0.5 percent), the next largest increase being clothing & footwear (0.3 percent) and then food (0.2 percent). Elsewhere prices were subdued and were down in transportation (0.6 percent).

Bottom line

Events last week focused on the Federal Reserve and its decision to begin to curtail its stimulus. Reaction in the markets was generally positive and much calmer than the initial reaction in the spring when the subject was first broached. Economic data were mixed. The big surprise was an upward revision is U.S. third quarter GDP.

There are little new economic data scheduled prior to the New Year. However, Japan does release its major economic data for November and the New Year begins with December purchasing managers’ indexes. And Latvia becomes the member state of the Eurozone on January 1.

Looking Ahead: December 23 through December 27, 2013

Looking Ahead: December 30 through January 3, 2014

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