Equities showed signs of trying to reverse October's losses all in one week. Equities (and other markets as well) yawned at the Federal Reserve Open Market Committee's decision to increase the federal funds rate for the 12th time by 25 basis points to 4 percent. The other three central banks that met - Reserve Bank of Australia, Bank of Japan and European Central Bank - kept the status quo and left policy unchanged. All equities markets followed here posted healthy gains last week.
Global Stock Market Recap
Europe and Britain
While stocks enjoyed their best day in two years on the last day of October, they only managed to put a dent in the month's formidable losses. But the positive performance carried through for the rest of last week as merger activity - real and rumored - stimulated investors' appetite for equities. Bids in telecommunications such as Telefónica of Spain's for O2, the UK mobile phone company, and Barrick Gold of Canada's for gold miner Placer Dome brought a new level of excitement. Although stocks were down slightly on Friday - pressured by weaker-than-expected job growth in the U.S. and tepid trading on Wall Street - all three indexes tracked here had sizable gains on the week.
European markets have comfortably outperformed Wall Street so far this year. But analysts are divided on prospects for the rest of the year. In the aftermath of previous October sell offs, there have been rallies in November and December. And no doubt investors will be anxious to ensure their 2005 gains.
European Central Bank
Despite the recent pickup of hawkish rhetoric from ECB officials, its Governing Council left the key interest rate unchanged at 2 percent, where it has been since June 2003. Inflation continues to be stubbornly above the Bank's 2 percent ceiling, while the three-month moving average for M3 money supply growth has soared to 8.2 percent on the year, well beyond the ECB's 4.5 percent target. Recent indicators show that the economy is stabilizing and improving. Analysts suggest - and the markets continue to build in - a rate increase that could come as soon as the December 1st meeting. With the Federal Reserve's latest 25-basis-point increase, the spread between European and U.S. interest rates has widened to 200 basis points or 2 full percentage points.
In his press conference after Thursday's meeting, ECB Chairman Jean Claude Trichet expressed the Bank's concern about an increase in inflation expectations and "second round effects" as higher energy costs force workers to push for higher wages. He also said that policy makers were prepared to increase interest rates at any time to contain inflation amid surging energy costs. Trichet ratcheted up the rhetoric saying the bank needed to show "strong vigilance" against inflation and confirmed that recent economic indicators suggest that activity is improving. His hard line stance kept open the possibility of an ECB interest rate rise as early as next month, ending more than two years in which the key policy interest rate has been left unchanged at 2 percent. But for some reason, the financial markets attached a slightly lower probability to a December increase than before, but still expected at least a 25 basis point rise by March.
Asia/Pacific
Japanese stocks bucked the downward trend in other stock markets and were up in October. And they continued their winning ways into November as the Nikkei vaulted above the 14,000 level for the first time in four years. The increase was abetted by particularly robust performance in the financial services sector, which had lagged the Topix earlier in the year. The sector is posting strong earnings and is enjoying record trading volumes.
On Tuesday, a software problem delayed stocks and convertible bond trading until mid-afternoon as Tokyo Stock Exchange recovered from the worst system failure in its 56-year history. The collapse of the system came at a particularly awkward time. Traders were deprived of their first opportunity to react to potentially market-moving news of the day before - a cabinet reshuffle reaffirming a commitment to the country's reform program and a closely watched Bank of Japan report that confirmed the economy was slowly emerging from deflation. Interest in the Japanese stock market has been heightened by strong merger and acquisition activities as well as the announcement of Alan Greenspan's successor at the Federal Reserve. The TSE managed a scant one-and-a-half hours of trading on Tuesday.
Systems failures at leading stock exchanges are rare, but not unheard of. The TSE's computer breakdown appears to have been sparked by a misplaced data file following a big capacity upgrade. Unlike other big exchanges, however, the TSE appears to have skimped on testing and crisis management. The back-up system, which should have kicked in when the trading system crashed, uses the same software. So do some of Japan's other stock exchanges. Similarly, the back-up system designed to withstand earthquakes simply duplicates the main system and is housed in the same (admittedly, robust) location.
Bank of Japan
As expected, the Bank of Japan left its policy interest rate at near zero and kept its ultra-loose lending policy intact at its meeting last Monday. The BoJ will continue to conduct money market operations aiming at the outstanding balance of current accounts held at the Bank at around ¥30 to ¥35 trillion. However, the monetary policy board signaled its intention to end its current policy within the next six to 12 months. In its half-yearly report on economic activity and prices, the BoJ revised its inflation forecast upward from 0.3 percent to 0.5 percent for the fiscal year to March 2007 (the Japanese fiscal year ends March 31, 2006). The bank had pledged to leave its quantitative easing policy, which was introduced in March 2001, unchanged until prices stabilize. While the bank conceded that there were a number of risk factors such as high oil prices (Japan imports virtually all of its petroleum) or an external shock. The BoJ has to be careful not to end its policy too soon and incur political wrath as it did when it prematurely increased interest rates only to have to rescind the move after 6 months in early 2001.
Deflation in Japan is a legacy of the bursting of asset price bubbles in the early 1990s, which dragged down equity and real estate prices by about 75 percent. The bubble had lifted the Nikkei up to a record 38,957 on December 29, 1989. The Nikkei, which fell to a 20-year low on April 28, 2003 of 2608, has risen over 22 percent this year. Land prices rose in central Tokyo for the first time in 15 years this year. The BoJ has maintained its quantitative easing policy since March 2001 to help overcome deflation. It has set three conditions that must be met for a change: core consumer prices must stop falling for at least a few months; policy makers are sure price declines won't resume; and the bank is confident about the overall strength of the economy. Core prices have risen only in one month since April 1998. The central bank first adopted the zero rate policy in March 1999. It raised rates in August 2000 in the face of government opposition, saying the economy had recovered sufficiently to cope with higher borrowing costs. Seven months later it was forced to cut rates again and adopt a quantitative easing policy following the slump in global growth after the internet technology bubble burst.
Reserve Bank of Australia
As expected, the Reserve Bank of Australia monetary policy board maintained its 5.5 percent interest rate for the eighth month. Recent data point to a weaker economy as employment was down for the latest month and the quarter index of consumer prices was up less than expected. Because of the narrowing interest rate spread between Australia and the U.S., the Australian dollar dropped to a four-month low. The spread between the two countries is now only 150 basis points - the lowest in four years. The RBA doesn't release a statement when rates are unchanged. On November 7th it will publish its quarterly monetary policy statement, which provides a commentary on the economy. The central bank has said it won't raise rates because of an initial increase in the inflation rate from oil if it doesn't lead to surges in wages and other prices.
Currencies
Interest rate differentials were the focus of currency traders last week, with four central banks meeting to decide policy. The dollar benefited from the inaction by the Bank of Japan and the ECB and the action by the Fed. The yen sank to a 26-month low against the dollar as currency market players bet that slower-than-expected job growth in the U.S. will not deter the Fed from continuing on its path of increasing interest rates. Japanese officials have indicated they are not concerned about the currency's decline. Rather, the weaker yen helps repatriated profits of exporters as well as their competitiveness in overseas markets and especially the United States. Japanese demand for foreign bonds has undermined the currency.
The euro was down last week as well as the spread between U.S. and EMU interest rates continued to grow when the Fed increased interest rates to 4 percent while the ECB maintained the status quo at 2 percent. The euro's decline was reinforced after Fed Chairman Alan Greenspan confirmed that growth remains firm in testimony before the U.S. Congress Joint Economic Committee. For some reason, the euro was also weakened after ECB President Jean Claude Trichet damped speculation the bank is poised to raise interest rates as soon as next month when he said that ECB rates were still appropriate. The probability of a 25-basis-point increase was seen as high after weeks of hawkish comments from bank officials that were interpreted to be preparing the market for an increase. Mr. Trichet's statement disappointed euro bulls.
Indicator scoreboard
EMU - October manufacturing purchasing managers' index climbed to 52.7 from 51.7 in September. The PMIs for Germany, Italy and Spain were higher but the index for France edged downward. Both the output and input price components were higher in October. Contributing to the index's improvement was a weaker euro combined with stronger worldwide demand. The index is compiled by NTC Research. An index level higher than the 50 breakeven point signifies growth.
October service sector business activity index edged up to 54.9 from 54.7 in the previous month. The index was higher in France and Italy but lower in Germany and Spain. New orders showed a similar pattern with higher readings for France and Italy as well as the EMU as a whole and lower ones for Germany and Spain.
September unemployment rate edged down to 8.4 percent from 8.5 percent in August. The major reason for the decline has to do with methodological changes in Germany that recently inflated unemployment data. Distortions now seem to have abated although there are problems with the seasonal adjustment. (There continues to be a significant difference between the national unemployment rate and that reported by Eurostat.)
September producer price index jumped 0.6 percent and was up 4.4 percent when compared with last year. The increase was due to higher energy prices that were up 1.7 percent and 16.4 percent on the year. Excluding energy, the PPI was up 0.2 percent and 1.3 percent on the year.
Germany - September seasonally adjusted retail sales were down 1 percent and 0.8 percent when compared with last year. Excluding autos and gasoline, sales sank 1.6 percent and were down 0.7 on the year.
October seasonally adjusted unemployment dropped by 26,000. Those unemployed were down by 21,000 in the west and 15,000 in the east. The unemployment rate for all of Germany was 11.6 percent, down from 11.7 percent in September while in the west, the unemployment rate edged down to 9.8 percent from 9.9 percent in the prior month and in the east, the rate declined to 18.2 percent from 18.4 percent. September employment was up by 31,000 jobs. One of the reasons given for the drop in unemployment was that far fewer persons reported themselves to be unemployed after having held a job.
September real, seasonally adjusted manufacturing orders rebounded and were up 2.8 percent after sinking 3.8 percent in August. The jump can be traced in part to an above average number of bulk orders. Orders were up 7.8 percent when compared with last year. Foreign orders were up 5.2 percent while domestic orders edged up 0.4 percent. Capital goods orders were up 5.1 percent while consumer product orders declined by 1.9 percent.
Italy - September producer prices were up 0.3 percent and 3.8 percent when compared with last year. The increase was mostly due to higher energy prices. Excluding energy, the PPI was unchanged on the month and up 0.9 percent on the year.
Asia
Australia - September retail sales declined 0.3 percent and were up 2.4 percent when compared with last year. Sales at department stores dropped 1.3 percent and sales at supermarkets were down 0.4 percent.
September merchandise trade deficit widened to A$1.62 billion ($1.2 billion) from a revised A$1.46 billion in August. Exports were down 0.7 percent while imports were up a scant 0.3 percent. Exports of metals, grain and meat declined while imports of business equipment increased. Farm goods, such as meat, sugar, wheat, and wool, were down 1 percent. Non-rural goods, which include metals and minerals, also dropped 1 percent. Capital goods imports which include business machinery and vehicles were up 3 percent while consumer goods imports were down 1 percent.
Americas
Canada - October employment increased by 68,700 jobs while the unemployment rate edged down to 6.6 percent from 6.7 percent in September. Most of the gains were part time, which were up by 59,100 jobs. Full time employment was up by 9,500 jobs. Most of the employment gains were in private sector jobs, up 59,000. Retail jobs increase by 30,000 while in finance, insurance, real estate & leasing jobs were up by 26,000. However, manufacturing jobs declined by 7,700 and public administration jobs were down 13,000.
Bottom line
Markets have become more volatile and are being buffeted by a wave of cross currents. The good news is that corporate profits remained strong in the third quarter, allowing higher dividends, share buy backs and a merger spree. Interest rate differentials have sparked a resurgence in the dollar as interest rates climb in the U.S. but not elsewhere. This could change as rhetoric from the Bank of Japan and ECB indicate that increased rates are on the horizon. The trick is to figure out just where that horizon lies. And inflation remains a worry despite sanguine core rates that are followed intently by market players and central banks alike. However, total inflation also counts - and that is climbing everywhere thanks to energy costs. It should be noted that weather forecasters are enjoying enhanced popularity in the financial markets as analysts attempt to measure the impact of the northern hemisphere winter on energy supplies.
A reversal of fortune
