By Anne D. Picker, International Economist, Econoday
Monday, September 5, 2005

Global Markets
Most economic news garnered little attention last week as all eyes focused on Hurricane Katrina and its horrific aftermath. But stock indexes gained last week anyhow. The U.S. dollar declined and weaker-than-expected economic data in the U.S. had little negative affect on equities. Worries about hurricane damage and high gasoline prices were offset by speculation that the Federal Reserve might not increase interest rates as much as expected, at least until it had time to assess the economic impact of Katrina. Crude prices stabilized after the U.S. said it would release some of its strategic reserves, and prices eased even more after the International Energy Agency (IEA) indicated on Friday that they were ready to release crude reserves as well.

The IEA acts as energy policy advisor for its 26 member countries that include the U.S., Canada, most European countries, Japan, New Zealand, Australia, Turkey and South Korea. Founded during the oil crisis of 1973-74, its initial role was to coordinate measures in times of oil supply emergencies. Now with a staff of around 150 energy experts and statisticians, the IEA conducts a broad program of energy research, data compilation, publications and public dissemination of the latest energy policy analysis and recommendations on good practices. This will help the U.S. to import additional supplies as needed. All members supported the IEA's release of 2 million barrels of oil per day to dampen the shock in the wake of Katrina.

Oil companies are endeavoring to assess damage to their production platforms, pipelines and refineries in the Gulf. And the regional electric company has indicated that it is making good progress on restoring electricity to the refineries. Both refineries and the pipelines that deliver the products to markets cannot function without it. The swift return of electricity will also help the natural gas crisis as well. The U.S. government has suspended certain clean air requirements that will help refineries maximize output as they come back on line. An added complexity concerns these facilities' employees - there is no place for workers to live, although one company said it will build a tent city for their employees.

Shipping companies are beneficiaries from the crisis. The government has waived the Jones Act to allow foreign-owned tankers to ship gasoline between U.S. ports after the pipeline supply interruption. The act requires that only U.S. owned, flagged, built and crewed vessels move cargo between U.S. ports. The statute was introduced in 1920 to help protect jobs. Waiving the act might increase demand for tankers. Oil product tankers have outperformed larger ships that carry crude oil.

Global Stock Market Recap

Europe and Britain
Higher crude prices usually are bad news for stocks because they increase inflation and/or lower economic growth. Last week was an exception. The FTSE, after having Monday off, was up 1.9 percent primarily because oil companies benefit from higher prices. The DAX and CAC were also up on the week as all three indexes regained some of the previous week's losses. Although the DAX and CAC maintained their poise during last week, the rising euro dampened investor expectations for exporters as the week headed towards a close and as the U.S. dollar headed for another weekly drop against the euro. Investors are concerned that the weaker U.S. currency will erode corporate profits.

Since July's merger between Royal Dutch and Shell, oil and gas has become the biggest component of the FTSE 100 index. This marks an important change. The merger has served to highlight that the London market is more leveraged to the economic cycle than once thought. For example, BP, Royal Dutch Shell and BG Group account for 20 percent of the FTSE's total capitalization while mining stocks account for another 5 percent. Combined, this has increased the weighting of this group to 25 percent - up from 16 percent four years ago.

The European Central Bank met on Thursday and as expected left their policy interest rate unchanged at 2 percent. It has been at this level since June 2003. At the same time, the ECB cut its economic forecast for a third time this year and raised its prediction for inflation as oil prices surged to a record. Its 2005 growth forecast has been cut to around 1.3 percent from June's 1.4 percent. It expects growth to accelerate to about 1.8 percent in 2006, less than the 2 percent it projected previously. The bank said inflation will average above their target at about 2.2 percent but would ease to 1.9 percent in 2006. In June, it had anticipated inflation of about 2 percent this year and 1.5 percent in 2006.

Asia/Pacific
All Asian/Pacific stock indexes followed here were up last week as investors bet that the Federal Reserve will end its measured increase in interest rates when it meets in three weeks. The implication is that higher rates won't be pressuring U.S. consumers or the housing market, which would foster export growth for Asian countries. In Australia, companies such as Caltex Australia led gains by oil refiners on speculation Katrina's devastation will worsen a shortage of U.S. fuel output, raising imports and prices around the world.

In Japan, the Nikkei vaulted to a four-year closing high. Investors were relieved that crude prices had eased and were optimistic about a domestic economic recovery. The biggest gains were made by real estate stocks, a heavily domestic sector. They were boosted by data showing the fastest annual increase in housing starts in more than seven years.

Although the equity market was boosted by stabilizing oil prices, the transport sector did not perform particularly well compared with other parts of the market. This suggested that broader sentiment about the Japanese economy in general was boosting stocks, rather than simply a reaction to oil. The effect of oil on the Japanese economy is often downplayed by analysts on the grounds that Japanese society is very energy-efficient compared with others.

On Sunday, September 11th, Japan will vote in a snap election called by Prime Minister Junichiro Koizumi after his bid to privatize Japan Post was voted down in the lower house of Parliament. Japan Post has an estimated ¥330 trillion ($3 trillion) of savings and life insurance assets - and also delivers the mail. At first it seemed that Koizumi was sure to lose, and the financial markets reflected the uncertainty that this would cause. However, recent polls suggest the prime minister has managed to gain in popularity and could possibly win his gamble after all.

Currencies
The U.S. dollar declined against virtually all major currencies last week on the widening fallout from Katrina. Amid wide-scale destruction and loss of life, currency markets focused on the potential impact on U.S. gasoline prices, with 10 percent of the country's refining capacity incapacitated. Traders speculated that the Federal Reserve will take a break from its consistent pattern of 25-basis-point interest rate increases.

Destruction from Hurricane Katrina, surging oil prices and signs of slowing economic growth have led market players to reassess their views on future Fed rate increases. Analysts are split on whether the FOMC will pass at their upcoming September 20th meeting or wait to see more data before pausing. The dollar had been gaining this year because of the widening interest rate spread between the EMU and the U.S. Weak manufacturing data and a so-so employment report played second fiddle to the horrific news from New Orleans. U.S. data suggested that both businesses and consumers were already being pressured by rising oil prices even before Katrina.

Indicator scoreboard
EMU - Second quarter gross domestic product was up 0.3 percent and 1.1 percent when compared with last year. International trade made no contribution to growth in the second quarter. Gross fixed capital formation reversed direction in the second quarter and was up 0.2 percent on the quarter. Even though private consumption edged downward by 0.1 percent domestic demand was up 0.3 percent thanks to investment and inventory accumulation.

July seasonally adjusted unemployment rate edged down to 8.6 percent from 8.7 percent in June. Unemployment was down in Belgium, Spain and Germany and remained unchanged in the remaining member states for which data was available. Eurostat estimated that 12.5 million people were unemployed in the eurozone. The unemployment rate is at its lowest level since February 2003.

August seasonally adjusted manufacturers purchasing managers' survey declined to 50.4 from 50.8 in July. The index was down in Germany and Italy but was up in France and Spain. German manufacturing continues to contract while in Italy, the index reading showed neither growth nor contraction. A reading above 50 signals growth while a reading below that level signals that manufacturing is contracting. The survey is conducted by NTC Research in Britain.

Germany - August seasonally adjusted unemployment dropped by 12,000. Unemployment was up by 1,000 in the west but dropped by 13,000 in the east. The unemployment rate for all of Germany remained at 11.6 percent. The unemployment rate in the west remained at 9.7 percent but dropped to 18.5 percent from 18.7 percent in the east. July seasonally adjusted payroll jobs were up by 30,000.

July retail sales were up 0.4 percent and 0.9 percent when compared with last year. Excluding autos and gas stations, retail sales sank by 0.6 percent and were up 0.4 percent on the year.

July industrial producer prices were up 0.5 percent and 4 percent when compared with last year. Energy prices jumped 2.2 percent and 14.7 percent on the year. Excluding energy, the PPI was flat on the month and up 1.4 percent on the year.

France - July seasonally adjusted unemployment rate declined to 9.9 percent from 10.1 percent in the previous month thanks to increased hiring combined with fewer new entries onto the jobless roles. The number of jobless dropped by 30,000. The unemployment data are based on the International Labour Organization's methodology which excludes jobseekers who did any work during the month.

Italy - July producer prices were up 0.3 percent and 3.6 percent when compared with last year. Excluding energy, the PPI was unchanged on the month and up 1.2 percent on the year. Energy prices were up 2 percent while mining prices were up 1.4 percent on the month.

June retail sales were down 0.2 percent and 0.7 percent when compared with last year. On the year, food sales, which account for about 40 percent of total sales, managed to edge upward by 0.1 percent but non-food sales sank by 1.2 percent. ISTAT's retail sales data are not closely watched because they show little or no correlation with consumer spending data as published in quarterly GDP statistics.

June merchandise trade deficit widened to €588 million from €358 million in May. The deficit a year ago was €1.2 billion. Exports were up 8.3 percent while imports were up 5.6 percent on the year.

Asia
Japan - July spending by households headed by wage earners plummeted 3.6 percent and dropped 2.7 percent when compared with last year. Spending was down for transportation and housing. Wage-earner household spending is an important gauge of personal consumption, which accounts for roughly 55 percent of GDP. The seasonally adjusted propensity for wage-earner households to consume, a ratio that measures the amount of disposable income that went to household spending, fell to 71.6 percent in July from 75.6 percent in June.

July unemployment rate increased to 4.4 percent from 4.2 percent in June. Although the workforce expanded by 170,000, the economy didn't add any new jobs.

July industrial production was down 1.1 percent and down 1 percent when compared with last year. The decline was led by makers of electronic parts and transportation equipment.

Australia - July merchandise trade deficit climbed to A$1.458 billion from June's deficit of A$1.404 billion. The increased deficit was attributed to the increased cost of imported oil. Exports were up 2.4 percent while imports were up 2.5 percent. Non-rural and other goods exports were up A$324 million while rural goods climbed A$13 million and services increased by A$17 million. Imports of intermediate and other goods were up A$252 million, capital goods $91 million and consumption goods $34 million.

July retail sales were unchanged and up 3 percent when compared with last year. Soaring gasoline prices were blamed for curbing spending. Australian households are now spending around A$169 a month on gasoline, 25 percent more than at the start of 2005, according to estimates by Commonwealth Bank of Australia, the nation's largest lender. The average cost of gasoline increased 3.7 percent in July from the previous month, according to figures from the Australian Institute of Petroleum.

Americas
Canada - Second quarter gross domestic product was up 0.8 percent and 2.7 percent when compared with the same quarter a year ago. GDP was up 0.5 percent and 3.2 percent in the first quarter. On the quarter, consumption expenditures were up 0.6 percent after increasing 1.6 percent in the first quarter. Gross business expenditures for fixed capital were up 1.2 percent after increasing 1.8 percent in the first quarter.

Bottom line
Monday offers but the beginning of a full slate of economic data and news during the week. The Banks of Japan, Canada and England will meet along with the Reserve Bank of Australia. The Bank of Canada could possibly increase their policy rate by 25 basis points to 2.75 percent. The others are expected to leave their policies unchanged.

Looking Ahead: September 5 through September 9, 2005