Monday, April 19, 2004
Bank of Canada reduces interest rates for 5th time
The Bank of Canada once again cut its key interest rate by 25 basis points. Their policy making interest rate is now 2 percent and matches a four decade low set in January 2002. This was the fifth interest rate cut since July 2003. In its statement, the Bank suggested this may be its last cut this year saying that risks now appear to be balanced. Inflation is not a problem with the core rate at 1.1 percent and scraping the bottom of their 1-to-3 percent inflation range. But other sectors of the export-driven economy are being negatively affected by the strong Canadian dollar.
In its statement the Bank said, "The Canadian economy continues to adjust to developments in the global economy. These include stronger world demand, higher commodity prices, the realignment of world currencies, including the Canadian dollar, and the intensified competition, together with the new trading opportunities, coming from emerging-market economies. These developments require shifts in activity among sectors and create a need for adjustments by many businesses. Monetary policy is facilitating these adjustments by supporting aggregate demand, with the goal of keeping the economy near its full potential and inflation on target. The Bank's outlook for economic growth and inflation remains essentially unchanged from the outlook published in the January Monetary Policy Report Update. The economy is projected to return close to its production potential by the third quarter of 2005 and core inflation is projected to move back to the 2 percent target by the end of 2005." The reduction still leaves the official rate at double the equivalent U.S. federal funds rate of 1 percent.
Too much of a good thing'
Slow growth displeases as apparently does rapid growth. China's gross domestic product soared at an official rate of 9.7 percent in first quarter 2004, bolstered by unrelenting investment in the manufacturing sector. This was higher than last year's full year growth rate of 9.1 percent. But some analysts - using a range of proxy indicators -suggest the official figures understate reality and China is actually growing at an even faster rate of 11 or 12 percent. Although Beijing welcomes rapid growth as a means to reduce unemployment, official alarm over the lopsided structure of the economy is growing. Of particular concern is runaway bank lending to questionable infrastructure and industrial projects that are driving up commodity prices and worsening power shortages.
The rapid production pace of cheap Chinese goods helped American consumers to spend last year without unduly lifting prices. But inflation has now become a bigger risk in China. Prices for raw materials and energy rose 8.3 percent in the first quarter and, as in the U.S., much of those higher costs were not passed to Chinese consumers. Chinese incomes have also been on the rise and have begun to contribute to overall growth, though not as much as Chinese industry.
Global Stock Markets
Nervousness about kidnappings in Iraq and other political uncertainties - always just below the surface for investors - counterbalanced favorable economic and earnings news last week. As the Federal Reserve's May 4th meeting approaches, investors are focusing on U.S. economic data with increasing intensity. This number is good' Well then, the Fed will raise rates sooner than later. This number isn't so good' Well then, maybe it will be awhile before the Fed acts. Talk of higher interest rates makes exporters to the U.S. (and investors in those companies) very nervous indeed! Exporters to the U.S. are very sensitive to U.S. interest rates (or anything else for that matter) that could cut demand for their products. Inflationary pressures from energy and other goods that could eventually stymie consumer spending are beginning to enter the dialogue as well.
Global Stock Market Recap
Europe and Britain
The FTSE, DAX and CAC were up on the week despite volatility which was attributed to a broad range of factors. Everything addled investors, from profit-taking to concern that demand for metals such as cooper and steel might be stymied if the Chinese government tries to slow growth. And what happens with U.S. interest rates contributed to the mix after U.S. consumer prices rose more than forecast, raising concern the Federal Reserve will lift interest rates. Stocks extended declines, paced by banks such as UBS AG and Credit Suisse Group. Banks, whose earnings tend to profit from low interest rates, were hit hard. Higher interest rates reduce the value of bonds owned by banks, brokers and insurers, and also crimp demand for mortgages and loans. They also make stocks that pay dividends less attractive to investors who seek income.
Asia/Pacific
Japanese equities bounced back from their biggest one day drop of the year to edge higher. Thursday's record volume sell-off was sparked by worries that the market had gained too much too quickly. Analysts are debating the Japanese equity outlook and the debate is becoming more fractious. One argues that Japan still lives and dies by its exports and that stock prices could hit turbulence later this year as external demand slows. The second says the market will keep rising regardless, as economic demand at home can now keep domestic demand on track.
Japan's economy has been reinvigorated - it grew 2.7 percent in 2003 and is expected to repeat that this year. Domestic demand is playing an increasingly prominent role in the recovery. Fourth quarter business investment contributed more to growth than exports, and more recent data show that even wary consumers are beginning to spend more. Corporate profitability has risen dramatically and is expected to continue to do so, thanks to both sales growth and increased efficiency.
Currencies
The dollar was initially higher last week as strong economic data persuaded foreign exchange traders that the Fed would raise U.S. interest rates sooner than later. But on Friday, the dollar softened on both a tepid industrial production report and a disappointing University of Michigan consumer confidence report. The hesitation was underlined by a Fed official who suggested that an interest rate increase won't happen as soon as some investors were predicting. But despite Friday's blip, the dollar was higher against the yen, euro, pound sterling and Swiss franc on the week. A higher Fed funds rate can boost the dollar by increasing returns on bank deposits relative to Europe, where the European Central Bank's key rate is 2 percent. A rate increase would also signal the U.S. central bank's confidence in the economic recovery.
Indicator scoreboard
EMU - Fourth quarter revised gross domestic product was unchanged from the previous release, up 0.3 percent and 0.6 percent when compared with the same quarter a year ago. A downward revision in domestic demand was offset by an upward revision in net exports.
March harmonized index of consumer prices jumped 0.7 percent and 1.7 percent when compared with last year. The monthly increase was mainly due to higher prices for clothing and shoes after the previous month's discounts. Energy prices soared 1.3 percent. Core HICP, which excludes energy, alcohol, food and tobacco, was up 0.5 percent and 1.8 percent on the year. HICP excluding energy and unprocessed food - the preferred core measure of the ECB - was up 0.6 percent and 2.1 percent on the year.
Germany - March wholesale prices jumped 1.3 percent led by jumps in energy and basic goods prices. The WPI was up 0.8 percent when compared with last year. Energy prices jumped 4.6 percent but are 6.2 percent below last year's level. Excluding petroleum products, the WPI was up 0.9 percent and 2 percent on the year.
France - February seasonally adjusted merchandise trade balance sank to a deficit of �73 million from a surplus of �838 million in January. Exports sank 2.9 percent while imports were virtually unchanged. The export malaise has been masked by "very large" military contracts and the sale of the Queen Mary II ocean liner. Most industry exports including semi-finished goods were flat.
Italy - February seasonally and workday adjusted industrial production was unchanged on the month and on the year. Consumer goods output was down 0.5 percent while investment goods output dropped 0.7 percent. Chemical products and synthetic fibers sector soared 5 percent and wood and wooden products jumped 3.5 percent. Energy goods were up 1.1 percent.
Britain - Average earnings including bonuses for the three month period ending in February jumped 4.9 percent. This is above the 4.5 percent rate that the Bank of England has said is consistent with stable inflation. Pay increases including bonuses at service companies rose 5.5 percent, the fastest since March 2000, following a 5.2 percent gain in the three months to January. The acceleration was led by financial companies including banks and insurers paying higher bonuses.
March claimant count unemployment declined for a tenth month by 4,200 to 882,200, after a revised 5,300 drop in February. The claimant count unemployment rate was 2.9 percent. For the three months through February, the International Labor Organization unemployment rate was 4.8 percent. This was the lowest rate since the data series began in 1984. Britain's ILO rate is the lowest among the Group of Seven industrial nations. By the ILO count, the number of jobless fell 33,000 in the quarter through February to 1.43 million from the previous three month period. Total employment climbed to of a record 28.33 million in the period from December to February.
Asia
Japan - February revised industrial production sank 3.8 percent but was up 3.4 percent when compared with last year. Shipments were down 4.5 percent on the month.
Americas
Canada - February merchandise trade surplus jumped to C$5.7 billion from C$5.1 billion in January. Exports soared 7 percent thanks to strong automotive shipments to the U.S. Imports were up 6.1 percent on higher imports of machinery and equipment. The 7.0 percent export growth to the U.S. was equal, in percentage terms, to the overall jump in exports. The United States was also the destination for 81.0 percent of all export shipments during the month. In turn, imports from the United States were up 5.8 percent. As a result, Canada's trade surplus with this country soared to just under C$8 billion. Import and export prices rose only slightly in February, indicating that most of the growth was real or volume related.
February factory shipments jumped 0.8 percent, thanks in part to spiraling industrial prices. On the year, shipments were down 1.4 percent. Higher prices pulled up nondurable goods shipments by 1.1 percent for the fourth increase in a row. Durable goods shipments were up 0.6 percent. Twelve of 21 industries accounting for 54 percent of total shipments reported increases. New orders dropped 0.8 percent. Weaknesses in computers, motor vehicles and aerospace products and parts manufacturing contributed to the drop. Unfilled orders were up 0.6 percent on the month but plunged 10.9 percent on the year.
Bottom line
The foreign exchange markets continue to focus on U.S. interest rate policies and will be looking for clues in the Fed's Beige Book on Wednesday to the FOMC's discussion in two weeks. The Fed continues to be rather laid back about historically low interest rates despite vigorous growth and creeping inflation and despite unease elsewhere.
As the earnings season picks up steam, investors will continue to respond to results and prospects for future earnings all the while trying to manage risk in an uncertain world.
Looking Ahead: April 19 through April 23, 2004
Interest rates both up and down