A rocky week Econoday International Perspective - Friday, August 3, 2007 By Anne D. Picker, Chief Economist

Global Markets

Global investors struggled to regain their equilibrium after the previous week’s losses. The result was a very volatile week as investors continued to grasp credit related news and at the same time deal with a spike in oil prices to record highs. An indication that credit woes have spread beyond the U.S. came in Australia and Germany. After a major Australian bank warned that two of its debt funds could face major losses, stock prices sank. Investors were further exacerbated by new warnings about U.S. debt funds. Later in the week, the bank reassured employees that the dislocation in the financial markets was temporary and the bank could withstand these conditions — stocks went up. And in Germany, the government has begun a rescue mission to shore up a specialist lender. 

In the U.S., September West Texas Intermediate rose as high as $78.73 a barrel, surpassing the previous record of $78.40 set in July of last year after weekly inventories data showed a huge decline in crude supplies. It should be noted that according to analysts, oil prices have typically peaked between mid-August and mid-September over the past seven years. Meanwhile, credit markets continued their rollercoaster ride as the fallout from the deteriorating US subprime mortgage market and concerns about the outlook for leveraged loans continued to drive sentiment.

As most market followers know, the U.S. employment situation report moves markets, and Friday was no exception. Employment went up less than anticipated while the unemployment rate edged upward to 4.6 percent from 4.5 percent in June — a move that was not expected. And the report was compounded by the ISM business survey that also showed softer business conditions across the board. U.S. stocks were down as was the U.S. dollar. And crude oil prices receded from recent highs because of slower than expected U.S. growth. On the week, only the FTSE managed to hold onto some of the gains accrued earlier in the week. Both Japanese indexes — Nikkei and Topix — are now lower than their yearend levels.

Global Stock Market Recap

Europe and the UK

Volatile trading in Europe and the UK was punctuated by new concerns over subprime loans and relief that neither the Bank of England nor the European Central Bank increased interest rates this month. But the week ended on a downbeat note after the U.S. added fewer jobs that forecast for July and growth in U.S. non-manufacturing sectors slowed. This in turn reignited concerns that growth may be slowing. Exporters stocks were down, paced by those companies that rely on U.S. sales. And even positive earnings news at times was ignored in favor of negative news elsewhere. But concerns over credit markets were never far away, as news emerged of a rescue effort to bail out a German bank from severe losses incurred from subprime investments.

Depending on the day, investors either ignored credit market woes and took the opportunity to pick up bargains or bailed out when there was new negative news. On Thursday, for example, despite signs of increasing credit market worries equity investors took their cue from Wednesday’s dramatic pre-closing rebound in the U.S. and sent equities broadly higher. And the ECB and Bank of England decisions also helped. European shares have benefited from some strong earnings in the investment banking sector that has been bruised by subprime woes. That in turn led to a broad rally on Tuesday. On the week, only the FTSE was able to hold onto some of Tuesday's and Thursday’s gains. Both the CAC and DAX were down on the week.

Bank of England bides time

As expected, the Bank of England's Monetary Policy Committee kept its key interest rate at 5.75 percent. The Bank last increased its key rate at its July 5 meeting. According to the minutes, the MPC was split on whether to increase rates by a margin of six votes for to three votes against. Its interest rate compares with 5.25 percent in the U.S., 4 percent in the EMU and 0.5 percent in Japan. Inflation as measured by the consumer price index was up 2.4 percent on the year in June after increasing by 2.5 percent in the previous month. Inflation has been above the Bank’s 2 percent inflation target for 14 months. The quarterly Inflation Report will be released on August 8. If the Bank's projections for reducing inflation to its target are in line with the market's current assumptions on interest rates, then another rate increase becomes likely. The UK economy grew slightly above trend in the second quarter. More recent reports point to a sound manufacturing sector and consumers who continue to spend despite a dismal (and wet) summer and higher borrowing costs.

There is a rate increase in the ECB’s future

As expected, the European Central Bank left its policy interest rate at 4 percent after increasing it to that level in June. While the harmonized index of consumer prices has remained just below the inflation target of 2 percent, M3 money supply growth has consistently been above the reference target of 4.5 percent. M3 growth soared by 10.6 percent for the three months ending in June when compared with the same three months a year earlier. Recent economic indicators for the eurozone continue to be strong with unemployment continuing to decline.

Usually the Bank does not hold a press conference after its policy meeting in August. (It held one last year when it raised its benchmark rate to 3 percent. Then, reporters and investors were informed a month earlier that a briefing was planned.) But in a surprise announcement, the Bank said Thursday that President Jean Claude Trichet would hold a press briefing to announce the outcome of today's Governing Council meeting. The unusual feature was that the press briefing was conducted as a media lockup, with an embargo for all media set until 15 minutes after the end of the press briefing.

In his hastily called news conference, Trichet said that the ECB must adopt a stance of "strong vigilance" to ensure that inflation risks do not materialize in the EMU. This was immediately interpreted to mean that the Governing Council would increase its interest rate at its September meeting. This is the language or code words he has used to signal each of the preceding eight rate increases since late 2005.

Asia/Pacific

All six equity indexes followed here were down for the second week, incurring large losses on the heels of subprime concerns. And the defeat of Japan’s ruling party in Sunday’s upper house elections gave investors another reason to sell Japanese stocks. Prime Minister Shinzo Abe's plan to deregulate state controlled industries and cut the government's $6.8 trillion debt may be hindered by the election’s outcome. Abe, who has been in office for only 10 months, has resisted calls to resign since the July 29 election displaced the Liberal Democratic Party as the biggest in the upper house of parliament for the first time since 1955. Analysts point out that the worse-than-expected defeat has prolonged political uncertainty and is clearly negative for the stock market — it does not like uncertainty. And volatility typically increases during times when investors wonder if there is a turning point in trading trends.

The biggest losses in Asian/Pacific stocks were incurred on Wednesday with declines of between 2.2 percent and 3.3 percent and they were too great to overcome by week’s end. All six indexes were down for the second week.

Currencies

The major currencies ebbed and flowed on investors’ views of risk. When equities rose, risk worries receded. The yen was particularly affected by investors’ views of risk — and the subsequent rise and fall of equities. In the foreign exchange markets, the currency most affected by risk valuations has been the yen because of its use in carry trade transactions where investors borrow at low cost (at a low interest rate) and invest in a higher returning asset which usually has more risk. Japan’s borrowing costs of 0.5 percent are the lowest among the major economies. It compares to 5.75 percent in the U.K., 5.25 percent in the U.S., 6.25 percent in Australia and 8.25 percent in New Zealand.

Indicator scoreboard

EMU — June unemployment rate was 6.9 percent, unchanged from May’s revised downwardly revised level. This sets a new low for the Eurozone series for which data begin in 1993. Among the major members, joblessness was down in Germany (to 6.4 percent from 6.5 percent), France (to 8.6 percent from 8.7 percent) and Spain (to 8.0 percent from 8.1 percent). As usual, the lowest rates were registered in the Netherlands (3.3 percent) and non-EMU member Denmark (3.5 percent). However, Slovakia (10.7 percent) and Poland (10.2 percent), which are also non-EMU members, posted the highest rates.

July flash harmonized index of consumer prices was up 1.8 percent when compared with last year. This matched the lowest reading since January 2007 and widened the gap with the 2.0 percent ECB pain threshold to 0.2 percent. As with most flash reports, no detail was available.

June producer price index was up 0.1 percent and was up 2.3 percent when compared with last year. Excluding construction, the PPI (pictured) was up 0.2 percent and 2.3 on the year. Core PPI was up 0.1 percent and 3.1 percent on the year. At sector level there was a broad based slowdown in annual rates with intermediate goods dipping to 5.1 percent from 5.4 percent, capital goods to 1.9 percent from 2.0 percent and non-durable consumer goods to 1.6 percent from 1.7 percent. Energy declined 0.5 percent after dropping 0.1 percent in the previous month. However durable consumer goods were up 1.9 percent after increasing 1.7 percent in the previous month. PPI inflation fell in Germany and Italy but was up in France and Spain.

June retail sales were up 0.4 percent and 0.9 percent when compared with last month. Sales had declined on the month in both April and May. Non-food sales posted a solid 0.8 percent increase on the month, albeit after a 0.7 percent slump in May. Food sales were unchanged and were mainly responsible for the sluggishness of total sales. By nation, Germany actually matched the market median (0.7 percent) but Spain managed an increase of just 0.5 percent and Slovenia 0.4 percent. Data for a number of the larger states were not available.

EU — July economic sentiment edged lower to 111.0 from 111.7 in the previous month. At sector level, changes in sentiment were marginal with industry (5) and construction (0) both down 1 point from June, consumers (-2) and services (21) both unchanged and retail (3) up a point. Geographically, shifts in sentiment across the region were similarly small with a minor increase in France contrasting with equally minor falls in Germany, Italy and Spain. The EU Commission was at pains to point out that industry sentiment is still at very high levels with production expectations and order books all boding well for future output.

Germany — June retail sales excluding autos and gasoline were up 0.7 percent after sinking 2.5 percent in May. Second quarter sales are only 0.8 percent above the first quarter level that was negatively affected by the hike in VAT introduced in January when sales dropped some 5.3 percent on the month. Retail sales including autos and gasoline were softer, gaining just 0.3 percent and posting quarterly growth of 1.8 percent after sinking 7.1 percent in the first quarter. Over the first half of 2007, weakness has been especially marked in the food and beverages sector (down 2.3 percent on the year) but even non-food sales are 0.9 percent weaker. The only areas of any real strength have been clothing and footwear (up 1.6 percent) and pharmaceuticals (0.9 percent).

July unemployment rate edged down to 9.0 percent from 9.1 percent in June. The number of jobless dropped 45,000. Unemployment was down 26,000 in the West and 19,000 in the East. The unemployment rate remained at 7.5 percent in the West and declined to 14.9 percent from 15.1 percent in the East. Employment levels according to the ILO data have risen every month from February 2006 through June 2007 and these data all but guarantee that July will extend this run.

France — June producer price index was up 0.2 percent and 1.9 percent when compared with the same month a year ago. Core PPI which excludes food and energy was unchanged on the month and up 2.5 percent on the year. Food prices jumped 0.4 percent and energy by 0.5 percent on the month. Most of the major categories within the core posted either very modest monthly gains or declines. Consumer goods dropped 0.1 percent on the back of a 0.2 percent decline in household durables while auto industry products were up only 0.1 percent. Capital goods prices were steady as machines fell 0.1 percent and semi-finished goods rose 0.1 percent.

June unemployment rate edged down to 8 percent from 8.1 percent in May and set a new 25 year low. The jobless level dropped by 34,000 in June after sinking by 21,000 in May according to the International Labour Organisation definition which excludes jobseekers who did any work during the month. Analysts were expecting the unemployment rate to remain at 8.1 percent. 

Italy — June producer price index was up 0.2 percent and 2.8 percent when compared with last year. This is the lowest reading since April 2004 and further proof of limited non-wage cost pressure in the Italian economy.  Excluding energy, the PPI was up 3.2 percent. Compared with June 2006, prices are still falling in minerals sector (1.4 percent) and coke & petroleum products (0.4 percent). The largest increases are in metals (7.5 percent), wood (5.2 percent), other manufacturing (3.7 percent) and paper (3.4 percent). For manufacturing as a whole, PPI inflation now stands at 2.9 percent and at 2.1 percent in capital goods, 5.0 percent in intermediates and 0.9 percent in the energy sector. 

Asia/Pacific

Japan — June preliminary industrial production was up 1.2 percent and 2.2 percent when compared with the same month a year ago. Analysts had expected an increase of 0.4 percent on the month. This was the first monthly increase since February. The industries that contributed to the increase were electronic parts and devices; transport equipment; and information and communication electronics. Shipments were up 0.7 percent during June.

June unemployment rate edged down to 3.7 percent from 3.8 percent in May. The number of unemployed people declined 370,000 when compared with a year ago. The number of employed was up 530,000 from the same month in the previous year.

June worker household expenditures disappointed once again and dropped 0.6 percent when compared with the previous year. In real terms, expenditures were down 0.4 percent. Analysts had expected expenditures to increase 0.8 percent. Expenditures for two or more person households also slipped. They were down 0.1 percent in nominal terms but up 0.1 percent in real terms.

Australia — June retail sales were up 1.4 percent and were up 6.7 percent when compared with the same month a year ago. All major categories were up on the month with the exception of recreational goods retailing, which was unchanged. Food sales were up 1.2 percent while clothing & soft good sales soared by 5.6 percent. Department store sales edged up 0.2 percent while other retail sales along with household goods jumped by 1.3 percent.

June merchandise trade deficit worsened to A$1,373 million, from May’s deficit of A$1,314 million. Exports dropped 3.4 percent while imports were up 0.8 percent. Non-rural and other goods exports dropped 5 percent while rural goods sank 4 percent. Services exports were up 1 percent. Imports of capital goods declined by 5 percent while intermediate & other goods were up 5 percent.

Americas

Canada — June industrial product price index sank 1.3 percent thanks to the stronger Canadian dollar against its U.S. counterpart. The IPPI was up 2.2 percent when compared with last year. Contributing to this benign increase were lower prices for primary metal products, petroleum & coal products and motor vehicles. On the month, prices were down for pulp & paper products (1.3 percent), machinery & equipment (0.8 percent), electrical & communications products (0.8 percent) and meat, fish & dairy products (0.7 percent). Prices for intermediate goods fell for the second month in a row (1.3 percent) reflecting widespread declines among major categories and now stand 3.6 percent above their June 2006 level. Prices for finished products fell 1.2 percent on the month and 0.1 percent on the year.

June raw material prices index was up 0.6 percent after declining 0.2 percent in May. Underpinning the increase were higher prices for mineral fuels (2.1 percent), vegetable products (1.9 percent) and wood (1.0 percent). These were partly offset by a fall in the price of animals and animal products (3.3 percent), itself in no small way a function of higher inventories for cattle and hogs for slaughter. On the year the RMPI has risen 4.9 percent, up sharply from the 1.9 percent posted in May but still well down on most readings earlier in the year. However, the relative softness here is heavily reliant upon weakness in mineral fuels. Without the 8.8 percent posted in this sector, the total RMPI would have jumped 20.4 percent over the last twelve months. Non-ferrous metals (45.4 percent) have made the largest contribution to the annual change but there have also been sizeable rises among vegetable products (17.5 percent) and wood (12.4 percent).

The value of the Canadian dollar against its U.S. counterpart dollar was up 2.8 percent from May to June. Consequently, without the effect of the exchange rate, the IPPI would have decreased 0.5 percent instead of dropping 1.3 percent. On a 12-month basis, the value of the Canadian dollar was up 4.6 percent. If the impact of the exchange rate had been excluded, producer prices would have increased 3.4 percent instead of 2.2 percent on the year.

May monthly gross domestic product was up 0.3 percent and 2.5 percent when compared with last year. Services were up 0.5 percent and 3.3 percent on the year while the manufacturing sector was up 0.3 percent but was down 1.1 percent on the year. Retail and wholesale trade were up 2.5 percent and 1.4 percent on the month respectively. The surge in the former was particularly impressive being both broadly based and the largest since November 2001. Within the service sector there were also decent gains in professional, scientific & technical (0.4 percent), arts & entertainment (0.6 percent) and accommodation & food (0.5 percent).  Within the goods producing area, there were increases in manufacturing (0.3 percent), construction (0.6 percent), and utilities (0.7 percent).

Bottom line

Last week saw a continuation of financial market volatility with most equity indexes followed here down for the second week. Both the Bank of England and the European Central Bank chose to leave their key interest rates at 5.25 percent and 4 percent respectively. Several U.S. indicators — among them employment, unemployment and the ISM manufacturing and non-manufacturing indexes — disappointed and brought U.S. growth worries to the forefront once again.

The weaker data will put an even more intense focus on the FOMC when it meets on Tuesday. While no change in policy is anticipated, you can bet that the accompanying statement will be parsed with a magnifying glass. Bank watchers in the UK will do the same with the quarterly Inflation Report. They will try to determine when the next interest rate increase will occur. Many think it could be as soon as September. Merchandise trade and industrial production dominate data releases in Europe. And the Reserve Bank of Australia meets. Higher inflation is adding to the pressures for a rate increase from the current 6.25 percent as are growing capacity constraints, a tight labor market and higher oil prices.

Looking Ahead: August 6 through August 10, 2007

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