Global Markets

With little new economic data last week, investors seized upon flash PMI indexes and in turn sent equities lower globally. A continued stream of mixed earnings reports also played a role in the week’s results. Equity markets dropped globally Friday as investors worried about an economic slowdown in emerging markets. The pessimism in the markets breaks a long and nearly unbroken rally. But many strategists had been anticipating some kind of pullback. On the week, losses ranged from 0.2 percent (Kospi) to 5.7 percent (IBEX). The Shanghai Composite added 2.5 percent on the week.

The declines during the week have been fed by disappointing economic news from China and the rest of the developing world. The January flash Chinese manufacturing PMI showed that the sector was contracting for the first time in six months. A number of slightly disappointing economic data points in the United States also led to some concern that a slowdown in China could be contagious. For example, Thursday’s data on home sales came in slightly lower than expected.

Emerging markets have been sensitive to the efforts of the Federal Reserve to curtail its bond buying program that has been used to stimulate the economy and lower interest rates. When the Fed announced last summer that it was planning to pull back on the program, it hit developing countries like China and India hard. Since the Fed officially announced (at its December FOMC meeting) that it would buy fewer bonds, investors in emerging markets have been cautious. There are fears that rising interest rates will choke off growth in countries dependent on foreign lenders. And during last week, currencies in several countries, including Turkey and Argentina, have been falling sharply.

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 is to increase the monetary base at an annual pace of about ¥60 to ¥70 trillion. The monetary policy board maintained its view that the economy will continue to recover moderately. It noted that growth overseas mainly in the advanced economies has started to recover. As a result, exports have been picking up. The BoJ 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 post-meeting 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. In turn, this is expected to contribute to increased inflation expectations and lead Japan's economy to overcome the deflation that has lasted nearly 15 years.

The MPB again forecast that in fiscal year 2015 core CPI will increase 1.9 percent. It forecast that GDP would grow 1.5 percent, also the same as its October forecast. For fiscal year 2014, the MPB said that GDP would grow 1.4 percent, down from 1.5 percent in October. It expects core CPI to increase 1.3 percent as it did in October.

At his press conference, Bank of Japan Governor Haruhiko Kuroda offered an upbeat assessment of the Japanese economy, hinting that its resilience to withstand the upcoming consumption tax increase from 5 percent to 8 percent could render additional easing unnecessary. He said that the downside risks to the economy were receding.

Strong domestic demand is providing evidence for the central bank's rosy view. In addition to consumer spending fueling domestic demand, capital investment is finally starting to show signs of recovering. Machinery orders, which are a leading indicator for capital investment, grew almost 10 percent last November, hitting the highest level in more than five years. In this month's economic report, the Cabinet Office upgraded its assessment of the Japanese economy to "recovering at a moderate pace" for the first time in eight years.

Bank of Canada

As expected, the Bank of Canada left its target overnight rate at 1.0 percent where it has been since September 2010 while the deposit rate remains pegged at 0.75 percent and the Bank Rate at 1.25 percent. However, the BoC left the door open to a fresh rate cut although the language of the forward guidance was modified slightly to suggest that the assessment of risks may be now somewhat more balanced than at their last meeting in December.

The retention of the status quo was no surprise. Growth is reasonably respectable — but looked better before the weak December employment report — and the BoC's new Business Outlook Survey was moderately upbeat. Moreover, for some the housing market is also too close to a potential bubble for comfort. However, the bottom line is that headline and core inflation are still hovering around the bottom end of the 1 percent to 3 percent target range and neither has been close to the 2 percent midpoint in well over a year.

The interest rate announcement was accompanied by an updated Monetary Policy Report which looks markedly similar to the October edition and so duly enhances the prospects of policy simply offering more of the same over coming months. The domestic economy is forecast to achieve a 2.5 percent growth rate this year and to continue to expand at this rate in 2015. The comparable figures from October were 2.3 percent and 2.6 percent respectively. Given this, it is hardly surprising that full capacity is not expected to be reached before the end of next year, also matching the previous forecast. Consequently, neither headline nor underlying inflation is thought likely to test the 2 percent target midpoint until the fourth quarter of 2015, essentially providing all the justification needed for today's unchanged interest rate announcement. In fact, the BoC's own core measure is still only showing a 1.9 percent annual rate at the end of the forecast horizon.

Global Stock Market Recap

Europe and the UK

Equities reversed direction after two positive weeks and dropped. Concerns over slowing growth in China weighed on Asian markets and carried over into European trading. The recent weakness of the U.S. markets also has contributed to the negative mood. Corporate financial results continue to be mixed. On the week, the FTSE slid 2.4 percent, the CAC dropped 3.8 percent, the DAX lost 3.6 percent and the SMI was 3.3 percent lower.

The broader negative sentiment in Europe mirrored sharp declines in Asia and the U.S., as renewed uncertainty about a potential “hard landing” in China ignited a wider flight to safe haven assets and an escape from riskier investments such as equities. Chinese manufacturing data earlier this week showed that the sector unexpectedly contracted in January. The disappointment added to existing headwinds for emerging markets that include a continued reduction in Federal Reserve stimulus along with high political uncertainty in countries such as Thailand, Turkey and Ukraine that have sparked sharp declines in their currencies.

A better than expected labour market report in the UK sparked debate over Bank of England guidance. The BoE said that a knockout threshold for increasing interest rates was when the ILO measure of unemployment reached 7.0 percent. The latest reading showed a decline from 7.4 percent to 7.1 percent in the three months to November. As a result, the rate is now just 0.1 percentage point above its knockout threshold and at its lowest mark since the February quarter 2009. Bank of England Governor Mark Carney signaled in a television interview that interest rates will not need to increase immediately despite the fall in the unemployment rate. Governor Carney said the assessment of how to adjust guidance to changing circumstances will begin in the February Inflation Report. He said that the monetary policy committee would consider a range of options to update the guidance.

However, wage pressures remain quite low, highlighted by the quiescent 0.9 percent rise in average earnings (excluding bonuses) for the three months through November from a year earlier. This is well below the more than 4.0 percent gains typical before the financial crisis, reassuring MPC members that significant slack in the labor market remains.

Asia Pacific

Most of the major equity indexes retreated last week after a disappointing report on Chinese manufacturing rippled through global markets, prompting investors to move out of risky assets, especially emerging market currencies. Asia Pacific equities fell broadly for a second day on Friday as growing concerns about slowing growth in China and a mixed bag of corporate earnings eroded investors' appetite for risk. The Nikkei dropped 2.2 percent while the Hang Seng lost 3.0 percent and the STI was 2.3 percent lower for the week. However, after sinking on Monday and retreating Thursday, the Shanghai Composite managed to increase 2.5 percent on the week and ahead of the Lunar New Year holidays beginning on January 31^st. The Sensex was up four of five days, only declining on Friday before the Reserve Bank of India’s upcoming meeting.

In addition to Thursday's flash January manufacturing PMI, which indicated a contraction in manufacturing, there have been additional signs of economic weakness in China. Data out at the beginning of the week showed that growth had slowed in the fourth quarter. Concerns over the Chinese economy along with a resumption of the domestic initial public offering market after a more than one year moratorium have led to a poor performance for Chinese stocks so far this year, with the Shanghai Composite down 2.9 percent since the end of 2013. A liquidity injection into the Chinese financial system, however, gave Shanghai a boost earlier in the week, while a stronger yen has led to declines in Japan with the Nikkei now down 5.5 percent in January.

Argentina devalued its currency the most in 12 years, the Turkish central bank intervened directly in foreign exchange markets for the first time in two years and most emerging market currencies remained under selling pressure on worries about a reduction in stimulus, building up risk aversion ahead of the Federal Open Market Committee's final meeting under Chairman Ben S. Bernanke scheduled for Tuesday and Wednesday.

Currencies

The U.S. dollar took a beating last week and was down against the euro, yen, pound sterling and Swiss franc. However, it was up against the commodity currencies — the Canadian and Australian dollars.

The Australian dollar slid to a new 3½-year low Friday after Reserve Bank of Australia external board member, Heather Ridout, said the currency needed to fall further. She opined that an Australian dollar around US$0.80 would be a fair deal for the country's importers and exporters. As an external board member of the RBA who helps shape interest rate policy, she does not speak on behalf of the central bank. After trading above parity with the U.S. dollar for years, the Australian dollar was the world's worst performing major currency over the past 12 months, falling by about 17 percent. Recently it touched a low against the U.S. currency not seen since July 2010. The remarks have given the market a new level of the currency to shoot at. In December, RBA Governor Glenn Stevens pointed to US$0.8500 as a satisfactory level.

While many emerging market currencies have steadily weakened for months, the pace of the selling picked up last week as investors realize some central banks are running low on foreign exchange reserves — the ammunition needed to buy currencies. Chinese demand for years has been a major engine of growth in emerging markets. Many investors are worried that any interruptions in Chinese growth could create even bigger headwinds in slowing economies such as South Africa and Brazil, which send raw materials to China. There are also fears that flagging growth will exacerbate the social unrest that has already led investors to pull cash from countries such as Turkey. Last year's declines stemmed from signals that the U.S. Federal Reserve will begin to scale back bond purchases, a key program in support of the U.S. economy since the 2008 financial crisis. The Fed began reducing purchases this month, exacerbating emerging countries’ woes.

Selected currencies — weekly results

Indicator scoreboard

EMU

January flash composite PMI index climbed 11.1 points to 53.2 and its highest level since June 2011. The January improvement was roughly evenly split between manufacturing, where the PMI provisionally gained 1.2 points to 53.9 (32 month high) and services, which saw a 0.9 point increase to 51.9 (4 month high). Manufacturing output (56.7) enjoyed a particularly strong gain, posting its sharpest increase in thirty-three months. The same was also true of total new orders and exports and confidence in the sector was strong enough to produce the first increase in headcount since September 2011. Service sector growth was more moderate but still the second fastest since June 2011. Payrolls here were trimmed but at least optimism about the year ahead held steady at a two and a half year high. Regionally the performance gap between Germany (composite output index 55.9) and France (48.5) continued to widened alarmingly but outside of the core conditions generally improved and output growth picked up to its highest level since February 2011. Flash estimates are available only for manufacturing in the U.S. and China. China’s flash reading dropped below the 50 breakeven point to 49.6 which indicates contraction. While the U.S. flash reading showed continued growth it was at a slower pace with a reading of 53.7, down from a final December reading of 55.0.

Germany

January ZEW survey was mixed with analysts generally more optimistic about the current state of the economy but just a little more cautious about the outlook. The current conditions balance jumped 8.8 points to 41.2 percent, its steepest rise in four months and its strongest reading since May 2012. By contrast, expectations posted their first monthly decline since July. However, the 0.3 percentage point drop was only minimal and probably overdue after a run of five successive gains. Moreover, at 61.7 percent, the measure still managed to secure its second highest level since May 2006.

United Kingdom

December claimant count unemployment dropped 24,000 while the claimant count unemployment rate edged down to 3.7 percent from 3.8 percent in November for its lowest rate since December 2008. The ILO unemployment rate for the three months ending in November, which is used as monetary policy guidance, declined to 7.1 percent from 7.4 percent. The number of unemployed dropped 167,000. As a result, the rate is now just 0.1 percentage point above its knockout threshold and at its weakest mark since the February quarter 2009. However, the tightening labour market has yet to have any real impact on wages. Hence, annual average earnings growth in the three months to November was just 0.9 percent, unchanged from the previous period and was also only 0.9 percent excluding bonuses, a minimal tick up on the October rate.

Asia/Pacific

Australia

December quarter consumer price index was up 0.8 percent after increasing 1.2 percent in the September quarter. On the year, the CPI was up 2.7 percent after increasing 2.2 percent in September. Both the trimmed and weighted means were up 0.9 percent on the quarter and 2.6 percent from the same quarter a year ago. The Reserve Bank of Australia’s inflation target range is 2 percent to 3 percent. The most significant price increases in the quarter were for domestic holiday travel and accommodation (up 6.9 percent), fruit (up 8.1 percent), vegetables (up 7.1 percent), new dwelling purchase by owner-occupiers (up 1.0 percent), international holiday travel and accommodation (up 2.6 percent) and tobacco (up 2.2 percent). The most significant offsetting price fall this quarter was for automotive fuel (down 1.1 percent). Domestic holiday travel and accommodation prices were up primarily due to peak season price increases for both airfares and accommodation while international holiday travel and accommodation prices were up primarily due to peak season price increases for airfares. Fruit and vegetable prices were up mainly due to a number of adverse weather events and deteriorating growing conditions in some areas. Tobacco prices rose primarily due to the effects of the federal excise tax increase that took effect 1 December 2013 and a flow on effect from the indexed rise in the excise in August. Prices for new dwelling purchase by owner occupiers were up mainly due to rising building materials and labour costs.

China

December industrial production was up 9.7 percent from the same month a year ago about as forecast, but lower than November’s 10.0 percent gain. On the month, output was up 0.71 percent. For the year 2013, output was up 9.7 percent. The annual pace was the slowest since July as the impact of summer stimulus fades. The peak pace in 2013 occurred in August when it was up 10.4 percent. Eight sub-categories grew less than they did in November while three grew faster. Among the sub-categories that were weaker in December was machinery which was up 11.0 percent after increasing 12.8 percent on the year in November. Transport equipment slowed to a pace of 9.0 percent from 10.3 percent the month before. Motor vehicles increased 22.8 percent after 25.6 percent on the year in November. Communication’s pace picked up to 11.8 percent from 11.3 percent in November. Cement, steel products and electricity also grew at a faster pace in December.

December retail sales were up a still robust rate of 13.6 percent on the year, down from 13.7 percent in November. For the year to date, sales were up 13.1 percent. On the month, sales were 1.24 percent higher. Urban sales slipped to 13.4 percent from 13.6 percent in the prior month while rural sales were up 14.8 percent on the year for the second month. Six sub-categories grew at a faster pace than the month before. Among them were grain & food oil which was up 14.8 percent after increasing 14.1 percent in November. Clothing was up 11.1 percent after 9.4 percent the previous month. Sports & recreation were up 10.5 percent after 7.8 percent. Auto sales were up 13.4 percent after increasing 11.6 percent in November. However, communications equipment was up 21.8 percent after two months of over 30 percent increases. Furniture eased to an increase of 20.1 percent after increasing 24.8 percent. Household nondurables were 14.0 percent higher after increasing 15.5 percent in November.

Fourth quarter gross domestic product was up 7.7 percent from the same quarter a year earlier. The pace was slower from the third quarter's 7.8 percent pace. For the whole of 2013, GDP was up 7.7 percent for a second year. The Beijing leadership is trying to reform the economy to end its reliance on debt-fuelled infrastructure investment and create more sustainable and environmentally friendly growth based on consumer spending and services.

Americas

Canada

November manufacturing sales were up 1.0 percent following a slightly weaker revised 0.7 percent increase in October. Their sixth monthly gain in the last seven months left shipments at their highest level since December 2011 and 1.9 percent above their year ago mark. The November advance in nominal shipments was almost matched by volumes which were up 0.7 percent. Within the monthly increase in nominal shipments, aerospace jumped 21.3 percent while motor vehicles increased 5.0 percent and in so doing attained their best level since November 2007. The machinery sector gained 5.4 percent for only its fourth increase in the last 11 months. The most notable monthly declines were recorded by food (1.5 percent) and chemicals (2.3 percent). Excluding motor vehicles, parts & accessories shipments were up 0.5 percent. Elsewhere in the survey, new orders were up 1.2 percent from October and backlogs were up 0.4 percent. Inventories edged 0.2 percent higher but this was not enough to stop the inventory/sales ratio from dipping 0.01 months to 1.37 months to match its reading in November 2012.

November retail sales were up 0.6 percent on the month and were up 3.1 percent on the year. Volumes advanced 0.8 percent from October. Within overall nominal sales, monthly gains were registered by nine of the 11 subsectors. Among these, motor vehicles & parts stood out with a 1.2 percent increase and without the benefit of this the increase in headline sales would have been reduced to 0.4 percent. Elsewhere there were solid increases in electronics & appliances (6.4 percent), furniture & home furnishings (1.8 percent), clothing & clothing accessories (1.1 percent) and gasoline (1.0 percent). The only areas of weakness were food and beverages (down 1.1 percent) and building material & garden equipment & supplies (down 1.5 percent).

December consumer price index declined 0.2 percent on the month and was up 1.2 percent on the year. The underlying picture remained subdued, although base effects ensured that both annual core rates saw some acceleration. Excluding food and energy, prices were down 0.3 percent from November and were up 0.9 percent on the year after a 0.7 percent annual increase last time. The BoC's preferred measure declined 0.4 percent and was up 1.3 percent on the year. Prices are seasonally weak in December and, after adjustment for such factors, the CPI was up 0.2 percent from November when it also gained 0.2 percent. On the same basis, the excluding food and energy index increased 0.3 percent and the BoC's gauge, 0.2 percent. Within the adjusted basket the main upward pressure stemmed from transportation, where charges jumped 1.0 percent, and from clothing & footwear, which saw a 0.4 percent advance. Apart from household operations, furnishings & equipment (0.3 percent) other monthly changes were only minimal and included a 0.1 percent drop in both food and in shelter.

Bottom line

Equities retreated last week on fears of slower growth in China. Emerging market currencies took a tumble prior to the FOMC meeting scheduled for Tuesday and Wednesday. The Federal Reserve is expected to continue to reduce its stimulus. Both the Bank of Japan and the Bank of Canada maintained the status quo and left their monetary policies unchanged.

Besides the FOMC announcement, the Reserve Banks of India and New Zealand meet. Investors will be watching the RBI to see if they adopt an inflation target at this meeting. Also on the calendar are fourth quarter 2013 first estimates of GDP from the UK and the U.S. And Japan releases its usual slew of economic data towards the end of the week. Investors will be watching market action closely to see if last week’s decline is the beginning of a long anticipated correction.

Looking Ahead: January 27 through January 31, 2014

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