Thursday, 31 May 2007

US stocks shrug off China plunge

What a contrast in performance by stock markets yesterday.

In China, stocks plunged, as AFP/CNA reports:

Chinese share prices slumped 6.5 percent Wednesday after taxes on share transactions were raised in the government's latest effort to curb the nation's booming stock markets, dealers said.

The benchmark Shanghai Composite Index, which covers both A- and B-shares listed on the Shanghai Stock Exchange, ended down 281.84 points at 4,053.09 on record turnover of 271.29 billion yuan (35.23 billion dollars)...

Dealers said the new tax measure, which saw a tripling of stamp duties on share trading from 0.1 percent to 0.3 percent, had an immediate psychological impact on investors, who chose to lock in their profits.

But in the US, stock indices made record highs. Reuters reports:

The Standard & Poor's 500 closed at its first record high in seven years on Wednesday after minutes from the Federal Reserve's latest meeting reassured investors about the economy's health.

As part of the broad-based rally in the U.S. stock market, the Dow Jones industrial average soared to its 25th record close so far this year, bringing a resounding end to a global equities sell-off sparked by a plunge in China's benchmark share index...

The Dow Jones industrial average shot up 111.74 points, or 0.83 percent, to close at a record 13,633.08, just off a lifetime intraday high of 13,636.09 set earlier in the session. This is the 47th record close for the Dow since October, when it first crossed 12,000.

The Standard & Poor's 500 Index jumped 12.12 points, or 0.80 percent, to finish at a record 1,530.23. At this level, the S&P 500 closed above its previous record of 1,527.46, which was set on March 24, 2000, in the waning days of the dot-com stock bubble. The Nasdaq Composite Index ended up 20.53 points, or 0.80 percent, at 2,592.59.

It is quite reasonable for other markets to downplay the significance of the fall in the Chinese market. After all, yesterday's action taken by the Chinese authorities was specifically directed at the local market. Combined with other measures already taken or to be taken, it may eventually put an end to the bull run there, but in the meantime stocks around the world will continue to be driven more by the liquidity that continues to flood markets.

Take money supply in the euro area for example. From Bloomberg:

M3 money supply, which the ECB uses as a gauge of future inflation, rose 10.4 percent from a year earlier, after increasing 10.9 in March,, the central bank said today. Economists expected growth of 10.7 percent, the median of 34 forecasts in a Bloomberg News survey shows. The rate of expansion in March was the fastest since February 1983.

This almost certainly means that the ECB will follow in the footsteps of the Norges Bank next month. From Bloomberg:

Norway's central bank raised its benchmark interest rate for the 10th time in two years to head of higher inflation as a mounting labor shortage boosted wage growth.

Oslo-based Norges Bank increased the deposit rate by a quarter-point to 4.25 percent today, as forecast by all 24 economists surveyed by Bloomberg, and reiterated rates would be raised "gradually."

However, the latest data from Japan have been somewhat more downbeat as industrial production fell by 0.1 percent in April while the NTC Research/Nomura/JMMA Purchasing Managers Index fell to 51.4 in May from 52.3 in April.

Wednesday, 30 May 2007

Bank of Canada may raise rates soon

The Bank of Canada appears ready to add its weight to global tightening. From Bloomberg:

The Bank of Canada said for the first time in a year that it's ready to increase interest rates because inflation is accelerating faster than it expected.

The central bank may raise rates "in the near term" should inflation stay above its 2 percent target, policy makers said today in a statement from Ottawa. The Canadian dollar rose to the highest level in more than 30 years and government bond yields surged. The bank, which kept the benchmark rate at 4.25 percent today, next meets on July 10...

"There is an increased risk that future inflation will persist above the 2 per cent inflation target and that some increase in the target for the overnight rate may be required in the near term to bring inflation back to the target," the central bank said today in its statement. The Bank of Canada had said since July that inflation risks were balanced.

Meanwhile, the European Central Bank does not appear to be stopping just yet. From Reuters:

European Central Bank policymakers have delivered stiff warnings on inflation, convincing investors that interest rates will rise at least twice again as inflation threatens to test the ECB's tolerance.

Governing Council member Axel Weber said in a newspaper interview published on Tuesday that euro-zone economic growth is robust and the ECB is ready to apply the monetary brakes through higher interest rates if necessary to control inflation.

His comments, combined with German data suggesting euro-zone inflation is hovering close to the ECB's 2 percent ceiling, persuaded bond markets that rates are very likely to reach 4.25 percent or higher later this year.

The Federal Reserve still looks the least likely among the G7 central banks to raise rates at the moment, although improving confidence could nudge it in that direction. From Bloomberg:

An index of consumer confidence in the U.S. jumped more than forecast in May, signaling consumers will continue to spend in the face of record gasoline prices and a slumping housing market.

The New York-based Conference Board's index of consumer confidence rose to 108 this month from a revised 106.3 in April, a five-month low. The index averaged 105.9 last year.

Tuesday, 29 May 2007

Positive Japanese data boost case for rate hike

A rate hike from the Bank of Japan appears to be on the cards after the latest data, reported by Reuters:

Japan's jobless rate fell to a nine-year low in April while the availability of jobs improved for the first time in nine months, signalling a tight labour market and boosting the Bank of Japan's case for a rate hike.

Separate data on Tuesday showed that household spending rose much more than expected, suggesting that consumption held up well in April after robust growth in the January-March quarter, although retail sales shrank from a year ago.

Taken together, the data supported expectations that the Bank of Japan could raise interest rates sometime after August, helping lift two-year Japanese government bond yields to a 10-year high.

Economic reports on Monday had also pointed towards rising inflationary pressures.

Prices of corporate services jumped in April.

Japan's corporate services price rose 1.1 percent in April from a year earlier, the biggest increase in nearly a decade, a sign that a steady economic recovery is helping pull the nation out of deflation.

And the output gap widened in the first quarter.

Japan's output gap, a measure of the balance of supply and demand in the economy, was plus 0.7 percent in the first three months of 2007, a research report by a government official showed on Monday...

The report, written by a Cabinet Office official, said the output gap turned positive for the second straight quarter and widened from plus 0.5 percent in October-December 2006.

The data in recent months appear to have vindicated the Federal Reserve in refusing to shift to an easing bias despite a slowing economy. It is now beginning to look like the BoJ's insistence on normalising interest rates despite flat consumer prices may also be vindicated.

Monday, 28 May 2007

US economic rebound could leave housing market behind

Last week saw a large rebound in new home sales in the United States. However, the rebound in the US housing market may not prove to be sustainable over the next few months.

On 24 May, the Commerce Department reported that sales of new single-family homes in April rose to an annual rate of 981,000 units. This was 16.2 percent higher than the pace of 844,000 in March, the biggest jump in sales in 14 years.

The sharp rise in sales helped bring the number of new homes for sale down to 538,000 in April from 546,000 in March. This represents 6.5 months of sales, a sharp fall from 8.1 months for March.

The housing data last week were not completely unambiguous though. For one, falling prices, a negative for the housing market, played a part in boosting sales. The median price of a new home fell to $229,100 in April from $257,600 in March.

Furthermore, the day after the Commerce Department data were released, the National Association of Realtors reported that sales of existing homes fell 2.6 percent in April to an annualised pace of 5.99 million units, the lowest since June 2003.

The data on existing home sales may not be so significant though. Existing home sales are counted on closure of a sales contract, unlike new homes sales, which are based on the signing of a sales contract or the acceptance of a deposit. Therefore, existing home sales are less timely than new homes sales as an indicator of the latest trend in the housing market.

Other reports released on 24 May had also pointed to strength in the US economy.

The Commerce Department reported that orders for durable goods increased by 0.6 percent in April while March orders were revised up to show a 5 percent increase. Orders for non-defense capital goods excluding aircraft, often used as a proxy for business investment, rose 1.2 percent in April after increasing 4.4 percent in March.

The Labor Department reported that initial claims for unemployment insurance rose by 15,000 to 311,000 in the week ending 19 May. However, the four-week moving average fell by 3,500 to 302,750.

In the face of such positive data, the yield on the 10-year Treasury note rose last week by 6 basis points to 4.86 percent, bringing it close to its high for the year.

In fact, the latest data reinforce the view of many economists that US economic growth is in the process of forming a bottom and should improve over the rest of the year. A stronger economy could help the housing market recover.

However, there are several headwinds. The inventory of unsold new homes remains high compared to historical norms. In addition, banks have recently tightened lending standards in the wake of problems in the subprime housing market.

Ironically, an improving economy could itself undermine home sales by pushing interest rates up. As the accompanying chart shows, the mortgage rate has historically played an important part in driving new home sales. The falling rate since the middle of 2006 (note that the mortgage rate is on a reverse scale on the chart) has surely helped to arrest the deterioration in the housing market.

If the rest of the US economy continues to improve as many economists expect, then we may have seen the low in the 10-year Treasury yield for the year. Indeed, yields should go up from here on.

This in turn should put a floor on the mortgage rate. If the mortgage rate stays around current levels for the rest of 2007, the current favourable trend in its year-on-year change starts to reverse around the middle of the year.

Such a reversal could put an end to the nascent recovery in the housing market.

Saturday, 26 May 2007

Inflation turns up, central banks still waiting

Inflation trends appear to be turning up.

Bloomberg reports that Japan's consumer prices fell at a slower pace in April.

Core prices, which exclude fresh food, declined 0.1 percent from a year earlier, the statistics bureau said today in Tokyo, matching economists' estimates. The measure of inflation fell 0.3 percent in March, the steepest drop in two years...

April's decline in core consumer prices was the third straight monthly drop. Core prices in Tokyo, a harbinger of nationwide prices, were unchanged for a second month in May, also in line with economists' expectations.

And consumer prices increased in four German states in May.

Prices in the German state of North-Rhine-Westphalia rose 0.2 percent from April, the state's statistics office in Dusseldorf said today. That matches monthly gains in the states of Saxony and Hesse. In Brandenburg, prices advanced 0.3 percent from April. Economists expect German inflation in May to hold at 2 percent, when measured by a harmonized European Union method, the median of 11 estimates in a Bloomberg News survey shows...

German import prices, an early indicator for inflation pressures, rose 0.9 percent in April from the previous month, the biggest gain in nine months, the Federal Statistics Office in Wiesbaden said today. Prices rose 0.5 percent in the year.

This comes at a time when the German economy is showing considerable resilience.

In Germany, consumer confidence rose to a five-month high, GfK AG's index for June showed today...

As is the UK's, as Reuters reports.

The Office for National Statistics said the economy grew by an unrevised 0.7 percent in the first three months of the year, the same heady pace as the past two quarters. The annual rate was revised up by a tenth of a percentage point to 2.9 percent, just below the 3.0 percent rate of the previous quarter...

The latest data showed the implied GDP deflator -- a measure of price pressures in the economy -- recorded an annual rate of 3.2 percent -- the highest since the fourth quarter of 2003.

If economic growth is strong and inflation is turning up, then interest rates must be too low. That is what this Reuters article says:

The world economy is booming, financial markets are supercharged, energy prices are sky-high and credit growth is accelerating. If that spells inflation to you, global monetary policy looks way too loose.

The problem is there is no single world interest rate to readjust accordingly and no one institution to do it. As a result, there's growing anxiety about whether any nascent world inflation threat can or will be met head on.

That is further complicated by the fact that inflation in the US appears to be hidden.

U.S. inflation appears to be ebbing as the economy slows, but the trend may have more to do with systematic undercounting than newfound purchasing power.

Perhaps the Federal Reserve should place greater weight on monetary aggregates and asset prices, as Doug Noland suggests.

There is inevitably a high price to pay for inapt policies that explicitly disregarded money and Credit, refused to address asset inflation and Bubbles, and promised aggressive reflations as necessary. Today, we negotiate and prescribe policy from a sadly weakened stature. After all, how can we earnestly stipulate fair trading practices when, as Fan Gang noted, “the U.S. prints money to buy things” – and floods the world in dollar liquidity in the process?

The latter is a good point. While China itself is widely believed to contribute to excess global liquidity, Chinese policymakers are unlikely to do anything about it as long as they themselves believe that they are only recycling liquidity created by the US.

And with Japan still waiting for inflation to make a comeback, that means that the European Central Bank and the Bank of England are the only major central banks contributing to global tightening for the time being.

Friday, 25 May 2007

Signs of economic strength, more tightening ahead?

It looks like those who expect a rebound in the US economy soon may be right. Reuters reports a strong recovery in new home sales:

Sales of new U.S. homes rose 16.2 percent in April, the sharpest climb in 14 years as builders slashed prices a record 11 percent, a government report showed on Thursday, signalling stabilization in the housing sector...

The number of new homes for sale fell to 538,000 in April from 546,000 in March. It would take 6.5 months to clear that inventory at the current sales pace, a sharp drop from the 8.1 months recorded a month earlier.

...continued growth in durable goods orders:

Another report showed April orders for durable goods rose a weaker-than-expected 0.6 percent, but key gauges of business investment and inventories signaled strength...

The rise in orders followed a strong 5 percent March gain, while orders for non-defense capital goods excluding aircraft, seen by economists as a proxy for business investment, rose 1.2 percent in April after a 4.4 percent increase in March.

...and a resilient job market.

In a third report, the Labor Department said new claims for jobless benefits rose 15,000 to 311,000 last week.

But a four-week moving average of claims, which irons out weekly variations to give a clearer picture of underlying labor-market trends, fell for a fourth successive week. The average hit 302,750, the lowest level since February 2006.

Markets appear to be waking up to the fact that rate cuts by the Fed are unlikely in the near future. Again from Reuters:

U.S. government bond yields climbed neared four-month highs on Thursday after a surge in new home sales reduced chances of an interest-rate cut, while the dollar hit a six-week high against the euro.

But rate-sensitive utility stocks and losses in the technology sector led U.S. stock indexes lower, as did a round of profit-taking ahead of a three-day holiday weekend...

"People are coming to grips with the idea that not only are there not going to be rate cuts any time soon, but if the 10-year Treasury (yield) goes much higher, then people are going to start talking about the Fed lifting rates again," said Jim Paulsen, chief investment officer at Wells Capital Management in Minneapolis.

However, Calculated Risk reminds us that possible revisions mean that we should take the just-reported data with "a grain of salt". Barry Ritholtz at the Big Picture says that "whenever New Home Sales jump double digits, it usually reflects a mean reversion from the prior (or subsequent) month's reportage". The Bonddad Blog points out that the positive tone in the news does not reflect the difficulties that companies in the industry are experiencing.

In any case, rate cuts appear unlikely because the Fed remains wary of inflation, and Harvey Rosenblum, head of research at the Federal Reserve Bank of Dallas, explains why the subdued core inflation rate may not be telling the full story.

"In the United States over the last 20 years, core measures excluding food and energy did take out a lot of noise. But in the last three years it has been extracting quite a bit of signal," said Harvey Rosenblum, head of research at the Federal Reserve Bank of Dallas...

"In the last three years, energy has moved in one direction for the most part, and food over the last two years has moved primarily up. And it is becoming annoying to people to see the central bank exclude those," he said...

On the other hand, Rosenblum said that because the Fed relies on a number of different measures of price pressure, there was not much risk the flaws in core inflation would translate into a policy mistake.

What other measures of price pressure could the Fed be relying on? Spare capacity for one. This Reuters article has more on it.

Inflation's not gone, it's gone global -- that's the conclusion of a growing number of economists who say global capacity pressures now have more influence on a country's inflation than factors closer to home.

Five years of the fastest world growth since the 1960s mean a dwindling amount of spare capacity is left at a global level, so central banks must look more beyond their own borders if they want to keep one step ahead of inflation, researchers say.

The OECD also thinks that strong global economic growth means that inflation should be a concern for central banks.

The global economy is doing better than for years as red-hot Chinese growth combines with comebacks by Europe and Japan to offset a U.S. slowdown, the Organisation for Economic Co-operation and Development said on Thursday.

Unemployment is falling and central banks need to remain on guard as inflation risks mount due to increases in the cost of food, commodities and shipping, the Paris-based OECD said in a twice-yearly report on international economic prospects.

"The current economic situation is in many ways better than what we have experienced in years," chief economic Jean-Philippe Cotis said.

Interest rate policy needed to remain tightish.

Indeed, the European economy has made a comeback, thanks to a large extent on German growth, which looks likely to continue. After the ZEW Center reported that German investor confidence rose to an 11-month high in May earlier this week, yesterday we got the following news from Bloomberg:

The Ifo institute's sentiment index, based on responses from 7,000 executives, was unchanged at 108.6, the Munich-based research institute said today. Economists expected an increase to 108.8, according to the median of 37 forecasts in a Bloomberg News survey. The index reached 108.7 in December, the highest since records for a reunified Germany began in 1991...

The biggest jump in company spending on equipment in seven years and rising inventories drove economic growth in the first quarter, the Federal Statistics Office said today. The economy expanded 0.5 percent from the fourth quarter, exceeding economists' 0.3 percent median estimate.

There have been other signs of strength in the European economy. On Wednesday. Eurostat reported that industrial new orders in the euro area rose 2.7 percent in March. Yesterday, Reuters reported that British manufacturers are looking to put up prices at their fastest pace in 12 years as order books improved for the fourth month, according to the Confederation of British Industry's industrial trends survey.

Thursday, 24 May 2007

But is it irrational?

Alan Greenspan has added his weight to those who are warning about the Chinese stock market. Bloomberg reports:

Former Federal Reserve Chairman Alan Greenspan said he was concerned Chinese stocks might undergo a "dramatic contraction" after its main stock index jumped more than 90 percent this year...

"It is clearly unsustainable," Greenspan told a conference in Madrid today by satellite. "There is going to be a dramatic contraction at some point."

Apparently, he did not say there is irrational exuberance, though.

Greenspan is sanguine about the rest of the global financial system.

Greenspan today said the global financial system remains resilient. "I am not worried about the system overall, but I am worried about some parts," he said. "I am concerned for example about China."

Others are possibly less sanguine. From another Bloomberg report:

Asia's economies, in "much better shape" since a region-wide financial crisis struck a decade ago, still aren't sheltered from the threat of a global slowdown and capital outflows, according to Lehman Brothers Inc.

Weaker U.S. growth spreading to Europe and Japan is one of the risks facing Asia's export-reliant markets, which are twice as dependent on sales abroad as the rest of the world, Lehman economists led by Robert Subbaraman said in a May 18 report.

Japan's trade data for April highlight that risk.

Exports grew 8.3 percent, cooling from 10.3 percent in March, the Ministry of Finance said in a report today in Tokyo. Shipments to the U.S. fell 4.8 percent, the steepest decline since May 2004.

The trade surplus rose 51.8 percent to 926.7 billion yen ($7.6 billion). The median estimate of 37 economists surveyed by Bloomberg News was for the surplus to widen to 953.7 billion yen. Imports climbed 3.5 percent from 0.1 percent in March.

According to the Lehman report, China's stock market adds to the risk.

A crash in China's stock market may make investors more wary of speculative bets on assets, sparking a flight in such funds, the report said. Emerging markets in Asia received net private capital flows of $197.3 billion last year, the ADB said in March.

If so, the large but much-maligned foreign exchange reserves would come in handy.

Still, Asia's record holdings of foreign-exchange reserves since the crisis will enable central banks to defend their currencies should capital flight occur, Lehman said.

And then there is the interest rate cut.

With inflation "well under control," central banks have room to cut interest rates should risks to growth emerge, Lehman said. Asian policy makers raised rates more than 25 times last year to curb inflation, control lending and stem money from overseas that were creating asset bubbles in their markets.

Here, Thailand showed the way yesterday.

Thailand's central bank cut its benchmark interest rate for a fourth time this year to revive spending by consumers and businesses whose confidence is near a five-year low.

The Bank of Thailand lowered its one-day bond repurchase rate to 3.5 percent from 4 percent. The decision was expected by 12 of 16 economists surveyed by Bloomberg News.

Wednesday, 23 May 2007

Impatient US meets resistant China

It appears that the talks between the US and China have not gotten off to a good start. AFP/CNA reports:

Facing increasing pressure from lawmakers, the United States called on China on Tuesday to step up economic reforms at high-level talks, but Beijing cautioned Washington against politicising trade relations between the two key powers.

US Treasury Secretary Henry Paulson, in his opening remarks at the two-day "strategic economic dialogue" meeting, underlined "persistent trade and financial imbalances" and sought prompt action from China to redress them, saying Americans were "impatient"...

In an apparent reference to increasing anxiety in the US Congress, Paulson said there was growing "anti-China sentiment" in the United States as China became "a symbol of the real and imagined downside of global competition."

[Chinese Vice Premier Wu Yi] did not mince words in her opening comment.

"Politicising trade and economic issues is absolutely unacceptable" and would "complicate the situation," warned the "iron lady" of China.

She also cautioned against what she called the danger of injecting politics into US economic and trade relations.

Unfortunately, it is all very much about politics. The Financial Times writes (via Yahoo! Finance):

For more than three years, Beijing has shouted from the rooftops that its economy is out of balance: too reliant on exports and investment for growth, with a dangerously high share of output from energy-intensive, polluting heavy industries.

But the plethora of policies rolled out to rebalance the economy has had little, if any, impact, partly because of their timidity and partly because the system is not responsive...

The time-worn analogy of turning around a supertanker is often used to illustrate the government's policy task. It might be more accurate to liken the Chinese economy to a flotilla of large and small boats, all steaming ahead at full bore, with little regard to the direction of the fleet or the diktats of its commanding officers in Beijing...

Meanwhile, China's political calendar, and the caution of Wen Jiabao, the premier, who is in charge of economic policy, makes any radical deviation from the incremental approach to reform unlikely in the near-term. Senior policymakers have become even more risk-averse and resistant to overt foreign pressure than normal in advance of the ruling Communist party's five-yearly congress later this year, which is expected to usher in sweeping changes to the leadership. The US, which is entering its own political season earlier than usual in the run-up to next year's presidential election, acknowledges the timing may not be right for the kinds of changes Washington wants.

"The great risk we face is that our respective political calendars are out of sync," said David Loevinger, the US Treasury representative in Beijing, in a recent speech. "The problem faced is: just at the point the US, for our own political reasons, really need a response by the Chinese, the Chinese are unable to provide it."

Tuesday, 22 May 2007

Chinese investors push up stocks, challenge government

China tightens, the stock market hits a new high. Such seemingly perverse reactions in markets have been almost a norm lately. From AFP/CNA:

Chinese share prices jumped 1.04 percent for another record finish Monday as investors shrugged off the central bank's latest efforts to cool the economy and stocks, using early losses as a bargain-hunting opportunity instead, dealers said.

They said prices opened down more than 3.0 percent but the key index was soon back in positive territory as investors discounted Friday's moves as more of the same measures that have failed to work since early 2006.

Other stock and asset markets did well yesterday too, as FT reports, with the S&P 500 climbing above its record high close of 1,527.46 at one stage.

But back to China, where Bloomberg reports that another billionaire is warning about a bubble.

Billionaire Lee Shau-kee, chairman of Henderson Land Development Co., said Chinese shares trading on mainland markets are at an "unreasonable" premium to those in Hong Kong, threatening to create "a bubble."

"Mainland investors are too keen to win in the stock market, chasing after stocks no matter what the prices are," Lee told reporters in Hong Kong today. "They are too irrational."

Too keen indeed. As bubbles often do, this one is tempting illegal behaviour. From FT:

The Shanghai government agency responsible for clearing drains and repairing lifts in apartment buildings has emerged as a leading shareholder in at least three listed companies, in spite of being barred from such risky investments.

Reuters sees the continuing gains in the stock market as a test of the Chinese government's will -- not often a good idea.

Rising to a record high immediately after the central bank hiked interest rates, China's booming stock market has entered a battle of wills with the government -- a battle that it may well lose...

"The market seems to have largely ignored the signal that the central bank has sent about a soft landing," said analyst Zhao Wuling at Everbright Securities. "But underestimating the central bank may prove dangerous."...

... [B]y brushing aside the central bank's tightening, the market has sent policy makers a challenge that they cannot afford to ignore if they want to maintain credibility, analysts said...

Investors putting new money to work in China's stock markets ignore the adage 'Don't fight the central bank'," global investment bank ING said in a report on Monday, warning that future pull-backs could unsettle risky markets globally.

Monday, 21 May 2007

US economy to regain ascendancy on demographics

A shift in focus to the long term today, with emphasis on demographics.

Barron's recently interviewed Joshua Feinman, chief economist at Deutsche Asset Management. Via Yahoo! Finance:

U.S. economic growth, he says, will keep lagging other parts of the world for the next year or two. The U.S. housing market's biggest declines are in the past. And export-driven U.S. companies are in their strongest position.

Feinman also asserts that U.S. investors remain insufficiently exposed to foreign-investment opportunities. And while the global economy is outgunning the U.S. right now, changing demographic trends indicate that the U.S. could outgrow Europe and Japan over the next few decades.

Elaborating on the long-term impact from demographics:

"... The U.S. population is aging, and there is no doubt that the U.S. will have to deal with the impact of that population shift. But our working-age population is still growing. In Japan, the working-age population is declining, and in Europe, fertility rates have fallen.

"China has been in a demographic sweet spot because a rising percentage of its population is in their prime working years. They have not had too many kids and do not yet have too many elderly, helping to fuel economic success. But the party is about to end. In the next decade, China's cohort of working-age citizens will get smaller and the elderly population will rise. That means less discretionary income for consumers to spend and less economic growth. But China's economy will still grow faster than the U.S.'s because they are still catching up to wealthier Western nations."

Indeed, the whole of East Asia has a demographic problem, which Philip Bowring at IHT tries to address.

... East Asia now has the world's worst demographics. Modernization, urbanization and industrialization have seen a collapse in birth rates far more sudden than in the West, and there is scant sign that the few modest measures Asians have taken to reverse the decline have had any significant effect...

Japan, with a fertility rate stuck at 1.3 births per woman, is on track to lose half its population by 2105. Other places are even worse off. Hong Kong, at 0.9 births per woman, is at the bottom of the world fertility league. Singapore, Taiwan and South Korea all have rates marginally lower than Japan, or the worst performers in southern Europe.

Using Europe as his model, Bowring thinks state spending is a solution.

The European example shows that state spending on child support, crèches and other such programs is money well spent to ensure that there will be a younger generation large enough to support the economy and pay the pensions of the old.

That is a lesson that East Asia has yet to learn. Investment in children through government spending may provide a much better return than accumulating vast fiscal surpluses to be invested in low yielding foreign assets or unnecessary infrastructure.

Perhaps that is overly simplistic. The blog to go to for a more comprehensive look at demographic matters is, where Edward Hugh has, among others, a post on the rather special case of fertility in China.

Saturday, 19 May 2007

China tightens again, markets yawn

From Bloomberg:

China's government increased the amount its currency can appreciate, raised interest rates and curbed bank loans in an effort to tame a runaway economy and ease trade tensions with the U.S. and Europe...

The yuan will be allowed to move as much as 0.5 percent on either side of a rate set each morning on China's foreign- exchange market, from 0.3 percent, the central bank said...

The one-year benchmark lending rate will be raised to 6.57 percent from 6.39 percent, starting tomorrow, the People's Bank of China said. That [is] the fourth increase since April last year.

The one-year deposit rate will be increased to 3.06 percent from 2.79 percent. Both rates are the highest in more than eight years...

Lenders must put aside 11.5 percent of deposits starting from June 5, up from 11 percent, the People's Bank of China said. That is the fifth increase in banks' reserve ratios this year, compared with three in all of last year.

So far, market reactions to the moves have been minimal. From Reuters:

The sharpest reaction on world markets was a jump in Japan's yen, often seen as a proxy for the yuan, against the dollar and euro.

But world stock markets paid scant attention. The FTSEurofirst 300 continued to rally at 6-1/2 year highs. Wall Street opened higher and stayed there.

The lack of reaction is ironic considering that the latest moves appear to have gotten more attention than previous ones. For examples, in the blogosphere, Dave Altig at macroblog, Barry Ritholtz at The Big Picture and David Gaffen at MarketBeat Blog all reported them. In contrast, previous tightening moves by the Chinese authorities had mostly not been reported -- certainly not the one in February.

I think the general lack of coverage previously had probably left investors unprepared when the Chinese market tanked in February. That is not the case this time around.

Having said that, we should probably wait for the Asian reaction next week. Remember that back in February, the Chinese stock market was up on the first day after that tightening took effect.

Friday, 18 May 2007

US leading index falls, other reports more positive

The Conference Board reports that its US leading index declined in April.

The Conference Board announced today that the U.S. leading index decreased 0.5 percent, the coincident index increased 0.2 percent and the lagging index increased 0.2 percent in April...

The leading index now stands at 137.3 (1996=100). Based on revised data, this index increased 0.6 percent in March and decreased 0.6 percent in February. During the six-month span through April, the leading index decreased 0.2 percent, with three out of ten components advancing (diffusion index, six-month span equals thirty percent.)

One of the components that contributed negatively to the index in April was weekly initial claims for unemployment insurance. That does not look like repeating in May. From MarketWatch:

The number of new filings for state unemployment benefits fell by 5,000 in the week ended May 12, the fifth straight decline, bringing claims to their lowest level since early January, the Labor Department said Thursday...

First-time claims fell a revised 8,000 to 298,000 in the previous week, compared with the initial estimate of a drop of 9,000 to 297,000.

The four-week average of initial claims fell 12,000 to 305,500. This marked the lowest level since the week ended April 15, 2006.

In addition, manufacturing continues to show signs of recovery. The Federal Reserve Bank of Philadelphia said its business activity index for the manufacturing sector rose from 0.2 in April to 4.2 in May.

And Ben Bernanke remains sanguine about the impact of the housing market on the rest of the economy. MarketWatch reports:

The slowdown in the housing market probably has further to run, but it won't have a significant impact on the rest of the economy, Federal Reserve Chairman Ben Bernanke said Thursday.

Thursday, 17 May 2007

Japan cools and leaves rates unchanged, China stays hot

The Bank of Japan left interest rates unchanged today after the economy was reported to have slowed in the first quarter. Bloomberg reports:

Japan's economy, the world's second largest, cooled in the first quarter as companies cut spending on concern that exports to the U.S. will slow. The central bank kept its benchmark interest rate unchanged.

Gross domestic product grew at an annual 2.4 percent rate in the three months ended March 31, the Cabinet Office said in Tokyo today. The fourth-quarter figure was revised to 5 percent from 5.5 percent.

Consumer spending, accounting for more than half of GDP, rose more than expected and may cushion the economy from waning growth in the U.S., the nation's largest export market. Bonds had their biggest gain in five weeks on speculation slower growth and two months of falling consumer prices will delay an interest-rate increase from 0.5 percent.

Low rates would keep the yen carry trade going. And continue feeding liquidity elsewhere.

Perhaps that has something to do with why China's stock market is in a bubble. From Bloomberg:

China's stock valuations are "too high" at 50 to 60 times earnings and prices are likely to decline, according to Li Ka-shing, the world's ninth-richest man.

"There must be a bubble," Li, 78, said at a press briefing in Hong Kong following the annual general meeting of Cheung Kong Holdings Ltd., his flagship property company. "As a Chinese, I'm worried about the stock market in China."

But it is not just the stock market. Fixed-asset investment in China has also been surging. Again from Bloomberg:

Fixed-asset investment in urban areas rose 25.5 percent to 2.26 trillion yuan ($294 billion) through April, the National Bureau of Statistics said today. That compares with 24.5 percent in all of 2006 and beats the 25.3 percent median estimate of 19 economists surveyed by Bloomberg News.

This comes a day after China reported that industrial production rose 17.4 percent in April.

Economic reports point to more rate hikes by ECB, BoE

Economic growth in the euro area has stayed relatively buoyant recently, but so has inflation. Bloomberg reports:

Inflation in the euro area remained at 1.9 percent in April as prices for food and drink rose, keeping the rate close to the European Central Bank's 2 percent ceiling...

Europe's economy grew a faster-than-forecast 0.6 percent in the first quarter from the fourth, when it expanded 0.9 percent. Reports in the last three weeks indicate that pace of growth has been maintained in the current quarter.

That should keep upward pressure on European bond yields, and a rate hike by the European Central Bank next month should proceed as expected.

The Bank of England may feel compelled to do the same. Again from Bloomberg:

The central bank said in its quarterly forecasts that it sees "upside" risks to inflation, which it reckons will exceed the 2 percent target in two years unless borrowing costs rise further. The bank also said economic growth will reach a 3 percent pace this year, the most since 2004, and the government reported earlier that jobless claims fell by 15,700 to 890,000 in April...

Yesterday, government data showed inflation eased to 2.8 percent in April from 3.1 percent in March, the highest in a decade after a surge in oil and energy costs...

Today's labor market report showed average earnings including bonuses rose 4.5 percent in the quarter through March, slower than the 4.6 percent gain in the three months through February, the Office for National Statistics said.

Excluding bonuses, wage inflation accelerated in the first quarter to 3.7 percent from 3.6 percent, the statistics office said. The number of workforce jobs rose to a record 31.58 million in December, today's report showed...

The claimant count rate declined to 2.8 percent in April, the lowest since November 2005, from 2.9 percent in March, the statistics office said today. Using International Labor Organization methods, the jobless rate held at 5.5 percent in the first quarter.

On the other hand, mixed economic data in the US should keep the Federal Reserve on hold for a while more. Recent housing data have been weak:

Builders broke ground on new dwellings at an annual rate of 1.528 million in April, a 2.5 percent increase from a revised 1.491 million rate the prior month that was weaker than previously estimated, the Commerce Department said today in Washington. Building permits slumped 8.9 percent to a 1.429 million pace, the fewest since June 1997...

A report yesterday showed builders became more pessimistic this month. The National Association of Home Builders/Wells Fargo sentiment index fell to 30 from 33 in April. The reading matched September's figure as the lowest since 1991. Readings below 50 mean most respondents view conditions as poor.

But industrial production appears to be rebounding.

The 0.7 percent increase in production at factories, mines and utilities followed a revised 0.3 percent decrease in March that was bigger than originally reported, Federal Reserve figures showed today. Capacity utilization, which measures the proportion of plants in use, rose to 81.6 percent from 81.2 percent in March...

Factory output, which accounts for about four-fifths of industrial production, rose 0.5 percent after rising 0.6 percent in March.

Wednesday, 16 May 2007

US inflation falls but hold the celebrations

Consumer price inflation in the United States edged down further in April. This is good news for the economy and for markets. However, it is still too soon to declare that inflation has been beaten.

Yesterday, the Labor Department reported that the consumer price index rose 0.4 percent in April, down from the 0.6-percent rise in March. Food and energy prices were responsible for much of the increase, rising 0.4 percent and 2.4 percent respectively. The core index that excludes food and energy prices rose 0.2 percent, up from 0.1 percent in March.

On a year-on-year basis, the headline CPI rose 2.6 percent in April, down from 2.8 percent in March, while the core CPI rose 2.3 percent, down from 2.5 percent in March.

Economists generally welcomed the news, saying that it is a sign that inflation is abating with the slowing economy, much as the Federal Reserve expects. In fact, if the core CPI rose 2.3 percent year-on-year in April, the core personal consumption expenditures price index, the indicator that the Federal Reserve focuses on as a measure of inflation, could have risen at about 2 percent or even less. In other words, inflation could have fallen within the Federal Reserve's comfort zone in April.

Nevertheless, we should probably hold the celebrations for the time being. While the inflation data yesterday were benign, further moderation could be limited, especially if the economy turns around as most economists expect.

In fact, the latest survey of professional forecasters by the Philadelphia Federal Reserve Bank shows that the forecasters expect core CPI inflation to average 2.3 percent in each of the next three years while core PCE inflation will average 2.1 percent over the same period. Real gross domestic product will recover from the first quarter low to grow 2.1 percent for 2007 as a whole with a further acceleration to 2.9 percent for 2008.

Indeed, the latest data from the Institute for Supply Management released earlier this month, apart from showing that the indices on economic activity have been rising, also show that the price indices are on a rising trend again. The headline CPI generally moves together with the ISM price indices. The core CPI, which tends to lag headline CPI, could yet accelerate in coming months.

However, as a measure of underlying inflation, the Labor Department's CPI less food and energy does not have a monopoly. In fact, in my opinion, the Federal Reserve Bank of Cleveland's 16% trimmed-mean CPI is a better measure. It tracks the trend in headline CPI slightly more closely than the CPI less food and energy without showing significantly more volatility. It also does not significantly lag the headline CPI so it identifies turning points in inflation better.

The trimmed-mean CPI rose 0.2 percent in April, down from 0.3 percent in the previous three months. However, on a year-on-year basis, the trimmed-mean CPI rose 2.8 percent, practically unchanged from the previous two months.

So it is too soon to conclude that inflation has been tamed. Certainly, the Federal Reserve itself continues to drum the same message into our ears at the end of every Federal Open Market Committee meeting, including the one last week: the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected.

Indeed, markets may face a test in coming months. There is a real possibility that investors see the ongoing decline in core inflation and become complacent about inflation and interest rates. If and when inflation turns back up, markets could be in for a bit of a shock.

Chinese stocks plunge

Just a day after I wrote that the Chinese stock market was surging, it plunged. From Bloomberg:

China's stocks fell the most in a month as investors judged gains this year to be excessive relative to earnings growth potential. China Minsheng Banking Corp. and China Merchants Bank Co. led declines...

The benchmark CSI 300 Index, which tracks yuan-denominated A shares listed on China's two exchanges, fell 129.78, or 3.5 percent, to close at 3604.64, the largest decline since April 19. It was the biggest fluctuation among equity markets included in global benchmarks. The measure had gained 83 percent this year before today.

Credit Suisse Group expects mainland policy makers to take steps to cool the local stock market. These may include raising interest rates, taxing share transactions, selling state-owned shares or the use of "harsh comments" by senior officials...

Equities also fell after China's securities regulator ordered the country's fund management companies to not get involved in speculative buying of shares, state-run Securities Times reported, citing a circular from an unspecified regulator.

The state of the Chinese economy apparently wasn't a direct concern.

Retail sales climbed 15.5 percent to 667.3 billion yuan ($86.8 billion) last month after gaining 15.3 percent in March, the National Bureau of Statistics said today. That was the biggest increase since May 2004 when the first two months of each year are combined to eliminate Lunar New Year holiday distortions.

Interestingly, the rest of Asia was little affected by the Chinese market this time. Instead, Japan pulled the rest of Asia down on weak economic data. Again from Bloomberg:

Asian stocks dropped after Japanese machinery orders unexpectedly fell and metals prices slumped...

Japan's benchmarks led the decline as the 4.5 percent drop in machinery orders in March dented expectations for regional economic growth that has helped fuel a four-year rally in the Morgan Stanley Capital International Asia-Pacific Index...

MSCI's Asia-Pacific index dropped 0.9 percent to 148.32 at 7:28 p.m. in Tokyo. The Nikkei 225 Stock Average fell 1.1 percent and the broader Topix index retreated 1 percent.

Tuesday, 15 May 2007

UK factory gate inflation eases, leading index rises

Yesterday's UK data could perhaps be used to justify a pause in the Bank of England's tightening campaign.

UK producer price inflation was relatively subdued in April. From Reuters:

Manufacturers' raw material costs rose less than expected in April while factory gate inflation eased after a strong pick-up in March, official data showed on Monday... Input prices rose 0.7 percent in April against forecasts for a 1.0 percent rise while core output prices gained just 0.1 percent, well below the 0.3 percent forecast.

Reuters also reports that house price growth was still strong in April.

The Royal Institution of Chartered Surveyors said its house prices balance rose to +28.9 in the three months to April from an upwardly revised +26.9 in March. Analysts had predicted a reading of +24.

But the strength in the housing market could be about to abate.

Surveyor confidence in house prices in the next three months fell to its lowest since September 2005 in April and they were their least upbeat about the prospect for future sales since September 2004.

On the other hand, the Conference Board's UK leading index shows that the economy appears to be in no particular need for additional stimulus.

The Conference Board announced today that the leading index for the U.K increased 0.6 percent, and the coincident index increased 0.1 percent in March...

With the 0.6 percent increase in March, the leading index now stands at 141.3 (1990=100). Based on revised data, this index increased 0.8 percent in February and increased 0.3 percent in January. During the six-month span through March, the leading index increased 2.0 percent, with six of the eight components advancing (diffusion index, six-month span equals 62.5 percent).

Monday, 14 May 2007

Japan's trade surplus surges, as does China's stock market

The Japanese economy seems to be coping well with the slowdown in the US economy. From Bloomberg:

Japan's current account surplus widened to a record in March, as exports to Asia and Europe helped counter slower growth in shipments to the U.S.

The surplus expanded 36.9 percent to 3.32 trillion yen ($28 billion) from a year earlier, the Ministry of Finance said in Tokyo today, more than the 2.95 trillion yen median estimate of 28 economists surveyed by Bloomberg News...

The trade surplus surged 62.1 percent, the fastest pace in three years, to a record, the Finance Ministry said.

Exports rose 9.6 percent, as a weaker yen increased the value of shipments...

Imports fell 1 percent, the first drop in three years, as oil prices were lower than a year earlier...

The income surplus...increased 13.2 percent to a record in March, today's report showed.

Oil price increases picked up pace in April though.

Japan's wholesale inflation accelerated in April as the cost of oil and other commodities rose, the Bank of Japan said today. An index of energy and raw materials prices paid by companies climbed 2.2 percent in April from a year earlier after increasing 2 percent in March, the Bank of Japan said.

Despite its booming economy, though, China got a respite from inflation in April. Again from Bloomberg:

Consumer prices gained 3 percent in April from a year earlier after rising 3.3 percent in March, the National Bureau of Statistics said today. The central bank's target ceiling for inflation in 2007 is 3 percent...

April's inflation rate was less than the 3.1 percent median estimate of 17 economists surveyed by Bloomberg News. Month-on- month, consumer prices declined 0.1 percent...

Money supply growth exceeded the government target for a third month in April and lending accelerated, the People's Bank of China said yesterday. The 17.1 percent gain in M2, the broad measure, outpaced the government's 2007 target of 16 percent...

Growth in M1...outpaced M2 for the fifth straight month, suggesting households are still switching money to be readily available for stock market investing. The gain was 20 percent.

That last paragraph certainly sounds about right. From AFP/CNA:

Investors are throwing money into China's share markets and the fever is nowhere more apparent than in the speculative trade involving the mountain of the bourses' money-losing companies.

Take Jiaozuo Xin'an Science and Technology. Last year the chemical maker lost 218.3 million yuan (US$28.4 million) but its share price has inexplicably tripled in the last three months.

According to various media reports the inexorable rise was triggered by rumours that the troubled firm was in talks to serve as a shell for a back-door listing of a securities brokerage.

The group denied it repeatedly, but its share price only climbed higher - a reflection of how China's overheated stock markets are defying economic logic and will eventually cause major economic fallout.

But no fallout today as Chinese stocks were up again, the Shanghai Composite Index rising 0.6 percent to close at 4,046.392.

Saturday, 12 May 2007

Chinese data look hot, US data do not

China's trade surplus shows few signs of narrowing. From Xinhua Online:

China's trade surplus in April more than doubled the figure of March to 16.88 billion U.S. dollars, though the country's exports grew slower and imports rose faster over the past month, according to the General Administration of Customs...

The administration said the aggregate surplus for the first four months has reached 63.31 billion U.S. dollars, with the April exports growing at a slower 26.8 percent to 97.45 billion U.S. dollars and imports, at a faster 21.3 percent to 80.57 billion U.S. dollars.

But things could change in a few years' time. From China Daily:

The supply of low-cost labor, widely considered to be fueling China's sizzling economy, could start drying up as early as 2010, a report warns.

One of the biggest reasons for the potential shortage is that the rural labor force may not be as large as previously thought, the report, issued by the Chinese Academy of Social Sciences on Thursday, says.

"China is moving from an era of labor surplus into an era of labor shortage," the report cautions.

As it is, China's boom is already putting upward pressure on producer prices. From Bloomberg:

China's producer prices climbed at a faster pace in April.

Factory-gate prices rose 2.9 percent from a year earlier, the National Bureau of Statistics said today, after gaining 2.7 percent in March. That's the same as the median estimate of 14 economists surveyed by Bloomberg News.

Little wonder that the People's Bank of China said it would keep tightening in its first quarter monetary policy report.

In contrast, markets are looking for interest rate cuts in the US, especially after yesterday's data. From Reuters:

A Commerce Department report on Friday showed sales by U.S. retailers fell 0.2 percent to a seasonally adjusted $372.03 billion last month, hurt by a one-two punch of soaring gasoline prices and a slumping housing market.

Separately, the Labor Department said that while costlier energy pushed producer prices up 0.7 percent in April, the so-called core rate that strips out food and energy costs was unchanged from March.

"Bottom line, today's data reinforces the view that inflation is contained while the economy is showing signs of a slowdown," said Alex Beuzelin, an analyst with Ruesch International in Washington.

"It also supports the view that the Fed will have to cut rates sometime this year," he added.

Friday, 11 May 2007

BoE raises rates, other central banks could follow

The Bank of England raised interest rates yesterday. FT reports:

UK interest rates hit their highest level in more than six years on Thursday after the Bank of England raised the cost of borrowing to 5.5 per cent...

In its statement accompanying the rise the Bank said it made the move because “output growth has remained firm. Business investment has been stronger than expected and, although indicators of consumer spending have been volatile, the underlying picture is one of steady growth.”

It added that relative to its 2 per cent inflation target, “the risks to the outlook for inflation in the medium term consequently remain tilted to the upside.”

The European Central Bank left rates unchanged yesterday, but as FT also reports, will probably move soon.

Jean-Claude Trichet, ECB president, committed the ECB to “strong vigilance” – a phrase widely understood to mean an interest rate rise is a month away. Eurozone interest rates are currently 3.75 per cent...

Commenting after a meeting of the ECB’s governing council in Dublin, Mr Trichet said “upside risks” to inflation remained, citing increasing capacity utilisation and the threat of high wage deals.

On Monday, the European Commission had raised its forecasts for growth and inflation this year, citing an unexpected first-quarter expansion in Germany, where factory orders rose 2.4 percent in March.

Even the Bank of Japan is committed to higher rates, according to another FT report.

Japan’s central bank governor on Thursday made the case for a gradual increase in interest rates, warning that keeping rates low could fuel the so-called yen carry trade and destabilise the country’s economy.

This is despite slower lending growth in Japan in April. From Bloomberg:

Japan's lending growth slowed for a third month as cash-rich companies ignored the lowest borrowing costs among major economies and used their own funds to invest.

Loans excluding trusts rose 1 percent in April from a year earlier, the Bank of Japan said in Tokyo today, slowing from 1.1 percent in March. Lending adjusted for currency fluctuations, bad loan write-offs and securitizations climbed 1.9 percent...

Japan's money supply, or M2 plus notes in circulation, rose 1.1 percent in April, the central bank said in a separate report. Broad liquidity, which includes bonds and investment trusts, gained 2.6 percent.

In addition, the OECD's composite leading indicator for Japan fell by 0.8 in March; its six-month rate of change has been on a downtrend since March 2006. The euro area did not do much better; its CLI increased by 0.1 in March but its six-month rate of change has fallen since June 2006. But the UK's CLI supported yesterday's rate hike; it increased by 0.7 in March and its six-month rate of change increased for the second month in a row. Elsewhere, the CLI for the US increased by 0.6 in March while that for China jumped by 7.4.

The US in particular would welcome an acceleration in its economy. Yesterday's trade data means that first quarter growth could be even worse than initially reported. From Reuters:

The trade gap grew more than 10 percent in March to $63.9 billion, as U.S. oil imports reached their highest level since August 2006 and the average price for imported oil rose to $53.00 per barrel from $50.71 in February, the Commerce Department said in a report.

Oil import prices continued to rise in April, a second report showed, suggesting further outward pressure on the trade deficit in the months ahead. Other import prices were surprisingly robust, analysts said.

The large March trade gap prompted some analysts to trim estimates of first-quarter U.S. economic growth to 0.7 percent or even less, from the 1.3 percent the government initially estimated last month...

Overall U.S. imports increased 4.5 percent in March to $190.1 billion, led by a gain of more than 11 percent in imports of industrial supplies and materials, which includes crude oil...

However, U.S. exports had another strong showing, rising 1.8 percent in March to $126.2 billion, second only to the record set in January.

There were other pieces of bad news yesterday.

In another worrisome sign for the economy, major department store chains said they had poorer-than-expected sales in April, with many blaming the early Easter holiday and cool weather for the results...

The private SpendingPulse survey released on Thursday showed retail sales increased 0.5 percent in April, but much of the gain was driven by a surge in gasoline prices.

After stripping out car and gasoline sales, retail sales grew just 0.1 percent in April, half the 0.2 percent rise in March, SpendingPulse said.

On the other hand...

In a bit of good news overshadowed by other data, the Labor Department reported the number of U.S. workers filing new claims for jobless benefits in the week ended May 5 fell unexpectedly by 9,000 to the lowest level since mid-January.

Together with the rising levels of imports and import prices, yesterday's US data mean that one cannot rule out the possibility that the Federal Reserve could yet join its foreign counterparts in hiking interest rates.

Thursday, 10 May 2007

Fed leaves rates unchanged, Japan's leading index points down

To no one's surprise, the Federal Reserve left interest rates unchanged yesterday. Bloomberg reports:

The Federal Reserve kept the benchmark U.S. interest rate at 5.25 percent and didn't budge from its conviction that inflation is the biggest risk facing the economy despite a yearlong slowdown.

"The committee's predominant policy concern remains the risk that inflation will fail to moderate as expected," the Federal Open Market Committee said in a statement today after meeting in Washington. "Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth."

The FOMC statement is here. Mark Thoma at Economist's View points out the changes, of which there are in fact only two. The changes essentially update the statement to reflect the latest backward-looking data.

In other words, the FOMC statement adds nothing new.

Elsewhere, there were some forward-looking data on Japan yesterday. Bloomberg reports the latest reading for the leading index.

The leading index was 40 percent in March, the Cabinet Office said today in Tokyo, matching the median estimate of 22 economists surveyed by Bloomberg News. A number below 50 indicates the economy may cool in three to six months.

Earlier, the Conference Board's leading index for Japan had told a similar story.

The Conference Board reports today that the leading index for Japan decreased 0.2 percent and the coincident index decreased 0.2 percent in March...

With the decrease of 0.2 percent in March, the leading index now stands at 87.8 (1990=100). Based on revised data, this index decreased 0.1 percent in February and decreased 0.5 percent in January. During the six-month span through March, the index increased 0.3 percent, and four of the ten components advanced (diffusion index, six-month span equals 40.0 percent).

Monday, 7 May 2007

May is here, should stock investors fear?

Stock markets around the world have had a good run lately. However, it is now May. Is it time for investors to sell and go away?

The bull run in stock markets -- now about four years old -- show few signs of ending at the moment. After some volatility earlier this year, most major markets have achieved good gains for the year. The Standard & Poor's 500 Index closed at 1,505.62 last Friday and is up 6.2 percent since the beginning of the year. The rest of the world have done a bit better; since the beginning of the year, the Morgan Stanley EAFE Index is up 8.6 percent in US-dollar terms.

Bulls could be facing a potentially difficult period ahead though. The six-month period from May to October is generally regarded as a relatively weak period for stock markets.

However, according to David Kotok, chairman and chief investment officer at Cumberland Advisors, much depends on what happens to interest rates over this period. In an article on 24 April, Kotok wrote that historically, the May-October period has been particularly painful for stock investors when the Federal Reserve was raising rates. However, when the Federal Reserve eases or remains neutral during this period, there was no obvious negative tendency in stock markets.

We will soon know how the season will kick off with respect to interest rates. The Federal Reserve meets this week and will announce its interest rate decision on Wednesday. It is likely to leave interest rates unchanged as recent economic data have not provided much evidence that the US economy is straying away from the central bank's forecast of below-trend but continued growth with some inflation pressures.

Last week's economic data reporting had started off on a relatively weak note, with the Commerce Department reporting on Monday that personal consumption expenditures rose 0.3 percent in March, less than the 0.4-percent increase in the price index. Personal income, however, rose a strong 0.7 percent.

The week ended with another weak report that raised doubts on the sustainability of that income growth. The Labor Department reported on Friday that the US economy added 88,000 jobs in April, substantially down from the average monthly rate of over 140,000 in the first three months of the year, and the unemployment rate edged up to 4.5 percent from 4.4 percent.

However, employment is a lagging indicator of the economy and the stock market shrugged off the data, the S&P 500 rising 0.2 percent on Friday.

Other indicators released last week appear more positive. Both of the Institute for Supply Management's reports last week were relatively strong. The PMI, its gauge of manufacturing activity, rose to 54.7 in April from 50.9 in March while its non-manufacturing business activity index rose to 56.0 in April from 52.4 in March. Further evidence of a recovery in manufacturing came from a Commerce Department report on 2 May showing that new orders for manufactured goods rose 3.1 percent in March, the biggest gain in a year.

The latest indices of leading indicators are also pointing up. The Economic Cycle Research Institute's Weekly Leading Index increased to 142.4 in the week ended 27 April from 141.1 in the prior week. Its annualised growth rate rose to 4.4 percent, a three-month high, from 3.6 percent the prior week. In April, the Conference Board had reported that its US leading index increased 0.1 percent in March after two consecutive declines.

On the whole, the data, though not conclusive, do not appear to be inconsistent with the view shared by many economists that the US economy could be near a bottom and ready to re-accelerate in the second half of the year.

If anything, inflation concerns could return to the fore. The March PCE price index was mixed, the 0.4-percent rise in the overall index not being confirmed by the core index that excludes food and energy, which was unchanged from February. However, both the ISM manufacturing and non-manufacturing surveys showed increases in the indices on prices in April -- to 73.0 from 65.5 in March for the former and to 63.5 from 63.3 for the latter.

Under the circumstances, the Federal Reserve is likely to leave rates unchanged this week. What happens to interest rates over the subsequent months will depend on incoming data but it appears to me that neither a hike nor a cut should be ruled out at the moment.

However, the Federal Reserve is not the only major central bank to meet this week. The Bank of England and the European Central Bank will announce interest rate decisions on Thursday.

The BoE is expected to raise rates this week after inflation hit 3.1 percent in March, more than a percent above its target. Despite a mixed inflation picture from last week's reports on the manufacturing and service sectors, interest rate futures indicate that traders are expecting yet another rate hike after that this year.

Inflation in the euro area, on the other hand, has remained steady over the past few months, so the ECB will probably leave rates unchanged. However, a hike is widely expected in June and interest rate futures indicate that traders expect yet another hike after that this year. The latest eurozone data show continued strength in the economy and M3 money supply rose 10.9 percent in March from a year earlier, the most since February 1983.

The Bank of Japan meets next week. After some relatively weak data recently on consumer spending, income, industrial production and consumer prices, a rate hike appears unlikely next week. Nevertheless, the BoJ has shown that it is determined to normalise interest rates, so a rate hike some time in subsequent months is likely.

So while the Federal Reserve may be on pause, with the direction of the next move in monetary policy uncertain, there is little doubt that the trend in interest rates in the rest of the industrialised world remains up. Whether this upward trend is enough to derail the ongoing bull market in stocks remains the big question.

Saturday, 5 May 2007

US job growth slows, European economy remains robust

MarketWatch reports that US jobs growth was sluggish in April.

U.S. jobs growth slowed in April to 88,000 with 12% fewer added jobs than economists had forecast, and the unemployment rate ticked up to 4.5%, the Labor Department said Friday.

In April, average hourly wages increased 2 cents, or 0.2%, to $17.25. Average wages rose 3.7% in the 12 months ended in April. The length of the average workweek fell to 33.8 hours from 33.9 hours.

According to Bloomberg, US Treasuries rose yesterday, but so did stocks. Takeover speculation may have helped the latter, but if stocks are being driven by liquidity, as many believe, the weak jobs report is not necessarily bad news for stocks, at least in the short term.

In Europe, weakness in the economy has been less of a concern. Yesterday, Eurostat reported that retail sales rose by 0.5 percent in the euro area and by 0.6 percent in the EU27.

However, Bloomberg reports that services growth slowed in April.

Royal Bank of Scotland Group Plc's services index fell to 57 from 57.4 in March. The index is based on a survey of purchasing managers by NTC Economics Ltd. and has held above 50, indicating expansion, for 46 straight months. Economists expected the gauge to rise to 57.6, according to the median of 33 estimates in a Bloomberg survey.

Economists were not too concerned though.

"Taken in conjunction with other, more upbeat indicators," today's report is "still consistent with robust growth," said Sandra Petcov, an economist at Lehman Brothers in London. "Its level is still high."...

Today's report "provides encouraging signs that the euro- area service sector has settled into a robust pace of growth, having shrugged off the VAT increase in Germany and recent interest-rate rises," said Jacques Cailloux, chief euro-region economist at Royal Bank of Scotland in London. "The outlook is promising."

Rather, inflation remains the concern.

"Domestic demand seems now strong enough to bolster the pricing power of European companies in the service sector, thereby increasing medium-term inflation risk," said Peter Vanden Houte, an economist at ING Bank in Brussels.

A gauge of input prices rose to 59.3 in April from 58.9 in March while a measure of prices charged increased to 54.4, the highest since June last year, today's report showed.

Friday, 4 May 2007

US stocks up on positive economic data

Bloomberg reports that US stocks had another good day yesterday.

The Dow industrials added 29.50, or 0.2 percent, to 13,241.38. The S&P 500 increased 6.47, or 0.4 percent, to 1502.39. The Nasdaq Composite Index advanced 7.62, or 0.3 percent, to 2565.46.

Strong corporate earnings growth was a factor.

First-quarter earnings at S&P 500 companies that have reported results increased 11.9 percent. Analysts revised higher their profit growth estimate for the period to 9.4 percent from 6.2 percent two weeks ago and 3.3 percent at the start of the reporting season.

Yesterday's economic data certainly helped too.

Productivity, a measure of how much an employee produces for each hour of work, rose at an annual rate of 1.7 percent last quarter, the Labor Department said today in Washington... Meanwhile, the Institute for Supply Management's index of non-manufacturing businesses, such as banking and retailing, climbed to 56 in April from 52.4 in March...

Additional Labor Department figures showed that the number of people filing claims for unemployment benefits fell to a three-month low of 305,000 last week. The cost of labor rose 0.6 percent annual pace after jumping 6.2 percent in the prior three months, the productivity report said.

However, Asha Bangalore at Northern Trust remains skeptical about the bullish economic data.

Today’s bullish-leaning economic data, jobless claims and the ISM non-manufacturing survey, are inconsistent with other recent economic reports pointing to soft economic conditions... In our opinion, the weight of economic evidence remains pointing to weakening economic conditions – for now.

And as a reminder that the tenor of economic data can change relatively quickly, Reuters reports that the UK service sector cooled in April.

The Chartered Institute for Purchasing and Supply/Royal Bank of Scotland service sector index fell to 57.2 from 57.6 in March -- the lowest since September and below expectations for a reading of 57.5.

The prices charged index slipped to 53.9 from 55.3 in March -- denoting the lowest rate of increase in four months -- while companies' costs also showed their weakest rise this year, with the input prices index easing to 58.6 from 59.3.

Thursday, 3 May 2007

More signs of strength in manufacturing

There were more signs of a recovery in US manufacturing yesterday. From MarketWatch:

Orders for U.S.-made factory goods rose 3.1% in March, the biggest gain in a year, the Commerce Department reported Wednesday...

The gains in March, led by a 38% increase in orders for civilian aircraft and an 11% increase in petroleum, were strong across the board. Read the full government report.

... Orders for core capital equipment...rose 4.8%, the fastest pace in nearly three years and stronger than originally reported. Orders for durable goods were revised higher to 3.7%. Shipments of factory goods increased 1.5%, the highest in 10 months. Unfilled orders grew 1.8%, the fastest pace this year. Orders in February were revised up by four-tenths of a percentage point to 1.4%...

In a report released Wednesday, payroll giant ADP said its monthly employment report showed 64,000 new jobs in the private sector in April, the weakest job growth in nearly four years. Manufacturing employment fell by 20,000, in line with the recent trends. See full story.

Manufacturing also accelerated in China, the CLSA China Purchasing Managers’ Index rising to 53.3 in April, its highest level since May 2005, from 52.3 in March.

In the euro zone, Bloomberg reports that the Royal Bank of Scotland's index of manufacturing was unchanged at 55.4 in April as the unemployment rate fell to 7.2 percent in March from 7.3 percent in the previous month.

In the UK, Reuters reports that construction activity growth picked up at its fastest rate in nearly 3-1/2 years in April. Nevertheless, a fall in mortgage approvals to 113,000 in March from 118,000 in February points to a possible moderation in the housing market.

Meanwhile, the recent negative trend in Japanese data continued yesterday, the Ministry of Health, Labour and Welfare reporting that Japanese wage earners' total cash earnings fell 0.4 percent in March from a year ago.

That could encourage more yen carry trades, although the Reserve Bank of Australia left interest rates at 6.25 percent yesterday.

Wednesday, 2 May 2007

US manufacturing and UK data re-ignite inflation concerns

The US economic data yesterday were mixed. Reuters reports that auto sales stalled in April but there were some signs of strength among other data.

The Institute for Supply Management said its index of national factory activity rose to 54.7 in April from 50.9 in May, above the median forecast of 51.0 among analysts polled by Reuters. The reading was the highest since May 2006...

The National Association of Realtors said its gauge of pending sales of existing U.S. homes fell 4.9 percent to 104.3 in March, its lowest in four years. That compares with an upwardly adjusted reading of 109.7 in February.

The ISM data do look strong. Quite clearly, the downtrends in the indices have been arrested, at least for the time being, although this also means inflation remains a concern.

New orders49.751.950.354.951.658.5

Inflation is also a concern in the UK, which is showing few signs of cooling.

Reuters reports that the Chartered Institute of Purchasing and Supply/Royal Bank of Scotland Purchasing Managers' Index slipped to 53.9 in April from 54.2 in March but the output prices index rose to 56.8 in April, near a record high hit in February, while the input prices index hit 63.2, its highest level since October. In addition, a survey from the Confederation of British Industry showed yesterday that retail sales volumes rose at their fastest pace in three years in April.

Tuesday, 1 May 2007

Consumer spending weakening, time to inject more liquidity?

The United States Commerce Department released details on consumer spending in March yesterday. Reuters summarises these and other reports:

Overall consumer spending rose 0.3 percent in March, but expenditures actually dropped 0.2 percent once inflation was factored in, the first such decline in nine months. The spending softness came despite a solid 0.7 percent rise in incomes...

The report showed overall consumer prices rose 0.4 percent in March from February, but core prices outside of food and energy held steady...

But the National Association of Purchasing Management-Chicago's report suggested the pattern could be ephemeral, with the prices paid component rising to its highest level in nine months.

The group's overall business barometer fell to 52.9 in April from 61.7 in March, below Wall Street forecasts but above the 50-threshold that separates growth from contraction...

Strength in commercial building helped pull overall construction spending up 0.2 percent in March despite a decline in residential projects, separate Commerce Department data showed.

There was also disappointing data on consumer spending from Germany yesterday. Reuters reports:

German retail sales fell by 0.7 percent on the month in March, bucking expectations for a rise, preliminary Federal Statistics Office data showed on Monday.

But Europe generally appears to be in optimistic mood. Bloomberg reports:

European business and consumer confidence stayed close to a six-year high this month, indicating the euro-area economy is withstanding increased oil prices and borrowing costs as well as the slowdown in the U.S.

An index of sentiment among executives and consumers in the euro region slipped to 111.0 from a revised 111.1 the previous month, the European Commission in Brussels said today...

And rapid money supply growth continues to fuel the eurozone economy.

M3 money supply, which the ECB uses as a gauge of future inflation, rose 10.9 percent from a year earlier, the most since February 1983, after increasing 10 percent in February, the central bank said today. Economists expected the rate to drop to 9.8 percent, according to the median of 34 forecasts in a Bloomberg News survey.

The situation is beginning to look absurd to some.

"The ECB's concept" of M3 "seems more and more absurd to me," said Holger Sandte, an economist at WestLB in Dusseldorf. "Monetary policy is still not restrictive. There are several good reasons to increase interest rates further."

But inflation in the euro zone remains contained for the moment.

The European inflation rate fell to 1.8 percent in April from 1.9 percent in March, the European statistics office Eurostat said today, remaining below the ECB's limit for an eighth month.

In contrast, inflation in the UK could exceed target all year.

U.K. inflation will exceed the 2 percent target for another year because the Bank of England cut interest rates too far in 2005, the National Institute of Economic and Social Research said.

Consumer-price inflation will average 3 percent in the three months through June, and stay above the central bank's goal until the second quarter of 2008, the London-based research group, whose clients include the central bank and the U.K. Treasury, said today. The forecasts assume a fourth interest-rate increase to 5.5 percent in the second half of this year...

House prices rose the most in almost four years in April as London buyers snapped up properties amid a shortage of homes, a report by Hometrack Ltd. showed today. The average cost of a home in England and Wales rose an annual 6.8 percent, the most since June 2003, to 174,600 pounds, the research company said today.

Some critics are targeting the Bank of England's inflation-targeting, according to another Bloomberg report.

A decade after the central bank won its independence from government control, surging U.K. property values are throwing into question the inflation-targeting approach of Governor Mervyn King and his colleagues, which focuses on consumer prices as the lodestar of policy and gives lower priority to asset values, money supply and credit growth.

The bank's approach isn't broad enough to tackle asset bubbles that can burst and lead to recessions, says Tim Drayson, an economist at ABN Amro Holding NV in London who formerly worked at the U.K. Treasury.

While the BoE is being criticised for having been too easy on inflation, the Federal Reserve is being criticised for the opposite reason. From another Bloomberg report:

Federal Reserve Chairman Ben S. Bernanke's assertion that interest rates may need to increase to curb inflation is wrong. That's what Goldman Sachs Group Inc., Merrill Lynch & Co. and UBS AG are saying.

While Bernanke warned last month that the odds of worsening inflation have increased, chief economists at the three firms say the worst housing slump in a decade may drive the U.S. economy into a recession and stifle consumer prices. Their chief economists say the Fed will cut its target for overnight loans between banks at least three times this year.

One would assume that these economists are objective in their assessments, but some have doubts.

"There's a little bit of wishful thinking," said Susan M. Phillips, dean of the George Washington University School of Business in Washington and a governor of the Federal Reserve Board from 1991 through 1998. Fed officials have said "they'll be looking at what the data indicates," and since the last meeting of policy makers, "energy prices have taken a hike," she said in an interview.

She could have been more emphatic.

"Nobody in his right mind thinks the Fed will ease three times," said Stan Jonas, who trades interest-rate options in New York at Axiom Management Partners LLC, in an interview. "The marketplace is not saying that at all."

Anyway, perhaps the correct question to ask is: Does the world need more liquidity?

The Chinese authorities probably didn't think so when they recently decided to tighten again. The Chinese stock market's reaction yesterday to that move was interesting. From Xinhua Online:

Chinese shares soared to a new high on Monday, the day after the central bank announced it would again raise the deposit reserve ratio for financial institutions in the hope of cooling the booming economy.

The benchmark Shanghai Composite Index surged 2.16 percent, or 81.4 points, to close at a record 3,841.27 points. The turnover reached 188.656 billion yuan (24.5 billion U.S. dollars).

The Component Index of the smaller Shenzhen Stock Exchange rose 177.33 points, or 1.66 percent, to conclude trading at a record 10,865.88 points on a turnover of 92.636 billion yuan.

You can, like Andy Xie, predict a stock market crash all you want, but I suggest you don't bet on it coming anytime soon.