Saturday, 30 June 2007

US core PCE inflation falls

We knew from the FOMC statement on Thursday that US core inflation is no longer elevated. Yesterday's PCE data provided confirmation. From Reuters:

The Commerce Department's "core" personal consumption expenditures price index, which removes food and energy costs, rose 1.9 percent in May from a year earlier for its smallest annual rise since March 2004.

On a month-to-month basis, overall prices rose a stiff 0.5 percent in May, but core prices edged up just 0.1 percent.

Consumer spending kept pace with overall inflation but income lagged.

The Commerce Department report also showed consumers boosted spending in May by 0.5 percent for the second straight month. That was less than Wall Street had expected and hinted that more sedate spending habits may keep a lid on prices. Incomes rose by 0.4 percent, also less than expected.

The Reuters/University of Michigan survey showed a final June reading of 85.3 reading, below 88.3 in May and its lowest since August 2006...

At least manufacturing's recovery appears to be sustained.

The National Association of Purchasing Management-Chicago business barometer came in at 60.2 in June, down from 61.7 in May but above economists' forecasts of 58.0. A reading above 50 indicates expansion.

Elsewhere, Europe's economy still appears to be in relatively good shape. From Bloomberg:

An index of sentiment among executives and consumers in the euro region eased to 111.7 this month from a revised 112.1 in May, the European Commission in Brussels said today. Inflation stayed at 1.9 percent, according to a separate report.

And the UK economy grew 0.7 percent in the first quarter, but leaving the saving rate at a 47-year low.

Friday, 29 June 2007

Japan's consumer prices fall, other indicators point to possible rate hike

Japan's consumer prices continued to fall in May. Bloomberg reports:

Japan's consumer prices fell 0.1 percent in May, a pace of decline unlikely to dissuade the central bank from raising its benchmark interest rate, the lowest among major economies.

Prices are not likely to start rising soon.

Tokyo's core prices unexpectedly fell 0.1 percent in June, the first drop in three months. Prices for the capital are released a month ahead of the nationwide number and seen as an indicator of the direction of Japan's prices. Economists expected a 0.1 percent gain.

But the Bank of Japan is likely to gradually tighten monetary policy anyway as the economy remains robust.

The jobless rate held at a nine-year low of 3.8 percent in May...

Household spending rose 0.4 percent from a year earlier, the bureau said, extending the longest winning streak in three years. The job-to-applicant ratio, which shows how many positions are on offer to a job seeker, rose to 1.06 in May from 1.05 a month earlier, the Labor Ministry said.

Japanese government officials appear confident about the economy.

"My view on the end of deflation hasn't changed," said Economic and Fiscal Policy Minister Hiroko Ota. Ota has said the end of deflation is in sight. The tighter labor market will fuel wage growth and eventually contribute to price gains, she said.

Finance Minister Koji Omi said today's numbers "confirmed the government's view that the overall economy continues to recover in a solid manner."

And most importantly, so is Bank of Japan Governor Toshihiko Fukui.

Fukui has said consumer prices will resume rising, given that the economy will probably exceed its potential growth rate. The bank estimates Japan's potential growth, the pace achieved by utilizing most of the country's capacity and workforce, is 1.5 percent to 2 percent, and predicts a 2.1 percent expansion in the current fiscal year and the 12 months ending March 2009.

So when are interest rates expected to be raised?

Fourteen of 31 economists surveyed from June 4 to 8 expect the bank to raise rates in August, up from eight last month, the Economic Planning Association, a government-affiliated think tank, said this week.

Fed holds on continued concern over inflation

As expected, the Federal Reserve left its target for the federal funds rate unchanged at 5.25 percent yesterday and maintained its vigilance against inflation by saying that "a sustained moderation in inflation pressures has yet to be convincingly demonstrated" and that "the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected".

Earlier in the day, the GDP report had provided a reason for the Fed's continuing concern over inflation. From Bloomberg:

The U.S. economy expanded at an annual pace of 0.7 percent in the first quarter, the slowest in four years, and a gauge of inflation watched by the Federal Reserve was unexpectedly revised up.

The increase in gross domestic product compares with the 0.6 percent rate estimated last month and follows a 2.5 percent gain the last three months of 2006... The price measure rose at the fastest since the second quarter of 2006...

The Fed's preferred inflation measure, which is tied to consumer spending and strips out food and energy costs, rose at a 2.4 percent annual rate, faster than the 2.2 percent previously estimated. The new estimate reflected higher costs for medical services...

Today's GDP revision mainly reflected a narrower trade deficit than previously estimated.

And another Bloomberg report says that the US labour market remains relatively healthy.

Initial jobless claims decreased by 13,000 to 313,000 in the week that ended June 23, the Labor Department said today in Washington. The four-week moving average, a less volatile measure, rose to 316,000 from 315,000.

Thursday, 28 June 2007

Norway raises interest rates, eyes turn to Fed

The Norges Bank continues with its tightening campaign. Bloomberg reports:

Norway's central bank raised its benchmark interest rate and said rates will be lifted more than previously forecast as widespread labor shortages threaten to boost wage growth and fuel inflation.

The bank increased the deposit rate by a quarter point to 4.5 percent. The rate will average 4.5 percent this year and 5.75 percent in 2008 and 2009, the bank said, lifting a previous forecast by a quarter-point this year and half a point for the next two years. In 2010, the bank sees the rate at 5.5 percent.

Elsewhere in Europe, Paris-based Insee reported yesterday that its index of sentiment among French manufacturers advanced to 110 from a revised 108 in May.

However, in the UK, consumers are reportedly feeling the effects of higher interest rates as a Confederation of British Industry survey found that retail sales slowed more than expected in June while data from the British Bankers' Association showed that mortgage approvals fell four percent in May from a year earlier.

The data from Japan continues to be mixed. Retail sales climbed 0.1 percent in May from a year earlier, the first gain in eight months, but industrial production unexpectedly dropped for a third month in May, falling 0.4 percent from a month earlier.

Today the FOMC makes its decision on interest rates with the knowledge that orders for US durable goods fell in May. Bloomberg reports:

Demand for goods meant to last several years fell 2.8 percent, the first drop in four months, after a revised 1.1 percent gain in April that was larger than previously estimated, the Commerce Department said today in Washington. Excluding transportation equipment, orders dropped 1 percent.

What remains uncertain, but could prove more important for monetary policy in the long run, is the US economy's long-term potential growth rate. From another Bloomberg report:

Federal Reserve policy makers disagree with their own staff economists, and a growing chorus on Wall Street, who say the U.S. economy can't expand as fast as it used to without pushing up prices.

The split, signaled in the minutes of May's Federal Open Market Committee meeting, may reflect debate over whether a slowdown in U.S. productivity is permanent. "Many" FOMC members were "somewhat more optimistic" than lower-ranking officials about the economy's speed limit, the records showed.

Also interesting would be if the FOMC starts to emphasise the headline inflation rate rather than the core rate, as Krishna Guha suggests in the FT.

Federal Reserve officials are expected to discuss ways to redirect market attention from current core inflation to its forecast of headline inflation at this week’s meeting of the rate-setting Open Market Committee...

Officials worry that their emphasis on current core inflation might have led the market to put undue weight on these monthly inflation figures.

Policy is forward-looking, and officials are focused on their forecast of where headline inflation will be in one or two years, not where core inflation was last month.

Wednesday, 27 June 2007

US housing market remains weak but keeps hope for Fed cut alive

While the consensus estimate is for the US economy to show a substantial rebound in the current quarter, yesterday's data show that the condition of the economy remains fragile. From Bloomberg:

The New York-based Conference Board's index of consumer confidence fell to 103.9 in June from a revised 108.5 the prior month. Purchases of new homes fell 1.6 percent last month to an annual pace of 915,000, the Commerce Department reported in Washington, and housing prices in 20 cities in April fell by the most in at least six years, according to S&P/Case-Shiller.

The weakness in new homes sales corroborate the weakness in other housing indicators such as existing home sales, the NAHB/Wells Fargo Housing Market Index and housing starts.

And things could get worse. In his latest commentary, PIMCO's Bill Gross warns:

... A recent research piece by Bank of America estimates that approximately $500 billion of adjustable rate mortgages are scheduled to reset skyward in 2007 by an average of over 200 basis points. 2008 holds even more surprises with nearly $700 billion ARMS subject to reset, nearly ¾ of which are subprimes.

That could lead to more delinquencies and defaults and lower home prices. Other areas of the economy could be affected.

... Consumption will be reduced to say nothing of new home construction over the next 12-18 months... Importantly, as well, and this point is neglected by most pundits, the willingness to extend credit in other areas – high yield, bank loans, and even certain segments of the AAA asset-backed commercial paper market should feel the cooling Arctic winds of a liquidity constriction.

Chilling thought indeed. But there is a silver lining: PIMCO expects "the Fed to issue an insurance policy in the form of lower Fed Funds at some point over the next 6 months".

Tuesday, 26 June 2007

Asian property prices heating up

While the existing home sales data show that the US housing market continued to weaken in May, the property market in Asia is booming. Reuters has a round-up of the latest developments in property markets in Asia.

Property markets are on the rise across Asia, fuelled by cash-rich investors looking for higher returns, the booming economies of China and India and the emergence of Japan from over a decade of economic stagnation.

With global investors increasing allocations to property and diversifying geographically, investment in Asia jumped 43 percent to $94 billion in 2006, consultants Jones Lang LaSalle say.

The flow of capital into Asia shows no sign of abating. The property arm of Morgan Stanley, for example, has earmarked around 60 percent of a $8 billion fund it has just raised for Asia -- and Japan, China and India in particular.

The Singapore property market has participated in the boom as well.

Home prices in Singapore have seen their biggest gains in over seven years led by strong buying by foreigners in the luxury segment, with government data showing a 10.2 percent rise in private residential property prices in 2006...

Office buildings are also reporting almost full occupancy as liberal tax policies draw financial firms to the city-state.

And this at a time when consumer price inflation in Singapore has been relatively tame. From Channel NewsAsia:

Singapore's consumer prices rose a seasonally adjusted 0.4 percent in May from April, according to Department of Statistics data.

Compared with the same month a year ago, the consumer price index (CPI) in May 2007 was 1.0 percent higher.

For the first five months of this year, the CPI rose by 0.6 percent over the same period of 2006.

Monday, 25 June 2007

BIS annual report

The Bank for International Settlements released its annual report yesterday. The overview is here. The following is a summary of the conclusion:

The consensus economic forecast expects the recent excellent global performance to continue. Yet at least four sets of concerns can be raised, even if our capacity to calculate both their likelihood and possible interdependence remains limited. First, a rise in global inflation pressures cannot be ruled out. Second, the current slowdown in the United States might prove more significant than expected and the global implications greater. Third, global current account imbalances, together with large and volatile capital flows, indicate an exposure to disruptive exchange rate changes with potential implications for financial markets as well as asset prices. And finally, with most asset markets already “priced to perfection”, any unwelcome shock might have unexpected consequences.

... [A]gainst a backdrop of concern about both overall global inflation and evidence of increasing financing imbalances in many areas, tighter monitoring and financial conditions would seem called for. Similarly, more fiscal restraint could have welcome short- and medium-term implications. Evidently, countries with large current account deficits should be in the forefront of such tightening moves. The chances of reducing global current account imbalances in an orderly way would also seem to be enhanced by more exchange rate flexibility, and by structural changes. Countries with current account deficits need to focus on the production of tradables, and those with surpluses on non-tradables. In this respect, neither the past strength of the housing sector in the United States nor the current strength of the export sector in Asia can be judged wholly welcome.

There are lots of charts in the actual report (PDF 244 pages, 7337 kb). Two of them taken from the chapter on monetary policy:

Notice any similarity between the charts?

Saturday, 23 June 2007

Week ends on downbeat note

Yesterday saw big falls in the Chinese and US stock markets.

Bloomberg reports the fall in China:

China's shares dropped the most in almost three weeks on speculation the government will raise interest rates to tame a stock-market boom and cool the economy. Industrial & Commercial Bank of China Ltd. paced the decline.

The CSI 300 Index slid 145.85, or 3.5 percent, to 4051.43 at the close, the biggest percentage change among markets included in global benchmarks. Citic Securities Co., the biggest listed brokerage, and China Vanke Co., the largest developer, fell.

And in the US:

U.S. stocks plunged, capping the worst week for the Standard & Poor's 500 Index since early March, as concern intensified that banks will be saddled with losses on mortgage bonds...

The S&P 500 Index lost 19.63, or 1.3 percent, to 1502.56. The Dow Jones Industrial Average fell 185.58, or 1.4 percent, to 13,360.26. The Nasdaq Composite Index slid 28, or 1.1 percent, to 2588.96.

What little economic data that were released yesterday were not too positive either.

In Europe, Bloomberg reports that German business confidence fell in June.

German business confidence fell more than economists forecast in June after a rebound in oil prices and higher borrowing costs raised concern economic growth may slow from the fastest pace in six years.

The Ifo institute's sentiment index, based on responses from 7,000 executives, fell to 107 from 108.6 in May, the Munich-based research institute said today. Economists predicted a decline to 108.4, the median of 43 forecasts in a Bloomberg survey showed.

And industrial orders in the euro zone were down in April.

European industrial orders fell in April as the higher euro damped exports of the region's textiles and machinery.

Orders in the euro area fell 0.4 percent from the previous month, the European Union statistics office in Luxembourg said today. Economists had forecast a decline of 0.8 percent, according to the median of 15 estimates in a Bloomberg News survey. From a year earlier, orders increased 12.2 percent, compared with an 8.1 percent rise in March.

In the US, the ECRI's latest gauge of the economy was also down. From Reuters:

The Economic Cycle Research Institute, an independent forecasting group, said its Weekly Leading Index, or WLI, was at 142.9 in the week ended June 15, versus a downwardly revised 143.7 in the prior week. It cited slower housing activity, higher interest rates and lower stock prices.

Friday, 22 June 2007

Global economy continues to look strong

Reuters reports that the US economy continues to show signs of recovery.

The Philadelphia Federal Reserve Bank said its business activity index jumped to 18.0 in June, its highest since April 2005 and up from 4.2 in May...

Applications for state unemployment insurance benefits rose 324,000 in the week ended June 16 from a revised 314,000 the previous week. Wall Street analysts had forecast claims at 312,000.

Still, a forward-looking economic gauge released later in the morning pointed to a pick-up in growth. The Conference Board, a private research firm, said its index of leading economic indicators rose 0.3 percent in May, suggesting the economy will strengthen through the summer and into the fall.

Bloomberg reports that European manufacturing and service industries unexpectedly accelerated in June.

European manufacturing and service industries making up two-thirds of the economy grew at an unexpectedly rapid pace in June as companies hired workers and invested in offices and equipment.

Royal Bank of Scotland Group Plc's combined index, spanning industries from oil and autos to banking and airlines in the euro region, rose to 57.7 from 56.8. Economists expected a decline to 56.6, according to a Bloomberg News survey...

The gauge of services increased to 58.3 in June from 57.3 in May, and the manufacturing index rose to 55.4 from 55.

Manufacturing is looking strong in the UK too, according to Reuters.

The Confederation of British Industry said its monthly manufacturing order books balance rose to +8 from +5 in May, matching the 12-year high it hit in March. Analysts had predicted an unchanged reading of +5.

The balance of firms expecting to raise their prices in the coming months eased to +16 from a 12-year high of +25 in May.

And in Japan, Bloomberg reports that a surge in exports helped the trade surplus widen in May.

Exports rose 15.1 percent from a year earlier, compared with 8.2 percent in April, the Ministry of Finance said today in Tokyo. The gain beat economists' estimates, helping the trade surplus widen 9.3 percent to 389.5 billion yen ($3.2 billion)...

Imports climbed 15.5 percent to a record 6.2 trillion yen, the ministry said, as a weaker yen increased the cost of goods purchased from overseas. Economists predicted imports to rise 10.3 percent and exports to increase 11.8 percent.

But while the real economy chugs along steadily, the risk of a financial crisis is always present, as the continuing Bear Stearns saga reminds us.

Thursday, 21 June 2007

Sweden's central bank raises interest rates, more to follow

Sweden's Riksbank raised interest rates yesterday. Bloomberg reports:

Sweden's central bank lifted its benchmark interest rate for the eighth time in 18 months and said it will raise it twice more this year as rising employment and slowing productivity growth threaten to fuel inflation. The krona surged the most in almost five years.

The repurchase rate was raised a quarter-point to 3.5 percent, the highest in more than four years, the Stockholm-based bank said in an e-mail today. The rate may be raised to "around" 4 percent by year-end, up from an earlier forecast of 3.5 percent, and to 4.4 percent in two years, the bank said.

The Bank of England is likely to raise rates soon too. Again from Bloomberg:

Bank of England policy makers defeated Governor Mervyn King's bid to raise interest rates this month, adding to speculation of an increase as soon as July.

Five of the Monetary Policy Committee's nine members overruled King with an unexpectedly slim majority, marking the second time in four years he has been outvoted as governor. King argued an increase was needed because of "upside" inflation risks, minutes of the June 6-7 meeting showed today.

Maybe the other members should have followed King's lead. May saw UK mortgage lending jump by 5.8 billion pounds, the largest amount in six months, while M4 rose by a monthly 1.2 percent and by 13.8 percent year-on-year.

Meanwhile, the Bank of Japan, is maintaining its gradualist policy. From Bloomberg:

The Bank of Japan's policy board retained its commitment to gradually raise the country's interest rates, the lowest among major economies, according to minutes published today in Tokyo.

Members agreed they would "adjust the level of interest rates gradually in accordance with improvements in the economic and price situation," according to minutes of the board's May 16-17 meeting. The bank has kept the key overnight lending rate on hold since doubling it to 0.5 percent in February...

Japanese manufacturers said they were pessimistic in the second quarter, a government survey showed today, signaling the Tankan may be "slightly softer," according to Richard Jerram, chief Japan economist at Macquarie Securities Ltd. in Tokyo.

Sentiment among large manufacturers fell to minus 2.2 points this quarter from 0.1 point in the previous three months, the Cabinet Office and Finance Ministry said. A negative number means pessimists outnumber optimists.

Wednesday, 20 June 2007

US housing starts, German investor confidence fall

The news yesterday was not too positive.

Bloomberg reports that US housing starts fell in May.

Home starts in the U.S. fell for the first time in four months in May as interest rates rose, suggesting the worst housing recession in 16 years will persist.

Builders broke ground on new houses at an annual rate of 1.474 million, down 2.1 percent from the prior month, the Commerce Department said today in Washington. Building permits increased 3 percent to 1.501 million.

Bloomberg also reports that German investor confidence fell in June.

German investor confidence unexpectedly fell in June as borrowing costs climbed, suggesting economic growth may have reached a plateau.

The ZEW Center for European Economic Research in Mannheim said its index of investor and analyst expectations declined to 20.3 from 24 in May. Economists expected a reading of 29, according to the median of 38 forecasts in a Bloomberg News survey.

In contrast, the Ticker Sense Blogger Sentiment Poll has recently risen to a level where it "has never been this bullish".

Tuesday, 19 June 2007

Housing market: Down in the US but still up in the UK

The US housing market remains weak. Reuters reports:

Sentiment among U.S. home builders slid in June to the lowest level in more than 16 years as tighter lender practices and rising mortgage rates crimped sales, the National Association of Home Builders said on Monday.

The NAHB/Wells Fargo Housing Market index fell two points to 28 in June, the lowest since it hit 27 in February of 1991, the group said.

As I've said before, the housing market will take a while to recover, especially with the prevailing trend in interest rates.

The UK housing market appears to be holding up better, although there are signs of moderation. Again from Reuters:

Asking prices for homes in England and Wales picked up modestly from mid-May to mid-June but property inflation held below peaks scaled earlier this year, a survey showed on Monday.

Property web site Rightmove said prices rose an annual 13.2 percent during the month. This compares with the previous month's 13.1 percent rise and four-year highs of 15 percent in late March/early April.

Saturday, 16 June 2007

BoJ leaves rates unchanged

The Bank of Japan left interest rates unchanged yesterday. The decision was expected. Furthermore, comments by BoJ governor Toshihiko Fukui yesterday provided no hint that there is any plan to raise rates next month.

A rate hike could still come later in the year though, as the Japanese economy continues to do reasonably well. The tertiary index, a gauge of spending on services, climbed 1.7 percent in April, the fastest pace in six months.
China could tighten even sooner after reporting that fixed-asset investment in urban areas rose 25.9 percent in the first five months from a year earlier.

But the Federal Reserve looks likely to stay on hold for some time to come, with yesterday's data not likely to change the view that inflation is still on a moderating path. From Reuters:

A steady rise in food and energy costs pushed overall U.S. consumer prices up 0.7 percent in May, the sharpest rise in 1-1/2 years, a government report showed on Friday.

But the core measure of the Labor Department's Consumer Price Index, which removes food and energy, rose just 0.1 percent, below Wall Street's median forecast of 0.2 percent...

The Fed reported that May industrial output was flat and that businesses were running at 81.3 percent of capacity last month, partly because utility companies cut output and auto producers turned out fewer new vehicles...

The [Reuters/University of Michigan] consumer sentiment index slipped to 83.7 in June from 88.3 in May and was far below forecasts for a reading of 88...

The Empire State general business conditions index jumped to 25.75 in June from 8.03 in May. Economists polled by Reuters had expected a 10.8 reading for June.

Even the Cleveland Fed's median CPI inflation moderated to 0.1 percent in May from 0.2 percent in April.

Friday, 15 June 2007

Latest news still point to higher rates

Bond markets have steadied somewhat recently, but bond yields are likely to stay on an uptrend if recent reports are anything to go by.

Yesterday, European Central Bank council member Axel Weber kept his reputation as a hawk on interest rates intact. From Bloomberg:

"Our monetary-policy stance is still on the accommodative side and far from being restrictive," Weber said in the text of a speech he gave in London today. "Inflation is projected to remain above our stability threshold" and the ECB "will do what is necessary to maintain price stability."

But inflation in the euro area remained below the ECB's limit in May, according to another Bloomberg report.

Consumer prices in the 13-nation euro region increased 1.9 percent from a year earlier, the same inflation rate as in April, the European Union's statistics office in Luxembourg said today. Labor costs rose 2.2 percent in the first quarter from a year earlier, the same pace as in the previous three months, according to a separate report.

While the ECB mulls over further rate hikes, the Swiss central bank took action yesterday. Bloomberg reports:

The Swiss National Bank increased the three-month Libor target rate by a quarter-point to 2.5 percent, the highest since September 2001...

"We have a Swiss economy stimulated by the weakness of the Swiss franc," [SNB President Jean-Pierre] Roth said in an interview in Bern. "On the other hand, we have import prices increasing. We see a need for further interest-rate increases if the situation does not calm down. We're optimistic about the Swiss economy."

Further interest rate increases could also be coming from the Bank of England after UK retail sales rebounded 0.4 percent in May while unemployment fell to the lowest since September 2005. However, growth in UK house prices slowed in May.

More tightening is also expected from China, especially after industrial production rose 18.1 percent in May from a year ealier.

But the Federal Reserve will probably not raise rates soon despite a relatively hot number yesterday on producer prices. From Bloomberg:

Prices paid to U.S. producers rose more than forecast in May, reflecting a fourth consecutive jump in fuel costs that threatens a broader pickup in inflation.

The 0.9 percent increase followed a 0.7 percent rise in April, the Labor Department said today in Washington. So-called core prices, which exclude fuel and food costs, rose 0.2 percent...

The number of Americans filing first-time claims for unemployment benefits held at 311,000 for a second week, pointing to a buoyant labor market, the Labor Department reported separately. The four-week average, a less volatile measure, rose to 311,250.

Thursday, 14 June 2007

Bonds rebound

Reuters reports:

U.S. government bond prices rebounded on Wednesday, with the benchmark 10-year Treasury note posting its best day since March technical factors and reduced selling by mortgage players after Tuesday's rout.

Benchmark yields, however, stayed near five-year highs as investors no longer expect the Federal Reserve to cut interest rates this year. Bonds brushed aside strong retail sales and inflation reports.

Investors drew some comfort from the Fed's Beige Book, which reported that overall wage pressures had not increased, but noted there were "significant" price increases for energy-related products.

Economic data earlier in the day, however, had been somewhat on the hot side. From another Reuters report:

Sales by U.S. retailers rose 1.4 percent, more than twice as much as expected, as consumers shrugged off higher gasoline prices and a housing slump to spend more on cars, clothing, building materials and electronics, a Commerce Department report showed on Wednesday...

U.S. mortgage applications rose last week for the first time in three weeks even as interest rates rose to their highest in nearly a year, the Mortgage Bankers Association said on Wednesday...

U.S. import prices rose 0.9 percent in May where Wall Street economists were expecting a 0.3 percent gain. Imported petroleum prices climbed 2.7 percent in May, the fourth straight monthly gain, after a 6.6 percent rise in April.

Elsewhere in the world, China also reported strong retail sales in May, which rose 15.9 percent from a year earlier.

However, Japan revised its April industrial output data down to show a 0.2-percent decline from the previous year from a preliminary 0.1-percent decline while industrial production in the euro area in April fell 0.8 percent compared to March.

Nevertheless, a rebound in bonds is not likely to be sustained for very long. The global economy generally still looks relatively robust so the trend in bond yields is still probably up, although it is possible the sharpest move is behind us.

Wednesday, 13 June 2007

Stocks and bonds fall again amid mixed inflation reports

Stocks and bonds continued their sell-off yesterday.

The day had started off rather badly, with China reporting that inflation rose to 3.4 percent in May from 3 percent in April. That caused the Shanghai stock market to fall more than 2 percent at one point, although it subsequently recovered.

The inflation news yesterday was better in Europe. In the UK, the inflation rate slowed to 2.5 percent in May from 2.8 percent in April, while in Sweden, the inflation rate slowed to 1.7 percent in May from 1.9 percent in April.

There was no inflation news from the US. The PPI report will be released tomorrow while the CPI report will be released on Friday. But there was a lot of discussion nevertheless on the US bond market.

Mike Larson reminds us that if the US yield curve were to normalise, the yield on the 10-year Treasury could rise to 5.82 percent.

Perhaps that is what is needed to curb inflation in the US. Macro Man says that with the rising trend in food and energy prices, the core prices that the Fed is focused on understates the actual rise in the cost of living, and "even a return to the 1.75% core PCE target would imply a trend headline CPI rate of 2.8%-2.9%".

Incidentally, a 2.8-percent inflation rate is what the Cleveland Fed's 16% trimmed-mean CPI has been showing for February, March and April. And as I mentioned in "US inflation falls but hold the celebrations", I think the trimmed-mean CPI is a better measure of underlying inflation.

So inflation is a good reason for the bond market to push yields up, but Brad Setser thinks that a move by Asian central banks towards the short end of the curve could also have played a part. And with both China and Japan continuing to report rising trade surpluses, Asian central banks are likely to continue to play important roles in the bond markets.

Tuesday, 12 June 2007

Not the end for bull market in stocks

Reuters has an article saying that investors continue to favour equities over bonds despite the recent rise in bond yields.

[A] straw poll of European-based investors conducted by Reuters on Monday suggests 10-year Treasury yields would have to rise beyond 5.6 percent from current levels around 5.15 percent to prompt a significant switch to bonds from stocks...

The reason institutional investors have so far remained sanguine is the view that the rise in bond yields has been driven not by a big upward shift in inflation expectations but rather by an improved outlook for the global economy...

A Morgan Stanley survey of 41 of its largest European hedge fund and long-only clients last week found that, despite worries about inflation and interest rates, equities remain easily the most popular asset class for the coming 12 months.

Some 85 percent expect equities to post positive returns in the coming 12 months, with 43 percent expecting returns of 10 percent or more.

That is despite almost one fifth of them predicting U.S. 10-year yields above 6 percent in a year and 70 percent expecting yields of 5 percent or above.

The key reason for the preference for equities: earnings yield on equities remain higher than bond yields. Reuters cites Michala Marcussen, strategy director at Paris-based Societe Generale Asset Management:

She estimates the earnings yield on U.S. equities is currently around 6.25 percent, based on the average price-to-earnings ratio of stocks.

The real yield on 10-year Treasuries, meanwhile, is around 2.6 percent -- 5.10 percent nominal minus around 2.5 percent inflation.

That gives U.S. stocks a roughly 3.7 percent premium over bonds, some 70 basis points above the 3 percent premium many consider to be a floor for investing in riskier stocks.

Ticker Sense provides the P/E ratios of various stock markets around the world and shows that relatively favourable valuations is a worldwide phenomenon.

But John Authers at FT points out that although bond yields remain relatively low, a 20-year trend of falling yields has been broken.

This is not yet the end of the five- year bull market in stocks. At 5.1 per cent, Treasury bond yields remain low by historical standards. But it may mark the beginning of the end.

Monday, 11 June 2007

Bond yields spike but stocks have cushion

Bond prices have fallen sharply recently, pushing global bond yields up and dragging stock markets down. Bond yields could continue to rise over the next few weeks as bond investors adjust expectations on the direction of interest rates but further damage to stock markets will probably be relatively limited.

Today, Bloomberg carried a story by Eric Martin entitled "Stock Rally May Fizzle as Bond Yields Rise on Fed Rate Concerns". The story says that the best may be over for the US stock market rally in 2007 as gains will slow in the second half of the year amid rising concern that the Federal Reserve will raise interest rates.

Last week, strong US economic data, signs of sustained inflationary pressures and interest rate hikes by central banks elsewhere in the world all combined to push bond yields up 15 basis points. The sell-off in bonds in turn led to a sell-off in equities, the Standard & Poor's 500 Index falling 1.9 percent last week to close at 1,507.67.

The fall in bond and stock markets was not restricted to the US. The story was the same in the rest of the world as well.

As the article explains, higher bond yields may lower corporate profits, make takeovers more expensive and weigh on stock market valuations.

However, there is a flip side to this, as pointed out by James Paulsen, chief investment strategist at Wells Capital Management in Minneapolis, in the article.

"The catalyst to this sell-off was a realization that the economy is growing far better than they thought," said Paulsen. "Ultimately, what's bad about that?"

Not bad at all, actually. Which means that stock investors should probably not over-react to the on-going correction in bonds.

This is especially since valuations in stock markets are not stretched. After the recent spike in bond yields, the 10-year Treasury note is yielding just over 5.1 percent. With the recent fall in stock prices, the S&P 500 is trading at a price earnings ratio of about 18, or an earnings yield of about 5.5 percent, still higher than the yield on the 10-year Treasury note.

In other words, there is still some slack in the valuation of stocks compared to bonds. Indeed, the Bloomberg article by Martin also points out that the S&P 500 remains below -- though only slightly -- Wall Street's average end-2007 estimate for the index of 1,550 based on a survey at the beginning of the year.

In fact, so far, it has looked as though it is the bond market that has been wrong-footed by the economy. Despite forecasts of a relatively shallow slowdown for the economy by most economists, including Federal Reserve officials, some bond investors had obviously bet on a rate cut by the Federal Reserve.

Indeed, looking at bond yields alone, one would have wondered whether the Federal Reserve had done anything to interest rates over the past few years. In early June 2004, the federal funds rate had been at 1.0 percent. Around the middle of May 2007, the federal funds rate was much higher at 5.25 percent. Over the same period, the yield on the 10-year Treasury went from 4.7 percent all the way to ... 4.7 percent!

Such a show of recalcitrance by the bond market was always going to invite some sort of punishment. With recent signs of an improving US economy and robust growth in the rest of the global economy, a bet on a Fed cut looks an increasingly poor one, and it is little wonder that yields have spiked up as investors abandon it.

However, with bond yields now close to the federal funds rate, any further rise in yields seems to me likely to be gradual and limited as long as the Federal Reserve continues to sit on its hands. Although Fed officials have consistently reiterated their concern about inflation, they have also consistently maintained that inflation is likely to moderate and are unlikely to hike rates in the near future.

Rather, the impetus for a continued rise in yields is likely to come from further tightening that is still expected from other central banks. Last week saw the European Central Bank and the Reserve Bank of New Zealand raise their respective benchmark rates by 25 basis points. The Bank of England and the Bank of Japan are also widely expected to raise rates further some time over the next few months.

Markets generally expect one or two more rate hikes from these central banks before the end of 2007. This should not put too much upward pressure on global bond yields.

On the other hand, one should never get complacent with markets. Market expectations can and do change quickly, as the recent rise in bond yields have shown.

And while stock markets may have a valuation cushion now, further increases in bond yields could make that cushion feel uncomfortably thin.

Saturday, 9 June 2007

Mixed economic data, fall in US trade deficit and the real cost of offshoring

Economic data yesterday were somewhat mixed.

Japan saw machinery orders rise 2.2 percent in April but this was less than the consensus forecast of 4.5 percent.

German industrial production fell 2.3 percent in April, the biggest fall in seven years. German exports rose 0.9 percent in April, less than an expected gain of 1.5 percent, while imports rose 0.8 percent.

In the UK, manufacturing production was up 0.3 percent in April, as was industrial production, but over three months, manufacturing output fell by 0.4 percent and industrial output fell by 0.2 percent. Nevertheless, the National Institute of Economic and Social Research thinks that UK GDP rose by 0.8 percent in the three months to May, the fastest rate of growth in almost a year.

The US economy is proving to be a drag for global growth at the moment. The US trade deficit fell by 6.2 percent in April. Exports were up by 0.2 percent but imports fell by 1.9 percent.

Somewhat related to this piece of news is this article, "The Real Cost Of Offshoring", by Michael Mandel at BusinessWeek (via Economist's View). Essentially, the article says that because of the way statistics treat offshoring, productivity in manufacturing has been overstated in recent years.

While this in itself does not seem to me to be a particularly profound insight, what may be of some immediate relevance in the light of recent developments in bond markets is his point that "the nation's long-term sustainable growth rate may be lower than thought, and the Fed may have less leeway to cut rates".

Assuming, of course, that the Fed recognises this phenomenon.

Friday, 8 June 2007

Rising interest rates making headlines

Reuters reports the latest action in bond markets.

U.S. Treasury debt prices collapsed on Thursday as benchmark yields posted their largest one-day spike in three years, spurred by fears of tighter monetary policy worldwide.

The market plunge was initiated by an unlikely source, New Zealand, whose central bank unexpectedly raised rates a day after the European Central Bank hiked rates to curb inflation.

Details on the New Zealand rate hike yesterday, from Bloomberg:

New Zealand's central bank unexpectedly raised its benchmark interest rate a quarter point to a record 8 percent, saying housing demand and consumer spending are fanning inflation. The currency rose to a 22-year high.

"A sustained period of slower growth in domestic activity will be required to alleviate inflation pressures," Reserve Bank Governor Alan Bollard said in Wellington today. A 60 percent surge in world prices of dairy products the past six months has boosted farmers' incomes and will stoke inflation next year, he said.

New Zealand was not the only country raising interest rates yesterday. So did South Africa, as Bloomberg reports:

South Africa's central bank increased its benchmark rate by half a point on concern that rising energy and food prices will push up other costs, threatening to keep inflation above the target range.

The Reserve Bank raised the repurchase rate to 9.5 percent, the first increase since Dec. 7, Governor Tito Mboweni said in a televised speech from Pretoria today. That was in line with the forecasts of 20 of 25 economists surveyed by Bloomberg.

The Bank of England, however, left interest rates unchanged at 5.5 percent yesterday while Brazil and Indonesia cut rates recently to 12.0 percent and 8.5 percent respectively.

The biggest player, however, remains on the sidelines even as the latest US data continue to provide evidence of improvement in the economy. From Reuters:

Fewer U.S. workers signed up for unemployment aid last week, according to the Labor Department. The number of U.S. workers filing initial claims for jobless benefits slipped by 1,000 to 309,000, the department said on Thursday...

A separate report from the Commerce Department on Thursday showed inventories at U.S. wholesalers rose 0.3 percent in April as stocks of nondurable goods saw the biggest percentage increase in five months...

U.S. retail chains on Thursday reported moderate May sales increases as warmer weather fueled demand for seasonal items, like gardening and other outdoor goods, helping retailers rebound from a dismal April.

But consumer credit growth slowed in April, according to another Reuters report.

U.S. consumer credit rose by a smaller-than-expected $2.6 billion in April following a big jump in March that was revised even higher, a Federal Reserve Board report showed on Thursday.

Consumer credit rose at a 1.3 percent annual rate in April to $2.429 trillion, the slowest pace since October 2006, the Fed said. The gain was well below the $6.0 billion consensus increase forecast by Wall Street economists polled by Reuters.

Not surprisingly, stock markets took a mauling yesterday, the S&P 500 losing 26.66 points, or 1.76 percent, to finish at 1,490.72.

Thursday, 7 June 2007

ECB raises rates but leaves markets uncertain

The interest rate hike from the European Central Bank yesterday was expected, but it looks like it may be about to get more data-dependent. From Reuters:

The European Central Bank raised interest rates to a near six-year high of 4 percent on Wednesday and showed its readiness to hike again to combat inflationary dangers in a strongly expanding economy.

However, ECB President Jean-Claude Trichet gave limited guidance over how soon the next rate increase would come, or how much tightening remains in store, leaving markets uncertain over the precise course ahead.

A fall in manufacturing orders in Germany in April, the first in three months, could put a damper on further rate hikes by the ECB.

Meanwhile, the Reserve Bank of Australia left its overnight cash rate target unchanged at 6.25 percent yesterday even as the Australian economy grew 1.6 percent in the first quarter, its strongest growth in three years.

The worldwide trend, however, is still towards more tightening, as inflation pressures refuse to go away.

In the US, estimate of first quarter productivity growth was revised down yesterday. Reuters reports:

The Labor Department said on Wednesday that nonfarm productivity...rose at a 1 percent annualized pace in the quarter after a 2.1 percent fourth-quarter advance.

A month ago, the department had estimated productivity grew at a 1.7 percent rate.

The downward revision pushed the government's measure of unit labor costs...higher. The department said labor costs rose at a 1.8 percent pace, not as tame as the 0.6 percent reported earlier...

The first-quarter productivity figure was followed by the Bush administration's downgraded assessment of the economy for this year.

In a forecast, the White House Council of Economic Advisers, Treasury Department and Office of Management and Budget revised down a forecast for 2007 GDP growth to 2.3 percent this year from 2.9 percent.

Meanwhile, in the UK, Reuters reports that a KPMG/REC report on jobs showed that wages are rising at their fastest rate in 7 years while a Nationwide building society survey showed that consumer confidence remains high.

However, the pace of further rate hikes in Japan remains in doubt as the economy continues to show signs of cooling. From Bloomberg:

Japan's broadest indicator of the outlook for the economy signaled for a sixth month that the longest expansion in more than 60 years may slow.

The leading index was 20 percent in April, the Cabinet Office said today in Tokyo, matching the median estimate of 33 economists surveyed by Bloomberg News. A number below 50 indicates the economy may cool in three to six months.

Wednesday, 6 June 2007

Bond yields rise as economic data remain upbeat

Gradually, markets are getting around to the idea that there may not be rate cuts by the Federal Reserve this year. From Bloomberg:

The U.S. stock market posted its first decline in a week after bond yields surged to a nine-month high amid signs the economy may be gaining momentum...

The Institute for Supply Management's index of non- manufacturing businesses rose to 59.7 from 56 in April, the Tempe, Arizona-based group said. Economists surveyed by Bloomberg News had expected a reading of 55.8. Readings above 50 signal growth.

Federal Reserve Chairman Ben S. Bernanke said core inflation remains somewhat elevated, though officials have seen a "gradual ebbing." He also said tighter lending standards for mortgages will "restrain housing demand, although the magnitude of these effects is difficult to quantify." Bernanke spoke via satellite to a conference in Cape Town, South Africa...

Traders who a month ago were convinced the Fed would lower its target for the overnight lending rate between banks at least once by year-end now see almost no chance of that happening, interest-rate futures yields show.

But higher yields in the US are not just the result of lower expectations of a Fed cut; strong growth and higher rates in Europe have contributed too. Again from Bloomberg:

Expansion in European service industries, the biggest part of the economy, gained pace for the first time in four months in May, supporting the case for higher European Central Bank interest rates.

Royal Bank of Scotland Group Plc said today its services index rose to 57.3 from 57 in April. The index is based on a survey of purchasing managers by NTC Economics Ltd. and a reading above 50 indicates expansion. Economists expected an increase to 57.1, the median of 33 estimates in a Bloomberg survey showed.

It has been a similar story in the UK. From Reuters:

British service sector activity grew slightly more than expected in May but companies raised prices at their weakest rate in more than a year, a survey showed on Tuesday.

The Chartered Institute for Purchasing and Supply/NTC index for activity in the services sector...came in at 57.2, well above the 50 divide between expansion and contraction.

Stock markets have done well over the past few months despite relatively weak economic numbers from the US. The more upbeat economic data recently, though, could prove to be bad news for stocks if it means higher interest rates.

Tuesday, 5 June 2007

Another China plunge, another shrug

Investors are beginning to have a better understanding of the significance of events in China's stock market.

Yesterday, Chinese stock markets plunged. Outside China, though, almost nobody cared. AFP/CNA reports:

Chinese share prices tumbled 8.26 per cent Monday for the sharpest drop in more than three months on concerns the authorities will take more measures to cool a speculative frenzy, dealers said...

While the February drop triggered panic in stock markets around the globe, Monday's plunge in China shares met with a relatively muted response in Asian markets, with Australia and South Korea reaching new highs.

And MarketWatch reports that US stock markets also closed at new highs yesterday.

David Gaffen at MarketBeat says that China's stock market "just isn't that big". Nevertheless, Helen Thomas at FT Alphaville thinks that the "the soap opera of Beijing’s attempts to grapple with its red-hot stock market is too good to ignore".

On the economic news front, Bloomberg reports that spending by Japan's largest companies rose to a record in the first quarter.

Capital spending climbed 13.6 percent in the three months ended March 31 from a year earlier, the Ministry of Finance said in Tokyo today. The pace was faster than the 10.1 percent median estimate of nine economists surveyed by Bloomberg News.

But in the US, factory orders disappointed, as Reuters reports.

New orders at factories rose a smaller-than-expected 0.3 percent in April, the weakest showing since January, on a sharp drop in aircraft orders, a Commerce Department report showed on Monday.

Analysts polled by Reuters were expecting factory orders to rise 0.7 percent. March orders were revised up to show a 4.1 percent gain from the previously reported 3.1 percent...

Excluding transportation, factory orders rose 0.7 percent after a 2.4 percent increase in March.

Orders for durable goods, long-lasting items meant to last three years or longer, were revised to show a bigger-than-expected 0.8 percent. Durables orders were previously reported to have risen 0.6 percent, and analysts polled by Reuters had expected the durables figure to stay unrevised.

In a sign businesses are continuing to invest, orders for capital goods excluding defense and aircraft, considered a proxy for business spending, were revised to an increase of 2.1 percent after a previously reported 1.2 percent gain.

In the euro zone, inflation remains a concern as Eurostat reports that industrial producer prices rose 0.4 percent in April.

Saturday, 2 June 2007

Another day of upbeat economic data

Reuters reports the flood of data from the US, starting with the jobs report.

The number of new U.S. jobs climbed by an unexpectedly brisk 157,000 in May...

The jobs report showed the unemployment rate unchanged in May from April's 4.5 percent. The department revised its April figures to show that 80,000 jobs were created, instead of the 88,000 it reported a month ago...

Average hours of work rose slightly to 33.9 from 33.8 in April, though overtime hours fell slightly to 4.1 in May from 4.2 in April.

But US consumers don't even need income growth to increase spending.

The Commerce Department report showed consumer spending jumped 0.5 percent in April despite the fact that incomes fell 0.1 percent.

Core inflation remained tame.

... [C]ore consumer prices...rose a smaller-than-expected 0.1 percent in April... 2 percent on a year-over-year basis...

And there's more.

Most of the economic news was upbeat, including a Reuters/University of Michigan survey that showed consumers were keeping their spirits up despite soaring gasoline prices. Its final May reading on consumer sentiment gained to 88.3 from 87.1 at the end of April, showing optimism about the future.

Another report from the Institute for Supply Management said factory managers began restocking depleted inventories in May, which helped nudge its index of national factory activity up to 55.0 from 54.7 in April.


One sour note came from the National Association of Realtors, which said its Pending Home Sales Index, based on contracts signed in April, dropped 3.2 percent to 101.4 from a revised 104.8 in March. It underlined the well-known woes facing the struggling housing sector.

On the other hand, auto sales steadied in May according to another Reuters report.

Not surprisingly, the manufacturing data in China also looked quite strong. Bloomberg reports:

China's manufacturing activity rose in May to the highest level in more than two years after a surge in bank lending, according to a survey by Hong Kong-based CLSA Asia Pacific Markets.

The Purchasing Managers' Index climbed to 54.1 from 53.3 in April, CLSA said today in an e-mailed statement. That is the highest since April 2005. A reading above 50 reflects an expansion in manufacturing...

A separate PMI, published earlier today by the National Bureau of Statistics and the China Federation of Logistics and Purchasing, fell to 55.7 in May, the lowest reading in three months, from a two-year high of 58.6 in April.

In the UK, manufacturing activity unexpectedly accelerated in May, reports Reuters, with possibly unwelcome implications for inflation.

The Chartered Institute of Purchasing and Supply/NTC purchasing managers' index rose to 54.9 last month from an upwardly revised 54.1 in April. Analysts polled by Reuters had expected a slight easing to 53.7...

The Bank of England is likely to be concerned to see the CIPS/NTC index measuring output price growth nudging higher to equal February's series high of 56.9...

Manufacturers may be raising prices in response to the return of a pick-up in the cost of raw materials. The CIPS/NTC index measuring input price growth hit its highest since September, up to 64.8 in May from 63.3 in April.

But in the euro area, manufacturing unexpectedly slowed, reports Bloomberg.

Royal Bank of Scotland Group Plc's index of manufacturing in the 13 euro nations unexpectedly fell to 55 from 55.4 in April. A reading above 50 indicates growth. Economists forecast that the gauge, compiled by NTC Economics Ltd. from a survey of 3,000 purchasing managers, would increase to 55.5, the median of 38 estimates in a Bloomberg News survey showed.

Friday, 1 June 2007

Economic growth heating up all over the world

India's economy is among the fastest-growing. From AFP/CNA:

India's economy expanded by a faster-than-expected 9.4 percent in the year ended March, official data showed on Thursday, beating a government forecast of 9.2 percent.

In the meantime, US economic growth in the first quarter slowed to the weakest in more than four years, but the slowdown could already be history. From Reuters:

The Commerce Department revised down its estimate for first-quarter expansion in gross domestic product, or GDP, to a 0.6 percent annual rate from the 1.3 percent that it estimated a month ago...

The National Association of Purchasing Management-Chicago business barometer rose to 61.7 from 52.9 in April, leading analysts to predict the factory sector now is poised to grow...

In another report, the Labor Department said new claims for jobless pay fell 4,000 last week to 310,000, a sign the job market remains healthy enough to support consumer spending.

A separate Commerce Department report showed April construction spending edged up 0.1 percent after a revised 0.6 percent gain in March -- all because of more spending on commercial buildings that offset weak spending on home construction...

A report from the Office of Federal Housing Enterprise Oversight on Thursday showed home prices rose at the slowest pace in a decade in the first quarter. Average home prices crept up 0.5 percent in the first quarter from last year's closing quarter, leaving them 4.3 percent higher than a year ago.

Despite the better data going into the second quarter, Asha Bangalore thinks a Fed cut may still be needed.

... The outlook for private sector spending is tied to the direction of Fed policy. If the Fed remains focused on waiting until core inflation readings are at or below 2.0% before dropping the funds rate, there is good chance for private sector spending to show additional deceleration in the quarters ahead.

Are interest rates too high? Maybe that is why the S&P 500 only edged up to a new record high yesterday.

There is no talk of rate cuts in Europe though. Not with the kind of data reported yesterday by Bloomberg:

European business and consumer confidence unexpectedly rose in May as German unemployment held at a six-year low, keeping Europe's economy on course to outperform the U.S. for the first time since 2001.

An index of sentiment among executives and consumers in the euro region rose to 111.9 this month, the highest level since January 2001, from 111.0 in April, the European Commission in Brussels said today. Germany's jobless rate stayed at 9.2 percent, the lowest since May 2001, while an index of consumer confidence in France rose to a record, separate reports showed...

The pace of European expansion is raising concern that inflation will accelerate later this year, prompting European Central Bank policy makers to signal they may increase interest rates again. While a report today showed inflation stayed at 1.9 percent in May, under the bank's 2 percent limit, ECB council member Nicholas Garganas said the central bank will probably raise its inflation forecast next month and is keeping options "open" after the rate rise policy makers signaled for June.

In the UK, Bloomberg reports that mortgage approvals fell and consumer credit dropped to the lowest in a decade in April.

Lenders granted 107,000 loans for house purchases, the lowest in a year and down from a revised 112,000 in March, the Bank of England said today in London. Borrowing by consumers on credit cards, personal loans and overdrafts fell to 498 million pounds ($983 million), the least since March 1997...

Weaker demand for mortgages is adding to evidence that housing market gains are slowing. Home values rose 0.5 percent this month after gaining 0.9 percent in April, Nationwide Building Society said today.

But consumer confidence shot up to a two year-high in May while a survey showed yesterday that retail sales grew slightly more than expected in May and shops are looking to raise prices at the fastest rate in eight years.