No Bernanke put?

As markets steadied somewhat yesterday, John Berry says in his Bloomberg column that the recent market volatility will not induce a rate cut from the Fed.

It's going to take more than the recent bout of volatility in stock and bond markets to change the outcome of next week's Federal Reserve policymaking meeting...

Neither the recent drop in stock prices nor the rise in yields on riskier debt has gone far enough to cause Fed officials to alter their forecast for continued moderate growth in this year's second half.

In her Bloomberg column, Caroline Baum finds someone else saying essentially the same thing.

"In the last 48 hours, the fed funds futures had the biggest change in outlook for Fed policy in months," Jim Bianco, president of Bianco Research in Chicago, said in a phone interview Friday...

"It's right out of the Greenspan playbook," Bianco said...

"The definition of a crisis in the Greenspan era was any market environment preventing a trader from getting 100 percent of his bonus potential,'' Bianco said...

At times like these, it's important to remember that "Greenspan is no longer Fed chairman," Bianco said. "It's a dirty little secret that not too many people know."

And David Kotok of Cumberland Advisors says:

... [T]he risk is centered in the private sector with hedge funds, private equity firms, carry traders and other leveraged players. This time the brokers and underwriters and credit insurers are taking the hits...

In the Fed’s view they took risks and they must incur losses if they erred...

In our view the Fed will not bail out the brokers, insurers, and other players who extended or leveraged or rated (S&P better watch their back) credit. The Fed will watch. It will be vigilant about the banking system. But it has no obligation to save a builder who is over extended or a condo flipper or a hedge fund.

Meanwhile, even as we assess the likelihood of a Fed cut, some central banks continue to tighten monetary policy -- for example, China's. Xinhua Online reports:

China will raise the reserve requirement ratio by half a percentage point to 12 percent for commercial banks from Aug. 15, the People's Bank of China (PBOC) announced on Monday.

In the UK, the prospect for further monetary tightening is less clear. Reuters reports:

Mortgage lending growth gathered pace in June and approvals for home loans held steady in a sign that a string of interest rate rises has not cooled the housing market...

The latest survey from mortgage lender Nationwide showed house prices virtually stagnated this month but were still up nearly 10 percent on the year. Data from property consultants Hometrack earlier on Monday also showed house price inflation slowing...

Unsecured lending rose by 874 million pounds last month...

M4, or broad money, increased by 0.7 percent in June for an annual rate of 12.9 percent...

And while many economists expect the Bank of Japan to raise interest rates in the next month or two, recent economic data still cannot convincingly justify such a move.

Date released yesterday showed that Japanese industrial production rose 1.2 percent in June. On the other hand, the NTC Research/Nomura/JMMA Purchasing Managers Index declined to 49.0 in July from 50.4 in June.

Labour and consumer spending data released today did not greatly clarify the economic outlook. From Bloomberg:

Monthly wages, including overtime pay and bonuses, dropped 1.1 percent from a year earlier, the Labor Ministry said today in Tokyo. Spending rose 0.1 percent from a year earlier, the statistics bureau said today in Tokyo, less than the 0.7 percent median estimate of 29 economists surveyed by Bloomberg News...

The drop in wages came even as the unemployment rate sank to 3.7 percent in June, the lowest in nine years, from 3.8 percent in May. The job-to-applicant ratio, which shows how many positions are on offer to a job seeker, rose to 1.07 in June from 1.06 a month earlier.

Markets in turmoil on fears of credit crunch

The past week was a tumultuous one for global markets. Stocks and most other risky assets around the world fell sharply as investors rushed into government bonds amid increased concerns over the availability of cheap credit in the wake of problems in the mortgage market in the United States. However, investors should probably remember that a similar bout of risk aversion last year had proved relatively short-lived.

Last week provided additional evidence that the problems in the US mortgage market are far from over. US home builders releasing financial results last week reported large losses and write-downs in the face of declining land prices. And Countrywide Financial, the second-largest US retail mortgage lender, confirmed fears that problems in the industry extended beyond subprime mortgages by reporting that delinquencies on prime home-equity loans to borrowers with high credit scores jumped to 4.6 percent in June from 1.8 percent a year earlier.

The problems in the US mortgage market is having wide-spread impact. In a move reminiscent of the problems faced by two Bear Stearns hedge funds last month, Australian hedge fund Absolute Capital Group Ltd announced last week that it had suspended withdrawals from two funds after forecasting losses on US subprime mortgages.

In the light of these developments, investors are becoming more risk-averse and are less willing to part with their cash. Last week brought news that bankers for Chrysler and Alliance Boots Plc had to take on loans to the companies after having difficulty in selling their debt.

The rising risk aversion resulted in a worldwide sell-off in stocks last week. The Standard & Poor's 500 fell 4.9 percent to 1458.95 last week, its worst weekly loss since September 2002. Elsewhere, the Dow Jones Stoxx 600 Index fell 5.1 while the Morgan Stanley Capital International Asia-Pacific Index lost 3.9 percent to 154.50.

Investors fled to safer investments, as a result of which government bonds rose and yields fell. The yield on the benchmark 10-year US Treasury note fell 19 basis points to 4.76 percent last week, the biggest fall in ten months. Elsewhere, the yield on the German 10-year bund fell 11.6 basis points to 4.32 percent while the yield on the 10-year Japanese government bond fell 10.5 basis points to 1.78 percent.

The rising risk aversion also meant some unwinding of the yen carry trade. For example, the New Zealand dollar fell nearly five per cent against the yen last week. That came despite the Reserve Bank of New Zealand raising its benchmark interest rate by a further 25 basis points to 8.25 per cent on Thursday.

The real economy took a back seat in investors' minds last week. Largely ignored was the International Monetary Fund raising its projections for global growth in both 2007 and 2008 to 5.2 percent from 4.9 percent. Also largely ignored was the 3.4 percent growth rate the US economy reportedly achieved in the second quarter.

On the other hand, with the focus on the credit market, the continuing deterioration in the US housing market was certainly not ignored. Last week's housing data showed that existing-home sales in the US fell 3.8 percent in June while new-home sales fell 6.6 percent. This followed a report from the National Association of Home Builders the previous week that its Housing Market Index fell four points to 24 in July, the lowest level since January 1991.

Amid all the selling, though, it is probably useful to remember that we have been here before. I am talking not so much of the jitters in February this year but the flight to safety back in May-June 2006. Notice from the accompanying chart how close interest rates in the US are today with those at that time.


However, mid-2006 proved to be a peak for interest rates and a bottom for stock markets. History could repeat itself and stock markets could stabilise or even recover soon. After all, global economic growth remains good and stock market valuations remain reasonable. The S&P 500, for example, now trades at a price-earnings ratio of 17.5, or an earnings yield of 5.7 percent, almost a full percentage point higher than the 10-year Treasury yield. Further risk aversion would push the Treasury yield even lower, making stocks appear even more attractive by comparison.

Nevertheless, the heightened concern over the possibility of a generalised credit crunch resulting from the troubles in the US mortgage market is also well-grounded. Like other interest rates, mortgage rates in the US also saw a short-term peak in mid-2006 but despite the subsequent decline in rates -- a decline that has since been reversed -- we are still waiting for a bottom in the US housing market. As the weakness in the housing market drags on, especially as adjustable-rate mortgages reset at higher rates in coming months, mortgage delinquencies and defaults will continue to rise, leaving the overall credit market looking increasingly fragile.

So there is reason to think that stock markets and risky assets in general could stage a rebound before long but the downside risk is real and investors in these markets could be in for more anxious moments.

Dow falls again even as US economy rebounds

The worldwide flight to safety continued yesterday as the Dow completed its worst week since March 2003. From MarketWatch:

The Dow Jones Industrial Average was off 208 points at 13,265, giving it a 4.2% loss for the week, its largest percentage decline since the week ending March 28, 2003...

The S&P 500 index ended with a 23.6 point drop at 1,459. It fell 5% on the week. The Nasdaq Composite ended 37 points off at 2,562 on Friday, losing 4.6% for the week...

Crude futures climbed, with September crude closing at $77.02 a barrel, its highest level since mid-August of last year. The contract was up 2.8% for the session and 1.6% for the week as supply and demand concerns returned...

Spreads between credit-default swaps on high-yield bonds and U.S. Treasury bonds rose past key levels, according to Markit Group, which measures that data.

On the other hand, the economic data released yesterday were reasonably positive. MarketWatch reports that the US economy accelerated in the second quarter.

After hitting a pothole in the first quarter, the U.S. economy rebounded in the second quarter, growing at an annual rate of 3.4%, the fastest pace since the first quarter of 2006, the Commerce Department said Friday.

The improvement in the second quarter was concentrated in a stronger trade performance, better investment in structures, faster government spending and a rebuilding of inventories after significant reductions in the past two quarters. Business investment was strong, led by the fastest growth in spending on nonresidential structures in 13 years. These offset a sharp slowdown in consumer spending and a decline in investments in homes.

And the University of Michigan consumer sentiment index rose to 90.4 in July from 85.3 in June.

Consumer confidence has also risen in Germany. Bloomberg reports:

Consumer confidence in Germany, Europe's largest economy, rose to an eight-month high after unemployment declined to the lowest level in 12 years.

GfK AG's confidence index for August, based on a survey of about 2,000 people, rose to 8.7 from 8.5 in July, the Nuremberg- based market-research company said today. Economists expected a gain to 8.8, according to the median of 25 forecasts in a Bloomberg News survey. The July reading was revised up from 8.4.

Unfortunately, so has the inflation rate. Again from Bloomberg:

The rate of inflation in Germany, Europe's largest economy, unexpectedly increased in July due to higher energy and holiday costs and exceeded the European Central Bank's inflation limit for a fifth month.

Inflation accelerated to 2.2 percent from 2 percent the previous month under a harmonized European Union method, the Federal Statistics office in Wiesbaden said today. Economists expected German inflation to slow to 1.9 percent from 2 percent in June, the median of 23 estimates in a Bloomberg News survey showed. From a month ago, prices rose 0.7 percent.

But things are moving in the reverse direction in Japan. From Bloomberg:

Japan's retail sales unexpectedly dropped in June, as higher taxes, lower wages and a furor over lost pension records weighed on consumer sentiment.

Sales fell 0.4 percent from a year earlier, the Trade Ministry said today in Tokyo. The median estimate of 25 economists surveyed by Bloomberg News was for a 0.6 percent gain...

The decline was led by falling sales of automobiles, household appliances and beverages, the ministry said. From a month earlier, retail sales slumped 0.8 percent.

And consumer prices continue to fall.

Japan's consumer prices declined for a fifth month in June, undermining the central bank's case that inflation will take hold and interest rates need to be raised.

Core consumer prices, which exclude fresh food, fell 0.1 percent from a year earlier, the statistics bureau said in Tokyo today, matching the median estimate of 44 economists surveyed by Bloomberg. Prices fell at the same pace the preceding two months.

Flight to safety in markets as US data disappoint

Bloomberg reports the market action yesterday.

Stocks tumbled around the world and U.S. Treasuries rallied on concern higher borrowing costs will slow takeovers, spur debt defaults and curb earnings, prompting investors to flee riskier assets.

The Dow Jones Industrial Average and Standard & Poor's 500 Index fell the most since February, while the FTSE 100's biggest drop in four years led declines across Europe. Benchmark stock indexes in Argentina, Brazil, Mexico, Turkey and Sweden sank more than 3 percent.

Considering yesterday's economic data, there is probably some justification for the market action.

Reuters reports that the data from the US were unexpectedly weak.

Orders for U.S.-made durable goods rose 1.4 percent in June, the Commerce Department reported, but they were below Wall Street expectations for a 1.8 percent gain, and a measure of business spending in the data fell unexpectedly.

Separate Commerce Department data showed continued weakness in the housing sector, with new single-family homes sales falling 6.6 percent in June to a lower-than-expected level leaving a bloated inventory of unsold homes.

There are also increasing signs of a slowdown in the UK housing market. From Bloomberg:

U.K. house prices rose at the slowest pace in 15 months in July after five interest-rate increases in a year squeezed Britons' finances, Nationwide Building Society said.

The cost of a home climbed 0.1 percent from June to an average 184,270 pounds ($378,000), the smallest gain since April 2006 and down from last month's 1.1 percent increase...

The Nationwide report adds to evidence of a cooling property market. The number of loans granted for home purchase fell in June by 2.7 percent on the month and 11 percent from a year earlier, to 75,318, the British Bankers Association said today.

In Germany, Bloomberg reports that business confidence fell in July.

The Munich-based Ifo research institute said its sentiment index, based on responses from 7,000 executives, fell to 106.4 from 107 in June.

But Europe is still looking relatively buoyant on the whole.

In France, business confidence held near a six-year high this month, Paris-based national statistics office Insee said yesterday...

European money-supply growth unexpectedly accelerated in June, the ECB said today. M3 money supply, which the bank uses as a gauge of future inflation, rose 10.9 percent from a year earlier after increasing 10.6 percent in May.

That acceleration in M3, however, also means that ECB tightening will probably continue, and that could put further pressure on credit markets.

Global expansion continues despite drag from US housing

The International Monetary Fund has raised its forecast for global economic growth this year.

The strong global expansion is continuing, and projections for global growth in both 2007 and 2008 have been revised up to 5.2 percent from 4.9 percent at the time of the April 2007 World Economic Outlook. Risks to this favorable outlook remain modestly tilted to the downside.

The projection for the US, though, was lowered by 0.2 percentage point to 2.0 percent.

In the meantime, the US economy appears to be maintaining a moderate pace of expansion, at least according to the Federal Reserve's Beige Book released yesterday. Reuters reports:

The Fed's Beige Book of anecdotal economic conditions had seven of the Fed's twelve districts reporting moderate or modest growth, while nearly all reported declines in housing construction and residential real estate activity.

Other data released yesterday support the reported weakness in housing.

Existing-homes sales hit a lower-than-expected 5.75 million unit annual rate while prices and inventories remained flat, the National Association of Realtors said in a report on Wednesday...

Existing-home sales were off 3.8 percent in June and hit their lowest level since November 2002 when sales posted a 5.73 million unit annual pace...

The inventory of homes for sale fell 4.2 percent to 4.196 million units at the end of June, which represents an 8.8 months' supply and matched the May supply.

The median home price in June edged up 0.3 percent to $230,100 from year-ago levels and was the first such increase in 11 months...

The Mortgage Bankers Association said its seasonally adjusted index of mortgage applications last week fell 3.6 percent to 609.0, its lowest since the week ended February 16 when it stood at 606.6.

Meanwhile, much of the rest of the world is still experiencing strong growth, for example, in South Korea, as reported by AFP/CNA:

South Korea's economy grew faster in the second quarter compared to three months earlier due mainly to robust exports and strong manufacturing output, the central bank said Wednesday.

Gross domestic product rose 1.7 percent quarter-on-quarter compared with a 0.9 percent gain in January-March, according to an advance estimate by the Bank of Korea.

And Japan's trade surplus soared in June. Again from AFP/CNA:

Japan's trade surplus surged 53.4 percent from a year earlier to 1.227 trillion yen (US$10.2 billion) in June, surpassing forecasts, the government said Wednesday...

June exports rose 16.2 percent to 7.283 trillion yen while imports increased 10.7 percent to 6.056 trillion yen, the ministry said.

In its report, the IMF suggested that "central banks will need to further tighten monetary policy". Well, one central bank may have just finished its tightening for this cycle. From Bloomberg today:

New Zealand's central bank raised its benchmark interest rate to a record 8.25 percent and said borrowing costs may be high enough to contain inflation, triggering a decline in the nation's currency.

"New Zealanders have been showing early signs of moderating their borrowing," Reserve Bank Governor Alan Bollard said in a statement released in Wellington today. If that continues "we think the four successive rate increases we have delivered will be sufficient to contain inflation."

European stocks fall amid signs of slower growth

European stock markets yesterday were dragged down by the plunge in US markets. Bloomberg reports:

European stocks fell to a four-week low after disappointing earnings from the largest U.S. mortgage lender pushed financial shares lower and the U.K.'s worst floods in 60 years weighed on retailers...

Europe's Dow Jones Stoxx 600 Index lost 1.5 percent to 388.94, as all 18 industry groups retreated. The index has declined 2.8 percent from a 6 1/2-year high reached June 1 on concern losses in the U.S. mortgage market will erode earnings for financial companies.

Economic data from Europe yesterday were mixed.

Eurostat reports that industrial new orders increased by 1.7 percent in May in the euro area and by 3.2 percent in the EU27, rebounding from falls in April.

However, data for more recent periods indicate that the European economies may be slowing. From Bloomberg:

Growth in Europe's manufacturing and service industries, which account for two thirds of the economy, slowed more than economists forecast in July as the euro rose to a record and oil prices increased.

Royal Bank of Scotland Group Plc said its combined index, spanning industries from autos to banking and airlines in the 13- nation euro region, fell to 57.3 from 57.8 in June...

Royal Bank of Scotland's manufacturing index fell to 54.8 from 55.6 in June while its gauge of services growth declined to 58.1 from 58.3. Today's report is an initial estimate of the indexes...

New manufacturing orders fell to their lowest since November 2005, while in the services sector orders reached the highest level since June last year, today's report showed...

French consumer spending on manufactured goods jumped 1.6 percent in June from May, more than twice as much as expected, as unemployment fell in Europe's third largest economy, Insee, the Paris-based national statistics office, said today...

Italian consumer confidence remained near a 14-month low in July as households fretted about higher gasoline prices, while German import prices increased more than economists predicted in June, led by higher oil costs, reports today showed.

There was also weakness in manufacturing in the UK, where the Confederation of British Industry said yesterday that its monthly manufacturing order books balance fell to -6 in July from +8 in June.

The silver lining here is that slower economic growth would discourage further interest rate hikes from the ECB and BoE and thus help support markets in general.

Liquidity and other environmental problems

The Bank of England's interest rate hikes appear to be draining liquidity from the UK housing market. From Reuters:

House price inflation in England and Wales eased to 10.3 percent in July from 13.2 percent last month, property Web site Rightmove said on Monday.

The figures suggest the housing market is starting to come off the boil following five interest rate hikes since last August.

However, Britain is facing another form of excess liquidity at the moment: flooding.

Another country experiencing house price inflation is China. From Xinhua Online:

The housing prices in 70 large-and medium-sized cities in China continued to rise in June, up 7.1 percent over the same period last year.

Last month, the prices of newly-built commercial housing units were up 7.4 percent year-on-year, according to figures released Monday by the National Development and Reform Commission in cooperation with the National Bureau of Statistics (NBS).

Incidentally, China is also facing flooding problems.

For the longer term, though, China needs to address wider environmental issues. From AFP/CNA:

Local governments in China are continuing to invest in dirty, resource-intense industries, jeopardising Beijing's goals of saving energy and cutting pollution, state media reported Monday.

Some regions are encouraging steel, cement and other heavy industries to boost economic growth despite demands from Beijing to rein in those sectors, the China Daily newspaper said, quoting a top development official...

In another setback, the Beijing News said the introduction of a formula that would hold local officials responsible for environmental damage had been "indefinitely postponed."

China raises interest rates

This was quick, if not exactly unexpected. From AFP/CNA:

China's central bank announced Friday it will raise interest rates for the third time this year in an effort to cool -- but not stop -- an economy that is growing at its fastest pace in over a decade.

Benchmark lending and deposit rates will each rise by 0.27 percentage points from Saturday, the People's Bank of China said in a statement on its website.

Some reactions from economists:

"Raising lending rates will not have much influence on high inflation, which was mainly pushed high by a very fast increase in food prices," said Huang Haizhou, a Hong Kong-based economist with Barclays Capital...

"The atmosphere in Beijing is still relatively relaxed, with no obvious belief among officials or local economists that this economy is careering out of control or growing seriously above potential," said [Standard Chartered senior economist Stephen] Green...

"We expect the boom to continue; we believe it to be sustainable," he said.

Chinese economy surges but US economy faces continued slow growth

Watch for more tightening from China after the latest economic data. From Reuters:

China's annual economic growth surged to an 11-½ year high of 11.9 percent in the second quarter, cementing expectations for tighter policy to keep the world's fastest-growing major economy from overheating.

The figures put China on course to chalk up its straight fifth year of double-digit growth and to overtake Germany as the world's third-biggest economy -- perhaps as soon as this year...

Soaring costs of pork and grain pushed annual consumer price inflation to a 33-month high of 4.4 percent in June, beating expectations and accelerating from 3.4 percent in May.

Other figures also were stronger than expected: industrial output in June rose 19.4 percent from a year earlier, retail sales were up 16.0 percent and investment in urban areas was up 28.5 percent.

The US economy could do with some boost from stronger growth elsewhere. There might not be so much in the US itself. The latest reading on the Conference Board's US leading index:

The Conference Board announced today that the U.S. leading index decreased 0.3 percent, the coincident index increased 0.2 percent and the lagging index increased 0.5 percent in June...

The leading index now stands at 137.5 (1996=100). Based on revised data, this index increased 0.2 percent in May and decreased 0.2 percent in April. During the six-month span through June, the leading index decreased 0.7 percent, with four out of ten components advancing (diffusion index, six-month span equals forty percent).

Inflation moderates in US and UK, Fed concerned about housing

Reuters reports Ben Bernanke's speech to Congress yesterday.

Federal Reserve Chairman Ben Bernanke told Congress on Wednesday housing market woes could dampen an expected pickup in U.S. economic growth, but he restated that the central bank's main worry is inflation.

"Overall, the U.S. economy appears likely to expand at a moderate pace over the second half of 2007, with growth then strengthening a bit in 2008 to a rate close to the economy's underlying trend," he told the House of Representatives Financial Services Committee...

As a result of weaker-than-expected home building, the Fed cut its forecast for growth this year by a quarter-percentage point to a range of 2.25 percent to 2.5 percent, and downgraded its 2008 projection as well.

Based on the data from the US yesterday, concerns over the housing market appear justified, but inflation remained relatively subdued in June. MarketWatch reports:

The Commerce Department reported that starts of new homes rose by 2.3%, to a seasonally adjusted annual rate of 1.467 million in June, the quickest pace since April.

Year on year, however, starts continue to be weak. June's housing starts were 19.4% below where they were at the same time last year...

Meanwhile, building permits sank by 7.5% in June, according to the government report, to a pace of 1.406 million annualized. Permits for single-family homes fell by 4.1% from May...

Separately, the Labor Department reported that U.S. consumer prices increased a moderate 0.2% in June, with falling energy prices offsetting rising food prices. It's the smallest increase in the seasonally adjusted consumer price index since January.

Indeed, the macroblog notes that "developments on the inflation front appear to be improving".

Consumer price inflation also moderated in the UK in June to a 2.4-percent rate last month from 2.5 percent in May. Meanwhile, average earnings rose at their weakest pace in 1-1/2 years in the three months to May despite a tightening labour market.

Yesterday also saw Japan's index of leading economic indicators revised to 40.9 in May from an initial estimate of 30.0.

US industrial production up in June

The Dow Jones Industrial Average may have hit a new record high yesterday -- and briefly climbed above 14,000 -- but on the whole, yesterday's global economic data were mixed.

In the US, industrial production was up in June. MarketWatch reports:

U.S. industrial production rose 0.5% last month after falling a revised 0.1% in May, the Federal Reserve reported Tuesday. Read full Fed survey.

Capacity utilization rose to 81.7% in June, the highest level since last October, from a revised 81.4% in the previous month...

Manufacturing output rose 0.6% in June after remaining flat in May, due in part to a pickup in output of motor vehicles and parts...

Capacity utilization in manufacturing rose to 80.3% from 79.9%...

In a separate report issued Tuesday, the Labor Department said headline wholesale inflation eased in June, but core prices rose were up 0.3%.

However, the NAHB/Wells Fargo Housing Market Index fell to 24 this month, its lowest level since January 1991, from 28 in June.

Earlier in the day, Japan reported that its tertiary index fell 0.1 percent in May after climbing a revised 1.6 percent in April, raising concerns about waning consumer spending.

And in Germany yesterday, the ZEW index of investor and analyst confidence dropped to 10.4, the lowest since March, from 20.3 in June.

New funding currency?

Inflation in New Zealand in the June quarter turned out to be higher than expected, with consumer prices rising 1 percent. This means that the central bank will continue to raise interest rates. It also means that the New Zealand dollar will continue to attract carry traders.

Andy Mukherjee thinks the Singapore dollar could become the new funding currency for carry trades in Asia.

While the Japanese yen and the Taiwanese dollar remain the vehicles of choice for financing purchases of the New Zealand dollar and other high-yielding currencies, the risk of a reversal in these trades is prompting the search for alternatives.

The cost of money in Taiwan is rising, partly because the central bank wants to kill the carry trade and arrest capital outflows. Although the yen remains very much in play, no one knows for how long. The Bank of Japan may signal higher interest rates as early as next month. And that makes funding positions in yen very profitable, but dangerous.

Amid these threats, the Singapore dollar may fit the bill nicely as a low-risk funding currency...

[C]onsumer-price inflation is subdued and the one-month interbank interest rate on the island is, thanks to a glut of capital, just 2.4 percent, almost 1 percentage point lower than at the beginning of the year. The implied cost of borrowing Taiwan dollars using the forward market is 2.6 percent for a month.

The liquidity overhang in Singapore is unlikely to disappear soon and that may be a reason for the nation's currency to replace the Taiwan dollar as a funding option.

"The Singapore dollar is also attractive as a funding currency because of its lower volatility, slightly below that of the Taiwan dollar and significantly below that of the Japanese yen," Citigroup Inc. economist Chua Hak Bin wrote in a note to clients yesterday...

With annual consumer-price inflation of 1 percent in May, little changed from a year earlier, the Monetary Authority of Singapore doesn't have a pressing reason to make its existing stance of seeking a "modest and gradual appreciation" more hawkish.

US retail sales fall but euro economy looks strong

Is US consumer spending weakening? June retail sales data released yesterday say yes but consumer sentiment actually picked up in early July. Bloomberg reports:

American shoppers took a breather last month as the worst housing recession in 16 years eroded demand for building materials, appliances and furniture.

The 0.9 percent drop in retail sales, the most in almost two years, followed a revised 1.5 percent increase in May, the Commerce Department said today in Washington. Sales excluding automobiles fell 0.4 percent, the most since September. A separate Labor Department number showed the price of imported goods rose for a fifth month on higher fuel costs.

Another report showed confidence among Americans rose more than expected this month, indicating the drop in sales may be temporary...

The Reuters/University of Michigan's preliminary index of consumer sentiment rose to 92.4 this month from 85.3 in June, which was the lowest in 10 months. The reading compares with an average of 88.6 in the 12 months through June.

The 1.0 percent increase in the import price index, which was bigger than forecast, followed a 1.1 percent gain in May, the Labor Department reported today in Washington. Prices excluding petroleum rose 0.2 percent after climbing 0.5 percent.

In contrast, the data from Europe the previous day had been strong. Bloomberg reports:

Europe's economy grew faster than previously estimated in the first quarter and is set to sustain its momentum through the year, European Union reports showed.

The economy of the 13 nations that share the euro expanded 0.7 percent from the fourth quarter, when it grew 0.9 percent, Eurostat, the EU's Luxembourg-based statistics office, said today. That compares with the 0.6 percent growth estimated last month...

The European Commission estimates growth of 0.7 percent in the second and third quarters, according to forecasts published on its Web site today. GDP will probably expand 0.6 percent in fourth quarter, up from a previous forecast of 0.5 percent...

Industrial production rose 0.9 percent in May, the most in five months, after falling 0.7 percent in April, according to a separate report today. From a year earlier, production rose 2.5 percent.

South Korea raises rates, Japan waits

South Korea has climbed on board the tightening bandwagon. AFP/CNA reports:

South Korea on Thursday raised its key interest rate for the first time in almost a year in an apparent attempt to curb high liquidity growth.

At its monthly rate-setting session, the Bank of Korea increased the July target for the call rate by 0.25 percentage point to a six-year high of 4.75 percent.

However, Japan, as expected, left interest rates unchanged yesterday. Bloomberg reports:

The Bank of Japan voted 8-1 to keep its benchmark interest rate unchanged as it waits for more proof that economic growth will be sustained and inflation will take hold. Board member Atsushi Mizuno opposed the decision.

Governor Toshihiko Fukui and his policy board colleagues held the key overnight lending rate at 0.5 percent at a two-day meeting that ended today, the central bank said in Tokyo.

Policy makers are confident in their outlook for the economy, though they want to examine more data before increasing borrowing costs, Fukui said. The Bank of Japan will probably raise the key rate, the lowest among major economies, next month, according to economists and investors.

Yesterday also saw the Ministry of Economy, Trade and Industry releasing revised data showing that industrial output in May fell 0.3 percent from April. The initial estimate was a decline of 0.4 percent.

On Wednesday, the Cabinet Office had reported that its consumer confidence index dropped to 45 in June, the lowest since December 2004, from 47.3 in May. However, Japan's current account surplus widened 31 percent in May from a year earlier to 2.13 trillion yen ($17.5 billion).

In other data on trade, the Commerce Department reported yesterday that the US trade deficit widened in May by 2.3 percent to US$60 billion from US$58.7 billion in April.

Concerns abound as China's trade surplus hits record

China grew even faster in 2006 than previously thought. From AFP/CNA:

China has revised up its economic growth figure for 2006 to 11.1 percent from 10.7 percent, the National Bureau of Statistics said Wednesday.

Exports have been key to Chinese economic growth, with the trade surplus soaring.

China's trade surplus hit 26.91 billion dollars in June, a rise of 85.5 percent year-on-year and the highest monthly figure on record, official data showed Tuesday.

China says it will work harder to cut its trade surplus.

"We will continue to take measures to reduce the trade surplus and expand imports so as to realise more balanced trade," [commerce] ministry spokesman Wang Xinpei told reporters.

As it is, the trade surplus is pushing up China's forex reserves.

China's foreign exchange reserves, already the world's largest, surpassed 1.33 trillion dollars at the end of June, the central bank said Wednesday.

At 1.3326 trillion dollars, the reserves were up 41.6 percent from 12 months earlier, the People's Bank of China said in a statement on its website.

And, according to Bloomberg, its money supply.

China's money supply growth accelerated for the first time in four months, increasing the likelihood that interest rates will rise.

M2, the broadest measure, rose 17.1 percent in June from a year earlier to 37.8 trillion yuan ($5 trillion) after gaining 16.7 percent in May, the People's Bank of China said today on its Web site. It topped the government target for the fifth straight month and was higher than the 16.6 percent median estimate of 18 economists surveyed by Bloomberg News.

Foreign concerns over the quality and safety of Chinese products could have an effect on China's trade surplus in coming months, though. From AP/IHT:

First it was pet food that sickened dogs and cats. Then came warnings about toothpaste, toy trains, car tires and several types of fish.

The warnings had one thing in common — all of the products came from China. And that has people worried.

"I'm scared to death. We are dependent on our government inspecting things," said Joyce Simple, a church secretary, interviewed on a recent shopping trip to a Wal-Mart in Houston. "I would be careful of anything that came from China."

But the Chinese themselves probably need to be concerned too. Xinhua Online reports that public health incidents killed 224 people in the first six months in China.

The problem at least seems to be recognised in Jiangsu, where pollution threatened water supplies recently. Li Yuanchao, secretary of Jiangsu Provincial Committee of the Communist Party of China, has reportedly vowed to introduce measures to curb water pollution even at the risk of slowing economic growth.

Whether from a reluctance of foreigners to buy Chinese goods or from self-imposed restrictions, a slowdown in the growth of China's trade surplus would have ramifications for global liquidity and financial markets.

Treasuries gain even as BoC hikes interest rates

The turmoil in the US subprime market continues to impact financial markets. Bloomberg reports:

Treasuries advanced the most since February after Standard & Poor's said it may cut credit ratings on $12 billion of bonds backed by subprime mortgages, sending investors to the safety of U.S. government debt.

Credit-default swaps, contracts used to speculate on a company's ability to repay debt, rose to the highest premium in more than a year in the U.S. and Europe. Stocks dropped on concern the housing slump will hurt corporate earnings and slow economic growth.

The fall in Treasury yields yesterday may be temporary though. Central banks around the world are still raising interest rates, for example, in Canada.

The Bank of Canada raised its benchmark interest rate for the first time in more than a year and said a "modest" tightening may still be needed to slow inflation.

Policy makers pushed the target rate for overnight loans up by a quarter point to 4.5 percent, the highest in six years and 75 basis points less than the Federal Reserve's target. All but one economist in a Bloomberg News survey predicted the increase.

Japanese machinery orders rise

The Bank of Japan meets on Thursday. No rate hike is expected, but the meeting in August is widely expected to see a rate hike. So the Japanese data over the next few weeks will be important.

Reuters reports yesterday's data from Japan.

Japan's core private-sector machinery orders rose more than expected in May, pointing to solid corporate capital spending and bolstering the case for a Bank of Japan rate hike in August.

Core orders, which exclude those for ships and machinery at electric power firms, rose 5.9 percent from April, Cabinet Office data showed on Monday, beating a market consensus forecast for a 2.3 percent rise and following a 2.2 percent increase in April...

The Cabinet Office upgraded its assessment of orders, saying they are seesawing, compared with its view last month that orders were somewhat weak...

Separate data from the BOJ showed that Japanese banks' outstanding loans rose 0.7 percent in June from a year earlier, increasing for the 17th straight month.

But the pace of growth was the slowest since March 2006...

Separately, a survey of Japanese service sector workers...showed their economic sentiment index dipped...to 46.0, the lowest since February 2005 when it hit 45.6, as an increase in local taxes and recent rise in oil prices hurt consumer sentiment.

As global unemployment falls, so do bond prices

Bond markets started the month of July in the same way they started the month of June: with a sell-off.

Government bonds in the United States, Europe and Japan all fell last week, causing yields to rise as most of the data released over the week showed that global economic growth remains strong. According to Bloomberg, the yield on the US 10-year Treasury rose 17 basis points last week, the yield on the 10-year Bund rose 11 basis points and the yield on the 10-year JGB rose 6.5 basis points.

The Global Manufacturing PMI, produced by JP Morgan with research and supply management organisations, rose to 54.4 in June, its highest level since last September, from 54.1 in May. Similarly, the JP Morgan Global Services Business Activity Index rose to 59.6, a 14-month high, from 58.7 in May.

The latest composite leading indicators (CLIs) compiled by the Organisation for Economic Co-operation and Development (OECD) suggest that moderate economic expansion will continue in the OECD area with improved performance in the May CLI’s six month rate of change in all the major seven economies except Italy.

With global economic growth continuing to be strong, central banks are likely to continue monetary tightening. Last Thursday, the Bank of England raised its official bank rate for the fifth time in a year to 5.75 per cent. On the same day, the European Central Bank left interest rates unchanged but president Jean-Claude Trichet said in a press briefing that day that "monetary policy is still on the accommodative side", implying that more rate hikes are foreseen for the future. The previous week, the Federal Reserve had also left interest rates unchanged but mentioned in a statement that it remained concerned about inflation.

One of the reasons that central banks remain concerned about inflation is that resource utilisation remains at relatively high levels in most economies. The Bank of England's decision to raise rates last week was accompanied by a statement saying that "the margin of spare capacity in businesses appears limited and most indicators of pricing pressure remain elevated". Mr Trichet said in his press briefing that "as capacity utilisation in the euro area economy is high and labour markets continue to improve, constraints are emerging which could lead in particular to stronger than expected wage developments" which "would pose significant upward risks to price stability". Similarly, the Federal Reserve's statement accompanying its monetary policy decision in the previous week mentioned that "the high level of resource utilization has the potential to sustain" inflation pressures.

Labour for one has certainly gotten relatively scarce recently. This can be seen in the unemployment rates released over the past week or so for the United States, the euro zone and Japan.

On Friday, the US Labor Department reported that nonfarm payroll employment increased by 132,000 in June, leaving the unemployment rate near a cycle low at 4.5 percent. At least, though, the unemployment rate in the US has stopped falling, thanks to its recent slowdown. However, with the US economy expected to accelerate from the second quarter onwards, a resumption in the downtrend in the unemployment rate over the next few quarters is a real possibility.

Elsewhere in the world, unemployment is still on a downtrend. The unemployment rate in the euro area fell to 7.0 percent in May, the lowest on record. In Japan, the unemployment rate fell to 3.8 percent in May, the lowest in nine years.

It is not surprising then that inflationary pressure for the global economy as a whole remains high. The JP Morgan global index for manufacturing input prices rose to 67.6 in June, the highest since August 2006, from 66.0 in May, while the input price index for services stayed at a relatively high level of 63.0 in June from 63.2 in May.

Under the circumstances, monetary policy globally is likely to continue to tighten. This in turn should keep bond prices under pressure and bond yields elevated.

Strong US job growth and UK and German manufacturing

The week ended on a positive note as far as economic data are concerned

MarketWatch reports that US job growth continues to be healthy.

The U.S. economy continued to add jobs at a healthy pace in June, with nonfarm payrolls rising by 132,000, the Labor Department reported Friday.

The unemployment rate remained at a very low 4.5% in June, while average hourly wages and the number of hours worked rose.

... [B]ig revisions in April and May totaling 75,000 put total employment above expectations.

Also above expectations were UK industrial output in May. Reuters reports:

The Office for National Statistics said industrial output rose 0.6 percent in May, its biggest month-on-month jump since November, helped by major shipbuilding work and rising output from the North Sea Buzzard oil field. Analysts had forecast a 0.3 percent gain.

Manufacturing output also rose more quickly than expected, up 0.4 percent on the month against forecasts for a 0.3 percent increase...

"It highlights that policymakers can continue to focus on the upside risks to inflation in the medium term, with few signs of a slowdown in output or expenditure growth in the economy," said Alan Castle, economist at Lehman Brothers.

On the strength of the latest figures, Castle reckons second quarter GDP growth could come in stronger than the 0.7 percent expansion in the first three months of this year.

On the other hand, the National Institute of Economic and Social Research estimates that the UK economy grew 0.7 percent in the three months ending June, slightly less than the estimated 0.8 percent growth in the three months to May.

Manufacturing also surprised on the upside in Germany in May. From Bloomberg:

Manufacturing orders in Germany, Europe's largest economy, increased more than forecast in May, led by foreign demand for investment and consumer goods.

Orders, adjusted for seasonal swings and inflation, rose 3.2 percent from April, when they dropped 1.6 percent, the Economy and Technology Ministry in Berlin said today. Economists expected a gain of 0.6 percent, according to the median of 37 estimates in a Bloomberg News survey. From May 2006, orders rose 7.5 percent.

BoE raises rates, ECB could follow

As expected, the BoE raised rates yesterday while the ECB did not. FT reports:

The Bank of England did nothing to confound market expectations of 6 per cent rates before the end of the year as it raised its main interest rate for the fifth time in a year to 5.75 per cent. It cited strong growth, limited spare capacity and indications businesses were poised to raise prices for the rise.

The ECB fears capacity constraints will push up inflation in the 13-member eurozone. Jean-Claude Trichet, the ECB president, also highlighted dangers posed by “vigorous monetary and credit growth in an environment of already ample liquidity”.

And expectations for a rate cut in the US are looking less and less realistic. From Bloomberg:

Growth in U.S. service industries unexpectedly accelerated to the fastest pace in 14 months in June, reinforcing evidence the economy picked up last quarter.

The Institute for Supply Management's index of non- manufacturing businesses, including banks, builders and retailers, rose to 60.7 in June from 59.7 in May, the Tempe, Arizona-based group said today. Readings above 50 point to growth...

ADP Employer Services said today that companies added 150,000 jobs in June after a revised 98,000 gain in May. The Bloomberg survey median was for an increase of 100,000 in June.

And Japan's commitment to further monetary tightening will probably not be swayed too much by the latest reading on its leading index. Again from Bloomberg:

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

The leading index was 30 percent in May, the Cabinet Office said today in Tokyo, lower than the 40 percent median estimate of 27 economists surveyed by Bloomberg News. A number below 50 indicates the economy may cool in three to six months.

But it was in China yesterday that threats of tighter policy had the most impact on markets. AFP/CNA reports:

Chinese share prices closed 5.25 percent lower Thursday as investors fretted that a special treasury bond issue and plans to allow greater overseas investment will sap liquidity, dealers said.

Stock markets elsewhere ignored the plunge in China yesterday. It remains to be seen whether they can also ignore the continuing rise in global interest rates.

European interest rates in focus

Will the Bank of England raise interest rates today? Reuters says the latest data say yes, but the data yesterday were actually quite mixed.

Nationwide's consumer confidence index fell to 95 in June from a 1-1/2 year high of 99 in May.

On the other hand, the Chartered Institute of Purchasing and Supply/NTC index of activity in the services sector rose to 57.7 last month from 57.2 in May. The input price index rose to 58.8 from 58.3, the highest since March, while the output price index rose to 53.3 from 52.5.

The UK housing market could be slowing though. Halifax said house prices rose 0.4 percent in June, taking the annual three-month rate to 10.7 percent. As it is, housing equity withdrawal had eased to 13.2 billion pounds in the January to March quarter from a downwardly revised 13.3 billion pounds in the fourth quarter of 2006.

And while UK inflation has been uncomfortably high of late, little of that inflation can be seen in the BRC shop price index, which was only 0.5 percent above the level a year ago in June, although it was up 0.2 percent from a month ago.

The European Central Bank also meets today, but no rate hike is expected from it. The data from the euro zone have generally been strong, as Bloomberg reports.

Growth in European service industries, the biggest part of the economy, accelerated to the fastest pace in a year in June, suggesting the European Central Bank may need to raise interest rates again to contain inflation.

Royal Bank of Scotland Group Plc said its services index rose to 58.3 from 57.3 in May...

The jobless rate fell to 7 percent in May, the European Union statistics office said yesterday, the lowest since revised data series began in 1996.

However, Eurostat reports that retail sales in the euro area fell 0.5 percent in May from April and gained only 0.4 percent from a year ago.

RBA leaves rates unchanged, BoE likely to hike tomorrow

Australia left interest rates unchanged today. Bloomberg reports:

Australia's central bank kept its benchmark interest rate unchanged for an eighth month as the fastest economic growth in three years is yet to stoke inflation.

Reserve Bank of Australia Governor Glenn Stevens and his board left the overnight cash rate target at 6.25 percent, a six-year high, today in Sydney. The decision was expected by 26 of 27 economists surveyed by Bloomberg News. One predicted an increase...

Reports yesterday showed retail sales fell 0.1 percent in May from April, the first back-to-back drop in more than seven years. Home-building approvals slumped 5.6 percent to a six-year low. The reports prompted traders to lower the odds of a rate increase this year.

Central bank watch now shifts to the UK, where the Bank of England is widely expected to raise rates on Thursday. Reuters reports:

British interest rates will go up this week if just one Bank of England policymaker switches sides and joins the minority who called for a hike last month.

Four Monetary Policy Committee members, including Governor Mervyn King, wanted to raise interest rates a quarter-point to 5.75 percent last month. They were outvoted by the other five -- only the second time the governor has been on the losing side.

But 56 out of 70 economists polled by Reuters last week reckoned that at least one of those who had wanted to hold rates at 5.5 percent in June just a month after the last quarter-point rise would be ready to hike on Thursday.

BoE members wishing to raise rates would probaby not be deterred by yesterday's economic data. Wage growth for permanent staff in Britain eased from a seven-year high in June but growth in the construction sector accelerated.

US factory orders, pending home sales fall

Some mixed economic data from the US yesterday. Bloomberg reports:

Factory orders fell less than predicted in May, reinforcing forecasts that manufacturing will help overcome the housing slump.

Orders placed with U.S. factories fell 0.5 percent after a 0.5 percent gain in April, the Commerce Department said in Washington...

Excluding transportation equipment, bookings increased 0.7 percent after rising 1.0 percent...

Orders for durable goods, which make up about 55 percent of factory demand, fell a revised 2.4 percent after a 1 percent gain in April...

Orders for capital goods excluding aircraft and military equipment, a measure of future business investment, fell 2.1 percent after rising 2.0 percent...

Yesterday's ISM report does suggest that manufacturing's recovery is sustainable though. But housing clearly continues to be weak.

The [National Association of Realtors] said its index of signed purchase agreements, or pending home resales, dropped 3.5 percent to 97.7, from a revised 101.2 in April.

Robust Tankan and global manufacturing PMI readings

Yet another indication that a rate hike is likely in Japan soon. From Bloomberg:

Confidence among Japan's largest manufacturers held near a two-year high and companies said they're increasing spending, supporting the central bank's argument for raising interest rates.

The Tankan, Japan's most closely watched business survey, showed sentiment was unchanged at 23 points in June from March and near December's two-year high of 25, the Bank of Japan said in Tokyo today. The result matched the median estimate of 26 economists surveyed by Bloomberg News. A positive number means optimists outnumber pessimists.

Sentiment among service companies held at a 15-year high of 22 points for a third quarter as the export-led expansion created jobs and spurred consumer spending. The report supports expectations the bank will raise its key 0.5 percent overnight rate, the lowest among major economies, as soon as August.

However, Reuters reports that another survey indicated more downbeat prospects for manufacturing.

The PMI index for Japan slipped to 50.4 in June, the weakest level in four years and only marginally above 50 -- the dividing line between expansion and contraction.

Britain's PMI also slipped.

Its PMI index fell to 54.3 from 54.7 in May.

But the PMI for the euro zone was better.

For the 13-country euro zone, the Purchasing Managers Index (PMI) rose to 55.6, its best since February and up from 55.0 in May, according to NTC Research, the consultancy which conducts the surveys.

China gave contradictory readings. Bloomberg reports:

The CLSA Purchasing Managers' Index climbed to 55 from 54.1 in May, the highest reading since March 2005...

A separate PMI, published earlier today by the National Bureau of Statistics and the China Federation of Logistics and Purchasing, showed the opposite. It fell to 54.5 in June, the lowest reading in four months.

But the ISM's manufacturing index for the US improved, according to another Reuters report.

In fresh evidence that the factory sector is so far weathering a persistent slump in housing, the Institute for Supply Management's manufacturing index rose to 56.0 in June from 55.0 in May, surpassing forecasts for no change.

That was enough to push up the global PMI. Reuters reports:

The Global Manufacturing PMI, produced by JP Morgan with research and supply management organisations rose to 54.4 in June from 54.1 in May, its highest level since last September...

Cost pressures also rose last month, with the Input Prices Index hitting 67.6, up from 66.0 in May, and its highest level since August last year.

Stocks ride out June turmoil but still face rising interest rates

June was a volatile month for stock markets and it is far from clear that investors will get to enjoy a calmer ride soon. Although inflation in the United States has moderated in recent months, global interest rates are still likely to go up in coming months, which could make further advances in stock markets difficult.

World stock markets held up reasonably well in June. This is especially after considering that they had to endure two major bouts of selling, first when bond yields spiked at the beginning of the month (see "Bond yields spike but stocks have cushion") and then, in the latter half of the month, when two Bear Stearns-run hedge funds holding collateralised debt obligations backed by subprime mortgages ran into trouble, raising concerns over wider market implications.

The table below shows the gains in the Morgan Stanley Capital International indices for the main developed stock markets. The German stock market outperformed both in June and in the year so far.

	June		Year-to-date
	Local currency (percent)	US dollars (percent)	Local currency (percent)	US dollars (percent)
USA	-1.79	-1.79	6.28	6.28
Japan	1.08	-0.30	5.96	2.24
UK	-0.40	1.02	6.03	8.70
Germany	1.49	1.86	18.77	21.64
France	-1.27	-0.91	8.32	10.94

As the Bear Stearns saga unfolded, there were fears that the write-downs and sell-offs that it was triggering could result in a spike in risk aversion and a generalised credit crunch. Those fears have not completely dissipated but markets have steadied themselves over the past few sessions. This means that the latest saga could yet turn out like other hedge fund debacles like Amaranth Advisors last year and Long Term Capital Management in 1998, where the fallouts were contained.

The problem, though, is that even if markets survive the latest episode, the risk remains that there are other hedge funds ready to implode. Whether markets can survive this and other potential hedge fund failures will depend partly on whether monetary conditions are tight to begin with.

In this respect, there may be reason to be somewhat sanguine as most analysts think that monetary conditions are not tight. Broad measures of money supply continue to grow rapidly all around the world. For example, the European Central Bank reported last week that M3 in the euro zone rose 10.7 percent in May from a year ago, close to the fastest rate in 24 years. Although bond yields had spiked at the beginning of June, they have since come back down. Liquidity remains ample and would help cushion any shock that comes along.

However, this in turn leads to the question of whether current conditions will be maintained. Central banks obviously are key here.

The most important central bank in the world, the Federal Reserve, is currently on hold. Events last week gave little reason to believe that this will change soon.

On Thursday, the Federal Open Market Committee decided to leave its target for the federal funds rate unchanged at 5.25 percent. In the statement accompanying its decision, it mentioned continued concern over inflation.

At the moment, though, inflation does not appear particularly elevated. On Friday, the Commerce Department reported that the core personal consumption expenditures price index that excludes food and energy rose by just 0.1 percent in May and by 1.9 percent over 12 months. Most Federal Reserve watchers think that it is comfortable when this indicator shows an inflation rate somewhere below two percent. Therefore, some analysts think that there is scope for a rate cut later this year.

However, inflation may not stay below two percent for long.

The Federal Reserve Bank of Dallas publishes two other measures of inflation based on personal consumption expenditures. The first is the overall personal consumption expenditures price index that is already reported by the Commerce Department. The other is the trimmed-mean price index that excludes components of personal consumption expenditures that have the highest and lowest rates of change.

The latest data provided on the Dallas Fed website show that these other measures of inflation remain above the Federal Reserve's comfort zone. The 12-month inflation rate based on the overall PCE price index was 2.3 percent in May and the inflation rate based on the trimmed-mean measure was 2.2 percent.

While it is possible that these measures of inflation will also fall below two percent, it is also possible that convergence in the various measures of inflation will occur the other way around. That is, the core inflation rate based on the price index excluding food and energy could rise above two percent.

Indeed, there is a good reason to think that the recent fall in the core inflation rate is temporary. The slowdown in the US economy over the past year has almost certainly played a large part in moderating inflation recently. However, with the economy expected to recover from the second quarter onward, further moderation is likely to be limited. In fact, many economists think inflation will re-accelerate as the level of resource utilisation in the economy remains high despite the recent slowdown.

The behaviour of oil prices recently certainly makes an acceleration in inflation look quite probable. NYMEX crude oil futures breached US$70 a barrel last week. It has risen about US$10 since the beginning of the year, with about half of the gain occurring within the past month alone. The Federal Reserve focuses on core inflation that excludes energy but it does not totally ignore inflationary pressure from higher oil prices because of the possibility of pass-through effects.

The prospect of a renewal of inflationary pressures does not necessarily mean that the Federal Reserve is likely to raise interest rates any time soon. However, it does mean that it is unlikely to cut interest rates.

In the meantime, other major central banks are still in tightening mode. Most analysts think that there will be at least one or even two more rate hikes coming from each of the European Central Bank, the Bank of Japan and the Bank of England before the end of the year as the economies in Europe and Japan remain strong.

So global monetary conditions will probably continue to tighten even in the absence of Federal Reserve action. This should be enough to keep global interest rates on the rise.

Furthermore, the events in early June show that markets have the power to push bond yields higher on their own. If overall inflation accelerates, they are likely to do so again.

Higher interest rates would weigh on equity valuations and make markets more vulnerable to shocks such as those arising from losses at hedge funds.

So stock markets may have weathered the storms in June but investors still face strong headwinds in the months ahead.