Faster US growth, lower Japanese consumer prices

Yesterday, the Commerce Department reported that the US economy grew 4 percent in the second quarter, somewhat faster than the 3.4 percent growth rate originally estimated a month ago. Although the revision was largely in line with expectations, it does remind us why the Federal Reserve may see little need for a cut in interest rates when it meets next month.

On the other hand, there may also be little impetus for the much-anticipated rate hike from the Bank of Japan after the latest batch of data. From Bloomberg:

Japan's consumer prices declined for a sixth straight month in July, signaling the world's second-largest economy has yet to beat deflation.

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 economists. Prices fell at the same pace in the preceding three months...

Tokyo's core prices, seen as an indicator of the nationwide index, were unchanged in August from a year earlier, reversing two months of declines. Economists expected a 0.1 percent drop.

Other reports today showed industrial output and household spending may be slowing, though economists said the figures were affected by one-time events.

Factory production slid 0.4 percent in July after an earthquake disrupted output at automakers Toyota Motor Corp. and Honda Motor Co. Output would have risen had automakers not dragged the number down 1.2 percentage points, the Trade Ministry said.

Spending by households unexpectedly dropped for the first time in seven months, as a typhoon kept shoppers at home and a tax increase weighed on sentiment.

Employment prospects improved. The jobless rate fell to 3.6 percent in July, the lowest since February 1998, from 3.7 percent. A ratio that shows how many positions are on offer for each job seeker held at 1.07, near a 14-year low of 1.09...

Investors see a 12 percent chance policy makers will raise the key rate at the Sept. 18-19 meeting, according to Credit Suisse Group calculations based on interest payments.

Back to nervous times

Yesterday's market action as reported by FT:

US and European stocks were hit by a new bout of nerves on Tuesday as economic reports and the minutes of the latest meeting of the US Federal Reserve forced investors to focus on the impact of the subprime mortgage crisis on the wider economy.

The drop in share prices triggered demand for the relative safety of government bonds while risk aversion was evident in the currency markets as the yen gained ground against high-yielding currencies such as sterling and the Australian and New Zealand dollars.

But the economic data yesterday were actually not too bad relative to expectations.

The Conference Board’s confidence index dropped to 105 in August from a downwardly revised 111.9 in August, although analysts had forecast a fall to 104...

Data from S&P/Case Shiller showed a record annual decline in US home prices in the second quarter.

But eurozone data on Tuesday painted a more encouraging picture. The Ifo survey of German business sentiment showed only a dip in the headline index from 106.4 in July to 105.8 in August against expectations of a fall to 105.4.

... Record growth in eurozone money supply last month kept alive inflation fears. Broad M3 money supply growth picked up to 11.7 per cent from 10.9 per cent in June, above analysts’ expectations.

I doubt that markets were particularly focused on the economic data yesterday. Sentiment has turned and the bounce in markets may be over for the time being.

Hawks flying off into the sunrise?

US existing home sales were down in July. Bloomberg reports:

Sales of previously owned U.S. homes fell to the lowest level in almost five years in July, and the glut of unsold properties climbed to its highest since 1991 as mortgage-market turmoil rippled through the housing industry...

Purchases declined 0.2 percent from the prior month to an annual rate of 5.75 million, the National Association of Realtors said today in Washington. While the retreat was less than forecast, inventories of single-family homes rose to the equivalent of a 9.2 months' supply. From a year earlier, existing-home sales dropped 9 percent.

This should keep expectations for cuts in the fed funds rate later this year alive.

Meanwhile, even the ECB may be considering a pause in its tightening campaign. FT reports:

The European Central Bank is keeping open its options on a possible September interest rate increase and will not decide finally until next week, Jean-Claude Trichet, ECB president, made clear on Monday.

In his first public appearance since the recent financial market turmoil, Mr Trichet deliberately created extra room for manoeuvre for the Frankfurt-based institution as it continues to assess the implications for the eurozone economy. The ECB was never “pre-committed” to any particular action, he said, and had always pledged to heed market developments.

In response, financial markets priced in an even lower chance of the ECB going ahead with a rise in borrowing costs on September 6.

But Andy Mukherjee suggests that Asia needs to continue to be wary of inflation risk.

The subprime turmoil of the past few weeks has failed to dethrone inflation as the biggest challenge facing Asian policy makers this year.

Risks in Asia remain just as tilted toward higher prices (and away from lower growth) as they were before the worldwide credit crunch.

Unlike in the U.S., where the Federal Reserve appears to have been forced to retreat from its fight against inflation with its Aug. 17 cut in the discount rate, lower interest rates in Asia are not on the menu, at least not anytime soon.

From China to Singapore and Sri Lanka, consumer prices are accelerating almost everywhere in Asia. And now that financial- market volatility has at least temporarily eased, an excess of money and credit, rather than a shortage, looks like the big concern for the region's monetary authorities.

US and eurozone economies hold up

The US housing market didn't too badly in July it seems. MarketWatch reports:

Sales of new homes increased 2.8% in July to a seasonally adjusted annual rate of 870,000 as the inventory of homes for sale dropped for a fourth straight month, the Commerce Department estimated Friday.

As if that was not positive enough, durable goods orders were also strong, according to another MarketWatch report.

Orders for U.S.-made durable goods jumped 5.9% in July on higher demand for airplanes, vehicles, computers, machinery, steel and most other kinds of long-lasting manufactured goods, the Commerce Department reported Friday.

No wonder US stocks saw solid gains yesterday. However, the economy could still deteriorate after the recent turmoil in credit markets.

Meanwhile, Bloomberg reports that growth in Europe's manufacturing and service industries slowed in August.

A preliminary estimate of Royal Bank of Scotland Group Plc's combined index, spanning industries from autos to banking and airlines in the 13-nation euro region, fell to 57.2 from 57.5 in July. A reading above 50 indicates expansion.

The drop, though, is small. We'll probably have to wait a while more to see the effects, if any, of the market turmoil on the economy.

BoJ leaves interest rates unchanged

FT reports:

The Bank of Japan kept interest rates on hold on Thursday and signalled it would be cautious about raising them in the near future, as Toshihiko Fukui, BoJ governor, said financial market turmoil linked to US subprime loans would take time to subside.

The recent market turmoil had also pushed up the yen. That could have an adverse impact on exports.

As it is, the Finance Ministry had reported on Wednesday that Japan's trade surplus narrowed in July. From Bloomberg:

The surplus shrank 21.1 percent in July from a year earlier to 671.2 billion yen ($5.9 billion), the first drop since January, the Finance Ministry said in Tokyo...

Exports rose 11.7 percent to 7.06 trillion yen last month, less than the 13 percent expected by economists and 16 percent in June...

Imports climbed 16.9 percent to a record 6.39 trillion yen, as a weaker yen in July drove energy costs higher...

World markets calmer, ECB may proceed with rate hike

From FT:

World markets enjoyed a calmer session on Wednesday as US investors put aside credit concerns to focus on the possibility of the Federal Reserve cutting interest rates.

Global equities made solid gains, government bonds retreated and the low-yielding Japanese yen lost ground, suggesting a tentative return of risk appetite.

Macro Man thinks that "the medium-term prognosis for risky assets remains broadly constructive", although "another noisy dip is very likely".

The rationale for the generally upbeat view of risk assets, meanwhile, rests on one word: liquidity. While asset markets have clearly seen a sharp reduction in the amount of micreconomic liquidity available (in other words, the amount of trading that can be done in asset markets without producing catastrophically expensive transaction costs), on a macroeconomic basis, liquidity remains ample.

Which is probably why the ECB has indicated that it is likely to proceed to hike rates next month. From Bloomberg:

The European Central Bank indicated it may still raise interest rates in September and announced an extra 40 billion euros ($54 billion) three-month loan to ease lending between commercial banks.

The Frankfurt-based bank responded to speculation that it may hold off raising interest rates on Sept. 6 by saying it's sticking to the policy stance expressed by President Jean-Claude Trichet on Aug. 2. At the time, Trichet pledged to show "strong vigilance" on inflation, a phrase he has used to signal each of the eight rate increases since late 2005.

Investors need to be careful over the next few weeks. With traders expecting a rate cut from the Fed soon, failure by the Fed to deliver such a cut could upset markets. In the meantime, most other major central banks still appear to be maintaining a tightening bias, which could adversely affect near-term liquidity despite the more benign prognosis for the longer term.

China raises interest rates amid concerns about inflation and asset bubbles

China View reports:

China will raise one-year deposit and loan interest rates by 27 basis points to 3.6 percent and 7.02 percent respectively as of Aug. 22, the central bank announced on Tuesday...

The move aims to control fast credit growth and curb the hovering risks of inflation, the People's Bank of China (PBoC) said in a statement on its Web site.

The Chinese authorities may also be worried about the surge in asset prices. From Bloomberg:

"This is a reflection of the central bank's concern about inflation and asset bubbles,'' said Ma Jun, chief China economist at Deutsche Bank AG in Hong Kong...

"This is targeted at slowing the money flowing into the stock market," said Liao Qun, chief economist at Citic Ka Wah Bank in Hong Kong. "As the bubble gets bigger, the chance of it bursting is also bigger."

If too much money in China is fuelling asset bubbles, William Pesek thinks the Fed and the BoJ may be partly to blame.

What's conveniently overlooked about Greenspan's 1987-2006 tenure is his role in China's asset bubble and, by extension, Asia's. Greenspan's policy of keeping interest rates unusually low in the first half of this decade fueled speculation in high- risk assets. That led to a cheap-capital-fueled investment bubble in China...

Low U.S. rates complemented zero rates in Japan. Today, as the BOJ begins a two-day policy meeting, the odds are extremely low that Fukui will boost rates from 0.5 percent. That may be a green light to investors to continue borrowing cheaply in yen and moving those funds overseas into riskier assets. The so- called yen-carry trade is feeding bubbles globally.

To be fair, the Fed and the BoJ were only trying to solve their own domestic problems, although they arguably overdid the monetary easing. China could have insulated itself better if it had allowed its currency to appreciate/revalue.

Spike in credit spread a risk to economy

The Federal Reserve cut its discount by 50 basis points to 5.75 percent rate on Friday. That act sent markets around the world rallying as investors gained hope that the financial turmoil of the past few weeks may be coming to an end. But was the action by the Federal Reserve justified?

At its meeting on 7 August, the Federal Open Market Committee had chosen to leave interest rates unchanged, stating that its "predominant policy concern remains the risk that inflation will fail to moderate as expected".

However, over the next one and a half week or so, financial markets deteriorated further. Overnight interbank rates spiked on the back of spreading concerns over credit quality, forcing the Federal Reserve and other central banks, especially the European Central Bank, to inject funds to keep rates at their target levels and avoid a credit crunch. This culminated in the Federal Reserve action on Friday.

This raises the obvious question: Was the cut in the discount rate by the Federal Reserve really necessary? How badly is the United States economy likely to be affected by the deterioration in the credit markets?

The answer is less obvious. James Hamilton at Econbrowser points out that an economic downturn is usually associated with a big increase in the spread between corporate and Treasury yields. However, although this spread spiked substantially last week, "the current spread of 206 basis points is not much above the long-term average or the short-term range we've seen over the last two years".

However, apart from the absolute level of the spread between corporate and Treasury yields, the change over a given period also matters, in my opinion. The chart below shows the year-on-year change in real gross domestic product as well as the change in the spread between the Baa corporate bond yield and the 10-year Treasury yield.


The chart confirms that spikes in the spread have in the past often been associated with deterioration in economic growth (note that the spread is shown on a reverse scale in the chart).

More importantly, the chart also shows that although the absolute level of the spread is still low, it may still potentially prove too much for the economy. Economic growth had taken off from around 2003 on the back of declining corporate bond yields and yield spreads. When bond yields and spreads levelled off in 2005, the growth rate turned down soon after.

This suggests that even a small rise in the spread could be associated with some damage in the economy. Therefore, some action on the part of the Federal Reserve to stem the financial turmoil appears warranted.

The next question in most people's minds is whether the Federal Reserve will take another step to bring relief to the financial system by cutting the federal funds rate. After all, the last time a similar spike in the spread was not followed by an economic downturn was in 1998, when the Federal Reserve responded with a cut in the federal funds rate.

Some think that this time around, the cut in the discount rate reduces the need for a cut in the federal funds rate. They are mindful of the fact that Federal Reserve officials have repeatedly said that they would like to see lower inflation become entrenched first and would not now want to be seen as being soft on inflation nor too willing to bail out investors as such an impression risks sparking higher inflation in the future.

On the other hand, others think that deterioration in the credit market is a serious threat to the financial system and an economy that is already facing falling consumer spending. Therefore, a rate cut is necessary to avoid a recession, and it is only a matter of time before it becomes apparent to the Federal Reserve.

In my opinion, both views have merit. It will be interesting to see how the Federal Reserve actually reacts.

In the meantime, other central banks appear relatively unperturbed by the financial turmoil. Over the past two weeks, the central banks of Australia, Chile, South Korea, Norway all raised interest rates by 25 basis points while South Africa's central bank raised rates by 50 basis points.

This week, we have another heavyweight central bank deciding on interest rates: Japan. Expectations for a rate hike by the Bank of Japan at the meeting on 23 August have fallen recently after the latest bout of financial turbulence. However, Governor Toshihiko Fukui has repeatedly said that he wants to normalise interest rates in Japan, so it may be only a matter of time before it hikes rates.

That is quite a contrast with the situation with the Federal Reserve.

Fed to the rescue

The Federal Reserve cut its discount rate by 50 basis points to 5.75 percent yesterday, sending markets surging. Bloomberg reports:

Stocks in the U.S. and Europe rallied after the Federal Reserve unexpectedly cut the discount rate to ease a credit crunch. Crude oil, copper and gold advanced on reduced concern that the U.S. economy, the world's largest, would slow. Three- month U.S. Treasury bill yields leapt as the safe haven of government debt faded and the dollar fell versus the euro for the first time in a week.

The Standard & Poor's 500 Index rose 34.67, or 2.5 percent, to close at 1,445.94, while the Dow Jones Industrial Average increased 233.3, or 1.8 percent, to 13,079.08. The Nasdaq Composite Index gained 53.96, or 2.2 percent, to 2,505.03.

Some think this may soon be followed by a cut in the fed funds rate.

While today's action may not be enough to end the turmoil in the corporate and mortgage debt markets, traders and investors are betting that the Fed will cut the benchmark federal funds rate at its September meeting and then keep easing until the slump is over.

Here is one reason why:

Yields on asset-backed commercial paper rated A1, the second-highest at Standard & Poor's, and maturing the next day rose 39 basis points to 6.01 percent, the highest since January 2001, according to data compiled by Bloomberg. The increase is also the biggest since September 2001...

Another day of market turmoil, another rate hike

Financial market turmoil continued yesterday, but central banks also continue to refuse to allow it to deter them from further monetary tightening.

Yesterday, it was the turn of South Africa's central bank to hike rates. Bloomberg reports:

South Africa's central bank increased its benchmark interest rate by half a percentage point for a second time this year as inflation remained above the target range.

The Reserve Bank raised the repurchase rate to 10 percent, the highest in almost four years, Deputy Governor Xolile Guma said in a televised speech from Pretoria today. That was in line with the forecast of all but one of 26 economists surveyed by Bloomberg.

In contrast, the talk in the US is largely focused on whether the Fed will cut rates, especially after yesterday's data showing that the US housing market is still in a downtrend. Bloomberg reports:

Builders in the U.S. started work on the fewest homes in a decade in July as the industry showed no sign of recovering from an 18-month recession.

The greater-than-forecast 6.1 percent decrease to an annual rate of 1.381 million followed a 1.47 million pace in June, the Commerce Department said today in Washington. Building permits also fell to a 10-year low.

Over in Europe, the focus of debate is on how much more the ECB would hike rates as inflation in the euro zone slowed in July. From Bloomberg:

Consumer prices in the 13-nation euro region increased 1.8 percent from July 2006, down from the 1.9 percent rate recorded in June, the European Union's statistics office in Luxembourg said today. Last month's rate matched an initial estimate published July 31. Prices fell 0.2 percent on the month...

The euro area's so-called core inflation rate, which excludes volatile food and energy prices, was unchanged at 1.9 percent. Core prices fell 0.4 percent from the previous month.

At least there isn't much doubt that China will continue to tighten. Although growth in industrial production slowed to 18 percent in July from 19.4 percent in June, fixed-asset investment continues to grow at a rapid pace, as Bloomberg reports.

China's spending on factories, equipment and property rose 26.6 percent in the first seven months of 2007, maintaining pressure on the central bank to raise interest rates to cool the economy.

Fixed-asset investment in urban areas climbed to 5.67 trillion yuan ($747 billion), the statistics bureau said today. That was close to the 26.7 percent increase from a year earlier for the first six months and more than the 24.5 percent growth for all of 2006.

Norges Bank raises rates, Fed faces mixed data

If investors think central banks are losing their nerve as a result of the on-going market turmoil and the recent bout of liquidity injections, they might want to think again. From Bloomberg yesterday:

Norway's central bank raised its benchmark interest rate by a quarter point because of concern that economic growth in excess of 4 percent this year will stoke inflation.

Norges Bank lifted the deposit rate to 4.75 percent, the fifth increase this year, and reiterated that the rate would continue to rise "gradually," according to a statement on the bank's Web site today.

But it's the Federal Reserve that really moves markets, and yesterday's mixed economic data out of the US does not really add much clarity as to whether it is likely to move soon.

While the NAHB housing market index fell to 22 in August, the lowest in 16 years, other data suggest that the Fed may still need to keep an eye on inflation. MarketWatch reports:

With gasoline prices falling, U.S. consumer prices increased 0.1% in July, the slowest inflation rate in eight months, the Labor Department reported Wednesday.

The core consumer price index, which excludes volatile food and energy prices, increased 0.2% for the second straight month...

The CPI is up 2.4% in the past year, the lowest year-over-year increase since February, while the core CPI is up 2.2%, close to the upper end of Federal Reserve's target zone...

In a separate report, the Fed said industrial output expanded by 0.3% in July, with the capacity utilization rate rising to 81.9%, the highest since last September. See full story.

Also, the Labor Department said inflation-adjusted average weekly earnings fell 0.1% in July and are up 1.3% in the past year.

Rounding out Wednesday's economic data, the Federal Reserve Bank of New York said regional manufacturing activity indicated continued healthy expansion. The Empire State Manufacturing index inched lower to 25.1 in August from 26.5 in July, far less than expected. See full story.

On the whole, the data seem to be consistent with what I wrote in an earlier post. Inflation is moderating, but probably not fast enough for the Fed to cut rates soon.

Cool data, turbulent markets

Yesterday's economic data gave monetary policy doves some ammunition.

In the US, producer price inflation in July looked contained. Bloomberg reports:

Prices paid to U.S. producers, excluding food and energy, rose 0.1 percent in July, the smallest gain in three months, the Labor Department said today in Washington. Producer prices overall increased 0.6 percent on higher costs for gasoline and natural gas, following a 0.2 percent decline in June.

In other good news for the US economy, the trade deficit shrank in June.

Another government report today showed that the U.S. trade deficit unexpectedly narrowed in June as exports soared to a record. The gap shrank 1.7 percent to $58.1 billion from a revised $59.2 billion in May that was smaller than previously estimated, the Commerce Department said in Washington.

In the euro zone, economic growth in the second quarter turned out weaker than expected. FT reports:

The 13-country economy expanded by just 0.3 per cent, leaving it again dragging behind the US. Eurozone GDP had expanded by 0.9 per cent and 0.7 per cent in the previous two quarters.

And in the UK, inflation dropped sharply in July. Again from FT:

July’s annual consumer price inflation rate plummeted to 1.9 per cent from 2.4 per cent in June, surprising investors who had expected a modest drop to 2.3 per cent. It was the largest monthly fall for five years in annual CPI inflation and the first time the measure was below the bank’s 2 per cent target since March 2006.

But yesterday also saw renewed turmoil in global markets. Investors may yet need all the relief on the monetary policy front they can get.

Expectations for rate hike by BoJ fall on weaker growth

Bloomberg reported on Friday that Japan's producer price inflation was high in July.

An index of prices companies pay for energy and raw materials climbed 2.1 percent from a year earlier after gaining 2.3 percent in June, the Bank of Japan said in Tokyo today...

From a month earlier, producer prices rose 0.6 percent in July after gaining 0.1 percent in June, the Bank of Japan said.

But yesterday saw news that Japanese economic growth slowed more than expected in the second quarter.

The world's second-largest economy expanded at a 0.5 percent annualized rate in the three months ended June 30 from a revised 3.2 percent in the first quarter, the Cabinet Office said in Tokyo today. The median estimate of 27 economists surveyed by Bloomberg News was for 0.9 percent growth...

Investors see a 32 percent chance of rate increase next week, down from as high as 75 percent on Aug. 9, according to Credit Suisse Group calculations based on interest payments.

In contrast, expectations for more tightening in China remains high after the latest economic data. Bloomberg reports:

China's retail sales grew at the fastest pace in more than three years as rising stock prices and wages left consumers in the world's most populous country with more money to spend.

Spending climbed 16.4 percent to 699.8 billion yuan ($92 billion) in July from a year earlier, the National Bureau of Statistics said today, after gaining 16 percent in June. That beat the 16.2 percent median estimate of 18 economists surveyed by Bloomberg News...

July's consumer prices rose 5.6 percent, the biggest increase in more than a decade, on higher food costs...

Compared to the Chinese, US retail sales growth of 0.3 percent in July certainly looks weak, although it does represent a rebound from June.

RGE Asian Economies Blog Aggregator

RGE's Asian Economies Blog Aggregator appears to be shrinking. I wonder why.


Perhaps it is time to replace it with a US Housing Blog Aggregator.

If you're looking for more news on the market turmoil . . .

... Don't look here. Not today anyway.

Instead, today I am focusing on economic data that came out of China yesterday.

Bloomberg has a report on China's latest trade data.

China's trade surplus surged 67 percent in July to the second-highest on record, bolstering U.S. Treasury Secretary Henry Paulson's case for a faster appreciation of the yuan...

The surplus narrowed from June's record $26.9 billion when businesses rushed to beat cuts to export incentives. The gap was $14.4 billion with the U.S. and $12.2 billion with Europe.

Exports jumped 34.2 percent in July, the fastest pace in five months, to a record $107.7 billion. Imports gained 26.9 percent, the biggest increase in six months. Oil imports climbed 39 percent to a record.

For the first seven months, the trade surplus grew 81 percent to $136.8 billion. China's M2 money supply, the broadest measure, grew 18.5 percent in July, the fastest pace in more than a year, the central bank said today.

The rapid growth in money supply could be fuelling inflation.

Inflation probably accelerated in July to 5.6 percent, the fastest pace in 10 years, according to a report today in the official China Securities Journal that cited unidentified people. The figure is due Aug. 13.

Economists surveyed by Bloomberg have a lower consensus estimate on China's inflation rate for July.

The median estimate of 17 economists surveyed by Bloomberg News is for a 4.6 percent increase in consumer prices from a year earlier, after a gain of 4.4 percent in June. The statistics bureau will release the figure at 10 a.m. on Aug. 13.

But consumer price inflation is largely attributable to higher food prices. Inflationary pressure elsewhere is less apparent, as shown by producer price data.

China's producer-prices had their smallest increase in 14 months as metal cost increases slowed.

Factory-gate prices rose 2.4 percent in July from a year earlier, the National Bureau of Statistics said today, after gaining 2.5 percent in June. That lagged behind the 2.6 percent median estimate of 15 economists surveyed by Bloomberg News. It was the third straight monthly decline.

Financial turmoil isn't going away so soon

After some stabilisation over the previous few days, markets were hit by another bout of turmoil yesterday. The proximate trigger this time appears to be Europe, although the ultimate source remains the US mortgage market.

From Bloomberg:

The European Central Bank, in an unprecedented response to a sudden demand for cash from banks roiled by the subprime mortgage collapse in the U.S., loaned 94.8 billion euros ($130 billion) to assuage a credit crunch.

The overnight rates banks charge each other to lend in dollars soared to the highest in six years within hours of the biggest French bank halting withdrawals from funds linked to U.S. subprime mortgages. The London interbank offered rate rose to 5.86 percent today from 5.35 percent and in euros jumped to 4.31 percent from 4.11 percent.

The ECB said it would provide unlimited cash as the fastest increase in overnight Libor since June 2004 signaled banks are reducing the supply of money just as investors retreat because of losses from the U.S. real-estate slump. Paris-based BNP Paribas SA halted withdrawals from three investment funds today because the French bank couldn't value its holdings. Stocks in the U.S. and Europe fell, a turnaround from the past three days when investors concluded that credit market risks were abating.

Later yesterday, the Federal Reserve had to respond similarly.

The U.S. Federal Reserve added $24 billion in temporary reserves to the banking system today, the most since April. Fed spokesman David Skidmore declined to comment on the increases in overnight money-market rates.

"This is an old-fashioned credit crunch," Chris Low, the chief economist at FTN Financial in New York, said in a report today. "This is not a small thing. A credit crunch, when the short-term credit markets seize up, is extraordinarily serious, almost always the precursor of a significant recession."

Today, it is the Bank of Japan's turn.

The Bank of Japan added 1 trillion yen ($8.49 billion) to the financial system, joining central banks in the U.S. and Europe in supplying cash to assuage a credit crunch.

While a lot of attention has been paid to the ECB's injection of funds, the central bank's release of its monthly bulletin was relatively neglected. But Bloomberg has the story.

The European Central Bank said interest rates are still boosting economic growth and financing conditions are "favorable," suggesting it sees scope to raise borrowing costs further.

"The ECB's monetary policy is still on the accommodative side," the Frankfurt-based central bank said in its monthly bulletin published today. "Strong vigilance is of the essence in order to ensure that risks to price stability over the medium term do not materialize."

If that report downplays the risks to the financial system, it is perhaps understandable. Indeed, before the storm broke in Europe, South Korea's central bank had raised interest rates yesterday.

The Bank of Korea unexpectedly raised its benchmark interest rate for a second time in two months to curb lending that may fuel asset-price bubbles.

Governor Lee Seong Tae and his board increased the overnight call rate by a quarter point to 5 percent, the highest since July 2001, the central bank said in Seoul today. None of the 14 economists surveyed by Bloomberg News predicted the move.

And more monetary tightening among central banks would certainly look like the correct action to take considering that even a relatively mature economy like Singapore's is growing at a double-digit rate. From Channel NewsAsia today:

The economy has picked up pace in the second quarter, with GDP expanding by 8.6 per cent year-on-year following 6.4 per cent in the previous quarter, according to data released by the Ministry of Trade and Industry on Friday.

Growth on a seasonally-adjusted quarter-on-quarter annualised basis increased to 14 per cent from 8.8 per cent in the first quarter.

This is going to be a very tricky period for central banks.

BoJ, BoE expected to raise interest rates

With the Federal Reserve's monetary policy decision now out of the way for the time being, the focus will increasingly shift towards the Bank of Japan, which meets later this month. Bloomberg reports the Japanese data released yesterday.

Japan's bank lending grew at the slowest pace in 16 months in July, as companies used profits or sold bonds to raise funds rather than borrow from banks.

Loans excluding trusts rose 0.3 percent from a year earlier in July, the Bank of Japan said in Tokyo today, slowing from 0.7 percent in June. Lending adjusted for currency fluctuations, bad loan write-offs and securitizations grew 1.1 percent from 1.6 percent in June...

Japan's machinery orders fell a seasonally adjusted 10.4 percent to 960 billion yen ($8 billion) in June, the Cabinet Office said today in a separate report. The drop is larger than a 1.1 percent estimated decline by 40 economists surveyed by Bloomberg News, indicating that capital spending is losing steam and may hamper economic growth...

Japan's money supply, or M2 plus notes in circulation, rose 2 percent in July, the central bank said in a separate report. Broad liquidity, which includes bonds and investment trusts, gained 4.2 percent.

While the data were not exactly hot, it was enough to maintain expectations for a rate hike later this month. From another Bloomberg report:

Investors see a 69 percent chance the Bank of Japan will increase its key rate to 0.75 percent after its next meeting ends on Aug. 23, according to calculations by Credit Suisse Group. The probability rose from 47 percent on July 30, the lowest in almost a month...

There are also high expectations for another rate hike from the Bank of England. FT reports:

Interest rates look certain to rise to 6 per cent before the end of the year after the Bank of England on Wednesday cemented expectations of an autumn increase as it forecast a significant slowing in consumer spending to bring down inflation...

The Bank’s quarterly Inflation Report, out on Wednesday, showed the central projection for inflation falling to its 2 per cent target in two years as long as interest rates rise by another quarter point.

And the BoE is not likely to be swayed much by the recent market turmoil.

In light of the recent global turmoil, the Bank’s monetary policy committee “will be monitoring credit conditions”, said [BoE governor Mervyn] King. But he welcomed the widening of credit spreads as “a more realistic appraisal of risks”, adding it was not the job of central banks to bail out lenders. “Interest rates are not policy instruments for protecting unwise lenders from the consequences of their decisions,” he said.

Fed sits tight, RBA chooses to hike

The Federal Reserve left interest rates unchanged yesterday. MarketWatch reports:

The Federal Open Market Committee voted unanimously on Tuesday to sit tight on interest rates and keep its focus on inflation, but at the same time acknowledged there were downside risks from the recent turmoil in financial markets.

"Although the downside risks to growth have increased somewhat, the FOMC's predominant policy concern remains the risk that inflation will fail to moderate as expected," the FOMC said in a statement following the meeting behind closed doors. Read full FOMC statement

As expected, the central bank chose to hold its target for the key federal funds interest rate at 5.25% for the ninth straight meeting.

The Fed said that it still expects moderate growth in coming months, despite volatile financial markets, tighter credit conditions and the ongoing correction in the housing market.

The Fed would have noted the fact that credit is not exactly drying up for the consumer. From MarketWatch:

An increase in credit-card debt pushed outstanding U.S. consumer debt up at a 6.5% annual rate, or $13.2 billion, to $2.46 trillion in June, the Federal Reserve said Tuesday.

And yesterday provided yet another reason for the Fed to stay concerned about inflation: productivity growth is slowing. Again from MarketWatch:

The latest figures on output in the U.S. workplace show a mix of slower productivity growth and upward pressures on wages, painting an unpleasant picture for the Federal Reserve.

Workplace productivity increased at a 1.8% annualized rate in the second quarter, while unit labor costs...increased 2.1% in the nonfarm business sector, the Labor Department said Tuesday...

In the past four quarters, productivity in the nonfarm sector has increased a weak 0.6%, the government's data showed. Over the same span, unit labor costs are up 4.5% -- the fastest pace since the third quarter of 2000.

But while the debate in the US has been mainly about a cut in interest rates, other central banks are still raising rates. The latest is the Reserve Bank of Australia today. Bloomberg reports:

Australia's central bank raised its benchmark interest rate a quarter point to the highest in almost 11 years. The increase may undermine Prime Minister John Howard's campaign to win a fifth term in office this year.

Governor Glenn Stevens raised the overnight cash rate target to 6.5 percent today in Sydney, the first adjustment since November, to curb an inflation rate running faster than he forecast and cool the biggest surge in lending since 1989. The nation's currency rose.

US stocks rebound strongly

MarketWatch reports yesterday's market action.

Stocks rallied to a sharply higher close Monday, sending the Dow industrials up by over 280 points for its best day since 2003, as investors snapped up financial shares, which have been heavily hit in recent weeks amid concerns about credit markets and bad home loans...

Crude oil futures came under severe pressure, with the front-month crude contract falling $3.42, or nearly 5%, to close at $72.06 a barrel. Traders are worried that a slowing U.S. economy will result in lower energy demand. See Futures Movers

The front-month gold contract also fell, losing $1.10 to $683.30 an ounce. See Metals Stocks.

Treasurys fell as investors removed safe haven positions amid the rally in stocks. The benchmark 10-year Treasury finished off 11/32 at 98-7/32 with a yield of 4.729%. See Bonds.

There were no new economic data from the US yesterday, but elsewhere the data were positive.

In Japan, the leading index rose to 80 percent in June, the first time it has been at or over 50 since October.

In Germany, manufacturing orders unexpectedly rose 4.6 percent from May, the biggest gain since December 2004.

In the UK, manufacturing output rose by 0.2 percent in June while industrial output as a whole rose 0.1 percent. In fact, the UK economy as a whole has done well recently, growing 0.8 percent in the three months ending July according to the National Institute of Economic and Social Research, but retail sales were weak in July.

While the rest of the global economy is looking good and even in the US, consumer confidence hit a 6-year high in July, John Hussman reminds us that economic optimism is a contrary indicator.

Unfortunately, if you examine the data, you'll quickly discover that consumer confidence is a lagging indicator, well explained by past movements in GDP, employment, and capacity utilization. Worse, for the stock market, it's a contrary indicator.

Hussman also warns us about looking for greater public participation to mark a top in the market.

Finally, while bullish sentiment on Wall Street has been extremely high for months, I doubt that this cycle will end with the same "public" frenzy for stocks as we saw in the late 1990's. The speculation of the public in this cycle has been largely tapped out on real estate - including heavy mortgage equity withdrawals...

To which I would add that the late 1990s remains fresh in the public mind. Investors seldom make the same mistake in consecutive cycles.

As markets get nervous, will central banks keep their composure?

Markets saw more volatility last week and many investors are now calling for central banks to cut interest rates to prevent a financial crisis. The calls are unlikely to be heeded for now though.

In fact, some central banks are still looking to raise interest rates.

The European Central Bank met last week and decided not to raise interest rates for the moment. However, at the press briefing after the decision was announced on 2 August, President Jean-Claude Trichet said that the "existence of upside risks to price stability at medium to longer-term horizons is confirmed by the strength of the underlying rate of monetary expansion" and that "strong vigilance is therefore of the essence", suggesting a rate hike is likely at the next meeting.

The indication of another rate hike was given despite an acknowledgement that financial markets were experiencing a period of nervousness. Trichet called the episode a "re-appreciation of risks" and "a phenomenon of normalisation of risk pricing". While he said that the central bank would "pay great attention to the developments in the market", he also said that the authorities would "keep their composure" and "permit the evolution of the market to be as effective as possible in terms of going back to a normal assessment of risks in general".

On the whole, it does not look as though the ECB is particularly concerned about the current turmoil in financial markets. In fact, more than a few analysts have even suggested that it welcomes it as a means of reining in excess liquidity.

Next week, the focus shifts to the Federal Reserve as the Federal Open Market Committee meets to decide on interest rates. No change is expected at this coming meeting. It seems likely to me that the Federal Reserve will follow in the ECB's footsteps, that is, acknowledge the developments in financial markets but not make substantial adjustment to its monetary stance.

Fed funds futures, though, show that rates are widely expected to be cut before the end of the year. Many investors think such a cut would be necessary to save the economy from what is perceived to be a developing credit crunch spreading from the mortgage market in the United States.

The Federal Reserve, however, will probably feel constrained from acting too soon. While it is likely to be more sensitive to the on-going turmoil in financial markets than the ECB because the market nervousness is centred on the US credit market and affects US financial institutions directly, the Fed's primary focus is ultimately on the effect of interest rates on inflation, not on the effect on financial markets. It would also be aware that, in addressing the risk to the financial system from the market turmoil, it risks creating a moral hazard by bailing out investors and, worse, aggravating inflation in the process.

Nevertheless, based on recent economic data, there is indeed hope for a rate cut later in the year to a large extent because the fear of renewed inflationary pressure is likely to continue to recede.

On Friday, the Labor Department reported that nonfarm payrolls increased by 92,000 in July, the smallest since February, while the unemployment rate rose to 4.6 percent, up from 4.5 percent in June. As the labour market weakens, inflationary pressure is likely to weaken as well.

In addition, the acceleration in US economic growth in the second quarter appears over for now. The Institute for Supply Management's indices for both manufacturing and non-manufacturing declined in July, the manufacturing index falling to 53.8 from 56.0 in June and the non-manufacturing index falling to 55.8 from 60.7.

Moderate economic growth and gradually rising unemployment should help keep inflation in check. As it is, all the main measures of core inflation in the US are now turning down, with the personal consumption expenditures price index excluding food and energy in June rising 1.9 percent from the previous year, a rate of increase that is within what is generally considered the Fed's comfort zone.


Having said that, other measures of core inflation remain above 2 percent. The consumer price index less food and energy rose 2.2 percent year-on-year in June, the Cleveland Fed's 16-percent trimmed mean CPI rose 2.6 percent and the Dallas Fed's trimmed mean PCE inflation rate was 2.3 percent.

And with oil prices maintaining an upward trend in recent months, the Federal Reserve will probably want to stay vigilant on inflation.

Therefore, while the probability of a rate cut by the Fed before the end of the year has clearly risen, unless we see a more sustained deterioration in credit markets, I think the Federal Reserve will prove to be less eager for a rate cut than many investors hope or think.

And perhaps that is the cue for investors concerned about the possibility of a credit crunch to take matters into their own hands, join in the "evolution of the market" and re-price risk accordingly.

Turmoil on Wall St continues

As MarketWatch notes, the Bear made another call yesterday.

U.S. stocks plunged Friday, with credit concerns and a weak jobs report driving a sell-off that marked the Dow's third worst day of the year and steep weekly losses for the broader market.

Already on the decline, the pace of the sell-off quickened after a Bear Stearns Cos. conference call about the impact of bad home loans on its funds failed to reassure investors...

The Dow Jones Industrial Average ended 281.4 points lower at 13,181.9, with all of its 30 stocks closing down and the Dow taking a weekly loss of 0.7%.

The S&P 500 dropped 39 points to close at 1,432.81 and a 1.8% loss for the week, while the Nasdaq Composite dived 64 points, or 2.5%, to close at 2,511, for a weekly drop of 1.9%.

Yesterday's nonfarm payroll data didn't help.

Nonfarm payrolls grew by a lower-than-expected 92,000 in July, the smallest gain since February. And the nation's unemployment rate rose to 4.6%, up from 4.5% in June and the highest reading since January, the Labor Department reported.

Nor did the ISM nonmanufacturing index, which fell to 55.8 in July from 60.7 in June.

Growth in service industries in the euro area, though, was maintained in July with the Royal Bank of Scotland Group Plc reporting yesterday that its services index stayed at 58.3, the highest since June last year.

ECB and BoE leave rates unchanged

Everybody is now focused on the US mortgage market but in the longer term, how well the mortgage and credit markets survive the current turmoil depends to a large extent on where central banks take official interest rates. Yesterday, both the ECB and the BoE left interest rates unchanged at their meetings.

The FT on the ECB decision:

The European Central Bank on Thursday signalled the cost of borrowing in the eurozone would rise again soon, with most economists tipping on a now-traditional quarter-point rise in the main rate to 4.25 per cent in early September.

But the central bank for the 13-member currency bloc made no comment on the trajectory of monetary policy beyond next month, leaving the door open to more rate increases or to a pause as past moves stem the speed of price rises.

The FT on the BoE decision:

The Bank of England kept interest rates on hold at 5.75 per cent on Thursday, as expected, but the City of London is betting on another increase before the year is out...

[A] cooling UK housing market seems to be the only real evidence that demand is slowing in response to the tighter credit conditions. Figures from the Halifax mortgage lender on Thursday showed prices rising 0.7 per cent in July, compared with an average of 1.5 per cent in the first three months of the year.

But while markets prepare for more rate hikes from Europe, the Fed is unlikely to have been moved by yesterday's economic data from the US. From Reuters:

Factory orders increased 0.6 percent in June...

June nondefense capital goods orders excluding aircraft...were unchanged, which was slightly better than a 0.7 percent decline seen in an earlier estimate by the government last week...

Excluding transportation, factory orders declined 0.5 percent...

The other main economic release on Thursday was from the U.S. Labor Department, whose data showed new applications for jobless benefits rose a slim 4,000 last week to a still-low 307,000...

Plunge on Wall St cut short, economic data mixed

Stock markets opened down in the US yesterday, but the weakness did not last. Bloomberg reports:

The Dow average erased a 79-point drop spurred by concern mortgage losses are spreading after Bear Stearns Cos. suspended withdrawals from a hedge fund. The S&P 500 climbed after falling below its 200-day moving average for the first time in a year...

The S&P 500 increased 10.54, or 0.7 percent, to 1465.81. The Dow average added 150.38, or 1.1 percent, to 13,362.37. The Nasdaq Composite Index increased 7.6, or 0.3 percent, to 2553.87.

The US economic data yesterday were mixed. Reuters reports:

The Institute for Supply Management said its index of national factory activity fell last month to 53.8, its lowest since March, and down from 56.0 in June...

A report from ADP showed the private sector created 48,000 jobs in July, below a downwardly revised increase of 143,000 in June as the number of manufacturing jobs fell...

The National Association of Realtors Pending Home Sales Index, based on contracts signed in June, rose 5 percent to 102.4 from a downwardly revised index of 97.5 in May...

The Mortgage Bankers Association's seasonally adjusted mortgage applications index dipped 0.3 percent to 607.1 in the week ended July 27. The index sank for a third straight week, to a level just above this year's low of 606.6 in the February 16 week.

In Europe, the Royal Bank of Scotland Group Plc's manufacturing index for the euro area fell to 54.9 in July from 55.6 in June but the Chartered Institute of Purchasing and Supply/NTC purchasing managers' index for the UK rose to 55.7 last month, the highest since July 2004, from an upwardly revised 54.7 in June.

China's manufacturing joined the slowdown group in July. The China Federation of Logistics and Purchasing and the National Bureau of Statistics said the manufacturing index fell to 53.3 in July from 54.5 in June. Meanwhile, the CLSA Purchasing Managers' Index fell to 53.2 from a 27-month high of 55 in June.

Rally on Wall St cut short, economic data mixed

Stock markets opened strongly in the US yesterday, but the strength did not last. Reuters reports:

Stocks had risen Monday and the first half of Tuesday's session, but the relief rally was cut short when American Home Mortgage Investment Corp. said it may have to liquidate assets. Shares of the mortgage lender fell 90 percent...

The Dow Jones industrial average slid 146.32 points, or 1.10 percent, to 13,211.99. For the month, the Dow was down 1.5 percent.

The Standard & Poor's 500 Index fell 18.64 points, or 1.26 percent, to 1,455.27. The Nasdaq Composite Index slumped 37.01 points, or 1.43 percent, to 2,546.27. For July, the Nasdaq was down 2.2 percent.

The US economic data yesterday were mixed. Reuters reports:

Personal spending rose a slight 0.1 percent in June after posting 0.6 percent gains in each of April and May, despite a rise in income, according to a Commerce Department report that suggested falling home prices and high gasoline costs were pinching consumers.

That was well below Wall Street economists' forecasts and was the weakest since last September, when spending declined...

The core personal consumption expenditures price index, which excludes food and energy, rose 0.1 percent on the month and 1.9 percent on the year, the smallest year-on-year increase since March 2004. The overall PCE price index rose 0.1 percent on the month and 2.3 percent on the year.

Incomes grew in June by 0.4 percent, matching May's increase, with its wages and salaries component advancing a solid 0.5 percent...

A report from the Conference Board in New York showed consumer confidence hit a six-year high of 112.6 in July -- its highest since August 2001 and well above an upwardly revised 105.3 in June...

In separate data, the Labor Department said second-quarter employment costs had gained by 0.9 percent, slightly faster than the first quarter's 0.8 percent rise as benefits climbed sharply...

In another report, the National Association of Purchasing Management-Chicago said its index of business activity in the Midwest declined to 53.4 in July from 60.2 in June...

Another sign of the problems facing the housing industry came in a Commerce Department report showing construction spending fell 0.3 percent in June as more commercial building failed to offset declines in homebuilding...

A report on home prices in major metropolitan markets -- the Standard & Poor's/Case-Shiller Home Price Index -- showed a continuing slide in prices during May, marking an 18th straight monthly decline.

In the euro area, confidence fell in July, but so did inflation. Bloomberg reports:

An index of sentiment among executives and consumers in the euro region declined to 111 from 111.7 in June, the European Commission in Brussels said today. That's lower than the 111.2 median forecast of 29 economists in a Bloomberg survey. Inflation slowed to 1.8 percent in July from 1.9 percent in June, staying below the European Central Bank's 2 percent limit for a 10th month, according to a separate report...

Capacity utilization in the euro area, which the ECB has cited as an inflation threat, fell to 84.2 percent in this quarter from a 17-year high of 84.8 percent in the previous three months...

... The euro-area jobless rate stayed at 6.9 percent in June...

And in the UK, consumer confidence fell but retail sales held up well in July. The Bank of England is scheduled to announce its latest interest rates this Thursday but no change is expected.

There was also no change in interest rates by the Reserve Bank of India yesterday. Instead, it raised its reserve requirement. AFP/CNA reports:

India's central bank on Tuesday warned inflation was still a risk and hiked its cash reserve ratio for banks by 50 basis points to seven percent but kept short-term borrowing rates unchanged.