Confidence falls in the US and Europe

The story from Tuesday's economic reports is that confidence is declining in both the US and Europe.

In the US, consumer confidence fell to the lowest since 2009 in August. Bloomberg reports:

The Conference Board’s index slumped to 44.5, the weakest since April 2009, from a revised 59.2 reading in July, figures from the New York-based research group showed today. It was the biggest point drop since October 2008. A separate report showed home prices declined for a ninth month.

The fall in the Conference Board's confidence index is in line with the fall in the Thomson Reuters/University of Michigan consumer sentiment index, which, as I mentioned on Monday, is similar to that in past recessions.

In Europe, the European Commission reports that the Economic Sentiment Indicator declined by 5.0 points to 97.3 in the EU and by 4.7 points to 98.3 in the euro area.

Forecasts for economic growth in the euro area are looking weak. From Reuters:

Economists said the euro zone economy may grow only 0.1 percent in the third quarter and come to a halt in the fourth.

"The (economic sentiment) index is now consistent with annual GDP growth of about 0.7 percent, implying that activity could fall outright in Q3 compared to Q2," said Jennifer McKeown, economist at Capital Economics.

US and Japanese consumer spending rise in July

US consumer spending rebounded in July. Reuters reports:

Consumer spending increased 0.8 percent on strong demand for motor vehicles as Japan-related supply restraints faded, a Commerce Department report showed on Monday. Spending had slipped 0.1 percent in June.

Prices also rebounded though, the PCE price index rising 0.4 percent in July after falling 0.1 percent in June.

Personal income lagged both spending and inflation in July, resulting in real disposable income falling 0.1 percent.

Among other US data, the Texas factory index fell to 1.1 in August from 10.8 in July, while a business confidence gauge fell to -11.4 from -2.0. Pending home sales declined 1.3 percent in July.

Investors appear to have focused on the positive. US stocks rose strongly on Monday, the S&P 500 rising 2.8 percent to 1,210.08.

Japanese consumer spending also improved in July. Data released today show that household spending fell 2.1 percent in July from a year earlier in real terms but rose 0.7 percent from June.

Less encouragingly, Japan's jobless rate rose to 4.7 percent in July from 4.6 percent in June.

No QE3 for now

Hopes for a third round of quantitative easing from the Federal Reserve were dashed on Friday, at least for the time being.

In his speech at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, Fed Chairman Ben Bernanke gave no signal of further monetary stimulus. He said that the Fed expected the recovery in the United States economy to continue and strengthen.

Bernanke did not rule out further stimulus. He acknowledged that economic growth during the first half of this year was considerably slower than expected. There was also an “extraordinarily high level” of long-term unemployment. Therefore, the Fed was prepared to continue to consider a range of tools that could be used to provide additional monetary stimulus.

Nevertheless, Bernanke said that “most of the economic policies that support robust economic growth in the long run are outside the province of the central bank”. He said that fiscal policy had a role. He said that “fiscal policy must be placed on a sustainable path” but taking into account the “fragility” of the current economic recovery.

Is Bernanke's decision not to proceed with another round of quantitative easing immediately correct? The answer, of course, depends on where you think the economy is headed.

On the day of Bernanke's speech at Jackson Hole, the Commerce Department also released data showing that the estimate for second quarter economic growth had been revised down from an annualised rate of 1.3 percent to 1.0 percent. This followed a growth rate of just 0.4 percent in the first quarter. Clearly, the US economy grew below trend in the first half of 2011.

While Bernanke said in his speech that the Fed expects the economic recovery to strengthen, another report on Friday casts some doubt on such a prospect. The Thomson Reuters/University of Michigan sentiment index fell to 55.7 in August from 63.7 in July. Sharp declines in this index have in the past often been associated with recessions.

On the other hand, there is a possibility that past monetary stimulus may finally be gaining traction. Economist and television show host Larry Kudlow noted on 18 August that the monetary indicator M2 has been “soaring”. As Kudlow said, strong M2 growth usually signals a fast-growing economy.

Unfortunately, M2 appears to have lost some of its value as a leading indicator in recent years, as the following chart shows.

Indeed, Kudlow does not think that the latest surge is good news. Rather, he thinks that it actually reflects a flight to safety.

“There’s a flight to government-guaranteed accounts,” he wrote. “Some people believe Europeans are withdrawing from their own banking system and parking their money in the U.S. banking system, guaranteed by Uncle Sam.”

“So contrary to monetarist theory, the M2 explosion seems more closely related to a deflation/recession risk,” Kudlow concluded.

And deflation risk, of course, was exactly what triggered the previous rounds of quantitative easing.

So do not rule out QE3 completely yet.

US growth revised down, no QE3, stocks rally anyway

US economic reports on Friday were negative.

The US economy grew at a 1 percent annualised rate in the second quarter, less than the previously-estimated 1.3 percent.

The Thomson Reuters/University of Michigan sentiment index fell to 55.7 in August from 63.7 in July.

Despite the weak economic data, Fed chairman Ben Bernanke gave no sign of further monetary stimulus in his speech at Jackson Hole.

And yet, US stocks finished the day up, the S&P 500 rising 1.5 percent to close at 1,176.8. For the week, the S&P 500 rose 4.7 percent, its first weekly rise after four consecutive weeks of losses.

European and Asian stock markets also snapped four-week losing spells this week. The Stoxx Europe 600 Index advanced 1.1 percent to 225.52 this week while the MSCI Asia Pacific Index rose 0.7 percent to 120.31.

The stock market rally is on.

Global economy still seeing inflation for now

Japan released data on consumer prices today showing that inflation moved into positive territory in July and confirming that the global economy continues to see inflationary pressure.

Japan's Statistics Bureau reported today that consumer prices in Japan rose 0.2 percent in July when compared to a year ago. Compared to June, prices were unchanged.

The July annual inflation reading was the first positive one for Japan since January 2009.

The Japanese data completed the picture of inflation around the world either holding steady or accelerating in July.

In the United States, consumer prices rose 3.6 percent in July from a year earlier, the same rate as in June.

In China, consumer prices were up 6.5 percent in July from a year earlier, accelerating from 6.4 percent in June.

In the United Kingdom, the July inflation rate was 4.4 percent, up from 4.2 percent in June.

The euro area diverged from the other major economies, with the inflation rate in July falling to 2.5 percent from 2.7 percent in June.

So inflation definitely persists around the world today.

However, recent data indicate that recession risks are also rising (see “Markets decline, recession coming?” and “Chicago Fed index improves but outlook less encouraging”). If we get a recession, things could change very quickly, as in 2008/2009.

Stocks rise as US durable goods orders jump

A jump in US durable goods orders in July helped the stock market rise for a second consecutive day on Wednesday. Bloomberg reports:

Bookings for goods meant to last at least three years rose 4 percent, the most in four months, after falling a revised 1.3 percent in June, a Commerce Department report showed today in Washington. The median projection of 81 economists surveyed by Bloomberg News called for a 2 percent gain. Orders excluding the volatile transportation category, unexpectedly advanced 0.7 percent...

Stocks rose, extending the biggest Standard & Poor’s 500 Index rally in a week, after the reports on durable goods and home prices beat forecasts and bank shares rallied. The S&P 500 advanced 1.3 percent to 1,177.6 at the 4 p.m. in New York. Treasury securities fell, sending the yield on the benchmark 10- year note up to 2.30 percent from 2.15 percent late yesterday.

The economic data from Europe were not as good, with eurozone industrial orders falling 0.7 percent in June and the German Ifo business climate index falling to 108.7 in August from 112.9 in July.

Still, stocks in Europe managed to rise for a third day on Wednesday, the Stoxx Europe 600 Index rising 1.4 percent.

Economic data negative, markets rally

Economic reports on Tuesday were mostly negative.

In the US, the Richmond Federal Reserve Bank's index of factory activity fell from minus 1 in July to minus 10 in August, the lowest reading since June 2009, while new single-family home sales fell 0.7 percent in July to a 298,000-unit annual rate, the lowest since February.

Elsewhere, flash PMIs show economic growth weakening.

In the euro area, the services PMI edged down from 51.6 in July to 51.5 in August. The manufacturing PMI fell from 50.4 to 49.7 in August, falling below 50 for the first time since September 2009. The composite index, though, stayed unchanged at 51.1.

In China, HSBC's Flash China Manufacturing PMI rose from 49.3 in July to 49.8 in August but remained below the 50 mark.

In spite of the negative economic data, markets rose on Tuesday. Bloomberg reports:

The MSCI All-Country World Index added 2.3 percent at 7:17 p.m. in New York, as weaker-than-anticipated U.S. economic data increased optimism for stimulus measures. The Standard & Poor’s 500 Index jumped 3.4 percent to 1,162.35, paring gains briefly after an earthquake shook New York and Washington. Oil rallied 1.2 percent. The Dollar Index fell 0.3 percent. The yen slid against the U.S. currency after Moody’s Investors Service cut Japan’s sovereign-credit rating. Gold sank the most since May.

Chicago Fed index improves but outlook less encouraging

The US economy improved in July, according to the Chicago Fed National Activity Index.

Led by improvements in production-related indicators, the Chicago Fed National Activity Index increased to –0.06 in July from –0.38 in June. Three of the four broad categories of indicators that make up the index improved in July; only the sales, orders, and inventories category deteriorated from June.

The index’s three-month moving average, CFNAI-MA3, increased to –0.29 in July from –0.54 in June. July’s CFNAI-MA3 suggests that growth in national economic activity was below its historical trend. Likewise, the economic slack reflected in this level of the CFNAI-MA3 suggests subdued inflationary pressure from economic activity over the coming year.

The trend in the Chicago Fed National Activity Index has historically correlated well with the trend in the spread between the 10-year Treasury yield and the federal funds rate. The Chicago Fed index tends to lag the spread, befitting the latter's status as a leading economic indicator.

With this correlation in mind, the recent development in the spread between the 10-year Treasury yield and the federal funds rate is ominous. The 10-year yield has declined from well over 3 percent in the first half of this year to just over 2 percent in recent weeks, leading to a corresponding fall in the spread since the federal funds rate is anchored at just above zero.

If the past correlation between the spread and the Chicago Fed National Activity Index persists, then the recent decline in the former indicates that in coming months, the latter could fall to a level close to those that had been associated with recessions in the past.

After tumble, stocks may see short-term rally

Bloomberg reports that the losses suffered by the US stock market over the past four weeks were the biggest since 2009.

U.S. stocks tumbled, sending the Standard & Poor’s 500 Index to its biggest four-week loss since March 2009, as concern the global economy is stalling overshadowed the cheapest valuations in 2 1/2 years...

The S&P 500 lost 4.7 percent to 1,123.53. It has sunk 16 percent since July 22 as about $3 trillion was erased from the value of U.S. equities, according to data compiled by Bloomberg. The Dow Jones Industrial Average fell 451.37 points, or 4 percent, to 10,817.65 this week, extending its four-week decline to 1,863.51 points...

The S&P 500 has fallen 18 percent from an almost three-year high on April 29 amid concern about Europe’s government debt crisis and a global economic slowdown. The decline through Aug. 8 drove the index to a valuation of 12.2 times reported earnings, the lowest level since March 2009. Its price-earnings ratio is now 12.3, compared with the average of 16.4 since 1954, according to data compiled by Bloomberg.

However, Andrew Smithers, who famously wrote in 2000 that the US stock market was overvalued just before it plunged, thinks that US stocks remain overvalued. From Bloomberg today:

Smithers said in a report dated Aug. 15 that the S&P 500 is still overvalued by about 43 percent relative to earnings for the past 10 years, a time frame endorsed by Yale University’s Robert J. Shiller. Relative to the Q ratio, a comparison of market value with the replacement cost of assets, the index is about 36 percent too high, he said.

“Investors should not, in general, buy stocks at this level, as the stock market is likely to become cheap at some time during the next 10 years and there is therefore a high risk that anyone buying today will lose money before they start to get a positive return,” Smithers said. “In these circumstances, they are likely to be better off by holding cash until the market has fallen.”

Still, Smithers thinks that a short-term rally is likely.

Companies are cashed up and likely to buy back shares at a time when price-to-earnings ratios are low, providing a trigger for a short-term rally, said Smithers, who claimed stocks were overvalued in 2000 before a near 50 percent decline over 2 1/2 years. Investors should sell shares once their holdings gain 10 percent...

Another analyst who thinks that there is scope for a short-term rally in stocks despite poor valuations is John Hussman. In his latest commentary today, he writes:

Despite prospective long-term returns that remain quite thin on a historical basis, some segment of investors may be willing to accept market risk in stocks and utilities based on comparative returns in an environment where Treasury yields are abominably depressed and distorted. On a long-term basis, I think that significant exposure is an mistake, because it relies on risk premiums to stay compressed indefinitely. Even so, on a near-term basis we've observed enough of a decline to taper our disdain for market valuations at least modestly. On the technical side, short-term market action is extremely compressed and oversold. Also, we saw a variety of "non-confirmations" last week - downside leadership eased, trading volume tapered off, new lows in more volatile indices such as the Nasdaq and Dow Transports were not confirmed by new lows in the S&P 500, Dow Industrials, or Dow Utilities, and so forth.

Stocks fall, yen and gold gain

Markets ended the week on a negative note. Bloomberg reports:

U.S. stocks fell, capping a fourth straight weekly slump for the Standard & Poor’s 500 Index, as the cheapest price-earnings ratios since 2009 failed to lure investors amid concern the global economy is weakening. The yen touched a post-World War II high against the dollar.

The S&P 500 dropped 1.5 percent to 1,123.53 at 4 p.m. in New York, after rising as much as 1.2 percent. The Stoxx Europe 600 Index fell 1.6 percent to its lowest close since July 2009. The Japanese yen reached 75.95 per dollar, its strongest postwar level as investors sought refuge in the currency. Oil slid 0.1 percent as it swung from gains to losses. Gold futures topped $1,880 an ounce for the first time. Ten-year Treasury yields rose less than one basis point after yesterday’s record low.

The European stock market is already in bear market territory and the US stock market is getting close too.

The S&P 500 has fallen 18 percent from an almost three-year high on April 29 amid concern about Europe’s debt crisis and a global economic slowdown. The decline through Aug. 8 drove the index to a valuation of 12.2 times reported earnings, the lowest level since March 2009. Its price-earnings ratio is 12.3, compared with the average of 16.4 since 1954, according to data compiled by Bloomberg. The benchmark for U.S. equities lost 4.7 percent this week.

Markets back in turmoil

Bloomberg reports the market action on Thursday:

Stocks plunged while Treasuries rallied, pushing yields to record lows, amid growing signs the economy is slowing and speculation that European banks lack sufficient capital. Gold climbed to a record, while oil led commodities lower.

The Standard & Poor’s 500 Index tumbled 4.5 percent to 1,140.74 at 4 p.m. in New York. The Stoxx Europe 600 Index lost 4.8 percent in its worst plunge since March 2009 and Germany’s DAX Index slid 5.8 percent, the most since 2008. Ten-year Treasury yields fell as much as 19 basis points to 1.97 percent as rates on similar-maturity Canadian and British debt also reached all-time lows. The dollar gained versus 15 of 16 major peers, strengthening 0.6 percent to $1.4336 per euro. Gold futures rallied as much as 2.1 percent to $1,832 an ounce, while oil slid 5.9 percent.

Banks led losses a day after the European Central Bank said a lender will borrow dollars for the first time in six months. Lars Frisell, chief economist at Sweden’s financial regulator, said it won’t take much for interbank lending to freeze and the Wall Street Journal reported regulators were scrutinizing the U.S. operations of Europe’s largest lenders to assess their vulnerability...

A jump in the Conference Board's US leading index failed to boost markets. From Bloomberg:

The index of U.S. leading economic indicators climbed more than economists expected in July, boosted by an increase in money supply that may reflect a flight to safety.

The Conference Board’s gauge of the outlook for the next three to six months climbed 0.5 percent after a 0.3 percent gain in June, the New York-based research group said today. Economists projected a 0.2 percent rise in July, according to the median forecast in a Bloomberg News survey.

Other data on the US economy were weak. The Philadelphia Fed reported weak manufacturing activity in its region.

Responses to the Business Outlook Survey this month suggest that regional manufacturing activity has dipped significantly...

The survey’s broadest measure of manufacturing conditions, the diffusion index of current activity, decreased from a slightly positive reading of 3.2 in July to -30.7 in August. The index is now at its lowest level since March 2009.

And the US housing market continues to struggle. From MarketWatch:

Sales of existing homes fell 3.5% in July to an eight-month low, with a high cancellation rate again taking its toll on an already troubled market, according to data released Thursday.

The National Association of Realtors said sales fell to a seasonally adjusted annual rate of 4.67 million. June’s data were upwardly revised to 4.84 million from an initially reported 4.77 million.

Meanwhile, further Fed moves to help the economy could be hampered by lingering inflation concerns. The Labor Department reported on Thursday that the CPI increased 0.5 percent in July after having fallen 0.2 percent in June. The 12-month change in the CPI remained at 3.6 percent for the third month in a row.

The US is not Japan

James Pach says that while the US has a debt problem, it is not like Japan. It's not so much that the problem in the US is not serious. Rather, it is that the problem is much bigger in Japan.

Let me explain. In 2009, the United States had a population of 307 million, Japan had 127 million. In 2050, the US is projected to have a population of 393 million, according to the middle series estimate of the US Bureau of the Census. Japan, by contrast, will have just 95 million people, according to its Ministry of Health. So, over the next 40 years, if these projections hold, the US population will grow by about 30 percent, while Japan’s will shrink by 25 percent...

The effects of this contraction on Japan are so profound that no reasonable discussion of macroeconomics can exclude them. Picture yourself as a Japanese manager. What would your thinking be as you made long-term plans for your company’s growth? That’s right, unless they operate in emerging sectors, Japanese companies are shuttering domestic facilities and taking their investment overseas. In disclosure after disclosure, companies are announcing bluntly that they see no more growth in Japan, and are looking abroad. Japan Inc. is becoming a holding company.

As private sector investments slow, Pach thinks that fiscal policy needs to compensate. However, in Japan, that task is complicated by the shrinking population.

The US government also needs to be spending right now, resisting the temptation to tighten too early. Like Japan in the 1990s, the United States is experiencing what economist Richard Koo calls a ‘balance-sheet recession,’ a sustained period of deleveraging that will contract the economy without fiscal stimulus. But the fundamental idea of deficit spending is that at some point the government can stop, returning to relative austerity and budget surpluses once the boom phase of the economic cycle returns. This is where the US and Japan part ways. Japan no longer has an economic cycle—population decline doesn’t allow it. The default position of the Japanese economy is contraction, or with robust productivity gains, something barely above standstill. So the government spending must continue indefinitely, and the debt grows.

Japan is coming to crunch time. Not because of the absolute size of its debt—the gross debt/net debt debate misses the point—but because of the cost of servicing the debt. Even at ludicrously low interest rates, the Japanese government spends almost half its tax take on debt servicing costs. Throw in the rising burdens of an aging population, and the country clearly needs to solve its problems soon.

Paul La Monica at CNNMoney covers similar ground with a focus on the rapidly-aging population in Japan.

Simply put, the United States is not faced with as big of a percentage of people getting older and retiring as was the case in Japan during its Lost Decade.

According to research from Brockhouse Cooper, a brokerage firm based in Montreal, the percentage of people aged 65 or older nearly doubled in Japan between 1990 and 2008. Meanwhile, that percentage has stayed roughly the same in the U.S...

Along those lines, Japan currently has only 2.9 workers supporting retirees, said Tom Higgins, chief economist with Payden & Rygel, a Los Angeles-based money management firm. By way of comparison, there are 5 workers for each retired person in the United States...

Simply put, the strain on the U.S. government by an aging population shouldn't be as severe as it was in Japan.

Eurozone economy slows, US industrial production grows

The eurozone economy slowed in the second quarter. Bloomberg reports:

European economic growth slowed more than economists forecast in the second quarter as Germany’s recovery almost ground to a halt amid the worsening sovereign- debt crisis.

Gross domestic product in the 17-nation euro area rose 0.2 percent from the first quarter, when it increased 0.8 percent, the European Union’s statistics office in Luxembourg said in a statement today. That’s the worst performance since the euro region emerged from a recession in late 2009. Economists had forecast the economy to expand 0.3 percent, according to the median of 34 estimates in a Bloomberg News survey.

The slowing economic growth exacerbates sovereign debt concerns. A meeting between the German and French leaders on Tuesday did little to alleviate those concerns in the near term. From Bloomberg:

German Chancellor Angela Merkel and French President Nicolas Sarkozy rejected an expansion of the 440 billion-euro ($633 billion) rescue fund and rebuffed calls for joint euro borrowing to end the debt crisis, saying greater economic integration was needed first.

The leaders of Europe’s two biggest economies agreed to press for closer euro-area cooperation, tougher deficit rules and a harmonization of their corporate tax rates. A plan to resubmit a financial-transaction tax, which the European Union rejected in 2010, sent stocks lower in New York trading.

The economic data from the US on Tuesday were mixed, with housing continuing to show weakness. From MarketWatch:

Housing starts slipped 1.5% in July, according to data released Tuesday that highlight the lack of demand for new homes.

Starts fell to a seasonally adjusted annual rate of 604,000, down from a downwardly revised 613,000 rate in June, the Commerce Department said.

However, industrial production grew strongly. Again from MarketWatch:

The output of the nation’s factories, mines and utilities surged 0.9% in July as auto assemblies rebounded and consumers turned on their air conditioners, the Federal Reserve said Tuesday...

Adding to the positive sense from the report, output in June was revised up to a 0.4% gain from the prior estimate of a 0.2% gain and output in May was also revised higher...

Capacity utilization — a gauge of slack in the economy — rose to 77.5% in July from 76.9% in June. This is the highest level of capacity utilization since August 2008.

Along with the reported rise in capacity utilisation, Tuesday also brought news that US import prices rose in July, suggesting that inflation pressures remain. From Bloomberg:

Prices of goods imported into the U.S. rose in July, led by gains in costs of fuel, industrial supplies and clothing.

The 0.3 percent gain in the import-price index followed a revised 0.6 percent drop in June, Labor Department figures showed today in Washington. Economists projected a 0.1 percent decrease for July, according to the median estimate in a Bloomberg News survey. Prices excluding petroleum rose 0.2 percent...

Compared with a year earlier, import prices rose 14 percent, today’s report showed. That was the largest 12-month increase since the 18.1 percent gain in the period from August 2007 to August 2008.

Inflation has been an even bigger concern in the UK. Reuters reports the latest numbers:

Inflation ticked up last month and appears on track to hit 5 percent later this year, further squeezing cash-strapped Britons and posing a major obstacle to any moves by the Bank of England to give the economy an extra boost.

Consumer price inflation rose to 4.4 percent from 4.2 percent in June -- a slightly bigger increase than economists had predicted -- as banks raised fees and after retailers brought discounts forward to the previous month, the Office for National Statistics said.

Inflation did edge down in India in July though. AFP/CNA reports:

India's annual inflation edged lower to 9.22 percent in July, official data showed Tuesday, still far above the comfort level of the country's central bank, which has been raising rates aggressively.

Inflation, according to the benchmark wholesale price index, the nation's most-watched cost-of-living monitor, slipped to 9.22 percent in July from June's 9.44 percent, the commerce ministry reported.

Markets positive, economic data negative

Markets had a good day on Monday. Bloomberg reports:

U.S. and European stocks rose, erasing all of last week’s losses for the Standard & Poor’s 500 Index, as companies announced $27 billion in global deals after equities traded near their cheapest relative to earnings since 2009. Credit risk fell. The Swiss franc and yen weakened.

The S&P 500 advanced 2.2 percent to 1,204.49 at 4 p.m. in New York after losing 1.7 percent last week. The Stoxx Europe 600 Index added 0.2 percent. The franc depreciated against all 16 of its most-traded peers. The Markit iTraxx SovX Western Europe Index of credit-default swaps insuring the debt of 15 governments fell to the lowest level this month. The 10-year Treasury note yield rose five basis points to 2.30 percent. Oil rallied 2.9 percent.

Economic data for the day, though, were mostly negative.

In Japan, Reuters reports that the economy contracted in the second quarter.

Japan's economy shrank much less than expected in the second quarter as companies made strides in restoring output after the devastating earthquake in March, but a soaring yen and slowing global growth cloud the prospects for a sustained recovery...

Gross domestic product fell 0.3 percent in the second quarter, less than a median forecast for a 0.7 percent contraction and a 0.9 percent decline in January-March.

US data were also negative. Reuters reports:

Manufacturing in the New York area contracted for the third straight month in August, data showed on Monday, tempering any lingering hopes for a rebound in the U.S. economy in the second half of the year...

The New York Federal Reserve's Empire State index showed the general business conditions index fell to minus 7.72 in August from minus 3.76 the month before. Economists polled by Reuters had expected a reading of zero...

Separate data also showed U.S. homebuilder sentiment was unchanged at a low level in August, as a glut of distressed homes, tight credit, and economic uncertainty kept new buyers out of the market.

The NAHB/Wells Fargo Housing Market index held at 15 in August, on target with economists' expectations. It has hovered at historic lows between 14 and 22 since the start of 2008.

Markets decline, recession coming?

Last week turned out to be another turbulent one for markets.

Stock markets fell for a third consecutive week last week after Standard & Poor's cut the credit rating for the United States to AA+ from AAA the previous Friday. The Standard & Poor's 500 Index fell 1.7 percent to 1,178.81, the STOXX Europe 600 Index slipped 0.6 percent to 237.49 and the MSCI Asia Pacific Index fell 3.3 percent to 121.92.

Policy makers took action last week after the prior week's market declines. In Europe, the European Central Bank bought Italian and Spanish government bonds, helping to push 10-year yields down by more than 100 basis points to about 5 percent. In the US, the Federal Reserve's statement following its monetary policy meeting last week said that the exceptionally low level of the federal funds rate is likely to be maintained at least through mid-2013.

Investors' reactions to the policy actions were mixed. Stocks fell again on Monday even after the ECB started buying Italian and Spanish bonds. Investors reacted better to the Fed move, pushing stocks up on Tuesday following its monetary policy meeting. Although those gains were given back on Wednesday, the rebound resumed on Thursday and Friday, enabling stock markets to end the week on a positive note.

The generally positive market reaction to the Fed's latest move is reminiscent of its earlier moves in 2009 and 2010 when it launched securities purchase programmes that have since been called quantitative easing 1 and 2 respectively. In both cases, markets also reacted favourably to the liquidity injections.

In fact, Edward Harrison at Credit Writedowns goes so far as to call the latest policy action QE3. In “The Fed has already begun its third easing campaign”, he writes:

This is what we just got last week, permanent zero. I believe this is the first salvo in a renewed easing campaign by the Fed. I had been saying full-blown QE3 wouldn’t begin until 2012. In fact, the permanence of the zero to which the Fed has committed is much longer than I had anticipated. I would go so far as to call this full-blown rate easing, one of the three easing policies I identified earlier as QE3 contenders. That’s why you got three dissents at the last FOMC meeting, which you will almost never see at the Fed.

At least one economic report last week provided supporting evidence that low rates will be needed in the US for quite some time longer. On Friday, the Thomson Reuters/University of Michigan preliminary index of consumer sentiment for August was reported to have plunged to 54.9 from 63.7 in July. The August reading was the lowest since May 1980.

Ryan Wang of HSBC wrote in a research note that the August consumer sentiment reading was almost 16 points below the average over the prior 12 months. He said that such declines are a “strong -- although not foolproof -- signal for a downturn in the U.S. economy”.

Somewhat more sanguine is the CalculatedRisk blog, which thinks that the decline in the index “was related to the heavy coverage of the debt ceiling debate, and not due to the usual suspects: gasoline prices or a weakening labor market”. As such, “sentiment should bounce back fairly quickly”, albeit only to an already-low level.

Retail sales data in the US also do not indicate a declining trend in consumer spending. A report also released on Friday showed that retail sales rose 0.5 percent in July, accelerating from a 0.3 percent rise in June.

Most economists also think that the economy will continue to grow. A survey of economists earlier this month by USA Today showed that economists put the chance of a US recession at 30 percent.

Having said that, economists are notoriously unreliable in calling recessions. For example, the last recession started in December 2007 but was not recognised by most economists until well into the second half of the following year. The stock market, which had peaked in October 2007, turned out to be a better predictor.

With that in mind, the fact that, at the end of last week, the S&P 500 closed 13.6 percent below its peak in April is not a good sign for the economy.

However, the full set of historical data show that the stock market itself is also not a reliable predictor of recessions. The stock market, for example, famously crashed in 1987 but no recession followed soon after.

One analyst who did foresee the last recession was John Hussman of Hussman Funds (see “Expecting a Recession”). And unfortunately, he is seeing recession once again. Hussman wrote today:

The composite of recession warning evidence we observe here (year-over-year GDP growth of just 1.6%, S&P 500 below its level of 6 months earlier, widening credit spreads versus 6 months earlier, yield curve spread at 2.2%, Purchasing Managers Index at 50.9, year-over-year nonfarm payroll growth below 1%) falls into a Recession Warning Composite that has been observed in every recession since 1950, and has never been observed except during or immediately preceding a recession.

Hussman's view notwithstanding, the question of whether a US recession is imminent will not be settled soon. The uncertainty over the direction of the economy means that, despite the positive end to last week, the wild ride for markets is likely to continue.

Stocks rise again amid mixed economic data

Stocks managed to rise for a second consecutive day on Friday. Bloomberg reports:

U.S. stocks rose, capping a week of record swings for the Standard & Poor’s 500 Index, as an increase in retail sales tempered concern the economy is slowing. European shares extended a rebound from a two-year low after some nations banned short-sales. Treasuries gained.

The S&P 500, which fell or rose at least 4.4 percent in the previous four sessions, climbed 0.5 percent to 1,178.81 at 4 p.m. in New York to trim its weekly drop to 1.7 percent. The Stoxx Europe 600 Index jumped 3.7 percent as banks climbed for a second day, surging 4.5 percent as a group after sinking 6.7 percent on Aug. 10. The yield on the 10-year Treasury note fell nine basis points to 2.24 percent. The Swiss franc slid against all 16 major peers as the nation considers pegging it to the euro.

US economic data had been mixed. From Bloomberg:

Retail sales in the U.S. climbed in July by the most in four months, showing consumers were holding up at the start of the third quarter.

The 0.5 percent increase reported by the Commerce Department in Washington today followed a 0.3 percent gain in June that was larger than previously estimated...

The Thomson Reuters/University of Michigan preliminary index of consumer sentiment for August slumped to 54.9, the lowest reading since May 1980, from 63.7 the prior month...

In Europe, the strong rebound in stocks came despite weak economic data. From Bloomberg:

European industrial production unexpectedly fell in June and France’s economy stalled in the second quarter, adding to signs that growth is losing momentum as governments struggle to contain the debt crisis.

Production in the 17-nation euro area slipped 0.7 percent from May, the European Union’s statistics office in Luxembourg said today. In France, the economy failed to expand from the first quarter, according to Paris-based statistics office Insee, missing the median forecast of 0.3 percent growth in a Bloomberg News survey of 15 economists.

Even China is showing signs of slowing. From Reuters:

China's bank lending slowed more than expected in July to seven-month lows as Beijing kept a tight grip on monetary policy to quell near three-year-high inflation...

Chinese banks made 492.6 billion yuan ($77 billion) of loans in July, the People's Bank of China said on its website, a pull-back from 634 billion yuan lent in June...

Underlining the tightness in the banking system, China's broad M2 measure of money supply grew only 14.7 percent in July, the weakest pace of growth seen since April 2005, and again missing forecasts for a 15.8 percent growth.

Stocks rally, shorting faces new curbs in Europe

Stocks managed to stage a strong rebound on Thursday. Bloomberg reports:

U.S. stocks surged, reversing most of yesterday’s plunge, and Treasuries sank as an unexpected drop in jobless claims and higher-than-estimated earnings tempered concern the economy is slowing as Europe’s debt crisis widens. The Swiss franc slid on plans to temporarily peg it to the euro.

The Standard & Poor’s 500 Index jumped 4.6 percent to 1,172.64 at 4 p.m. in New York. The Stoxx Europe 600 Index rallied 3.2 percent, rebounding from a two-year low. Treasuries extended losses as demand weakened at an auction of 30-year bonds, sending the benchmark 10-year note yield up 22 basis points to 2.32 percent. The franc slid at least 4.8 percent against all 16 major peers. Gold retreated from a record above $1,800 an ounce, while zinc and lead rallied...

U.S. equity futures erased losses before markets opened today after first-time applications for jobless benefits decreased 7,000 in the week ended Aug. 6 to 395,000, the fewest since early April. Economists forecast 405,000 claims, according to the median estimate in a Bloomberg News survey. The Labor Department said the number of people on unemployment benefit rolls and those getting extended payments also dropped.

However, the situation in Europe remains a source of concern. From Reuters:

Fears about the health of French banks intensified the scramble for U.S. dollars on Thursday and drove up European banks' borrowing costs to levels not seen since the 2007-2009 global credit crisis...

In the repo market, sources at two big Wall Street firms said they raised their rates for some European banks, but are not cutting them off. Money market funds have been reducing exposure to French banks as well.

Meanwhile, French and other European banks lined up at the European Central Bank and borrowed more than 4 billion euros in emergency overnight cash, the highest amount since mid-May.

Three-month dollar LIBOR rose for a 13th straight session to 0.28617 percent, up from 4 basis points from a month ago.

In a sign of their concern, market authorities in Europe have taken action. From Bloomberg:

France, Spain, Italy and Belgium will impose bans on short-selling from today to stabilize markets after European banks including Societe Generale SA hit their lowest level since the credit crisis.

“While short-selling can be a valid trading strategy, when used in combination with spreading false market rumors this is clearly abusive,” the European Securities and Markets Authority, which coordinates the work of national regulators in the 27-nation European Union, said in a statement after talks ended late yesterday. National regulators will impose the bans “to restrict the benefits that can be achieved from spreading false rumors or to achieve a regulatory level playing field.”

Meanwhile, economic data on Thursday were mixed.

Japan saw a jump in machinery orders in June. AFP/CNA reports:

Japan's core private-sector machinery orders unexpectedly soared 7.7 percent in June from the previous month, official data showed on Thursday...

The core data, which exclude volatile demand from power companies and for ships, rose for the second straight month after a 3.0-percent increase in May and a fall of 3.3 percent in April, figures from the Cabinet Office showed.

However, apart from the positive report on jobless claims, the US also provided a more negative report on the trade situation. MarketWatch reports:

The U.S. trade deficit widened unexpectedly in June, reaching its highest level in almost three years as the nation’s exports were held in check by the global slowdown, according to government data Thursday.

The gap between imports and exports expanded 4.4% to $53.1 billion from $50.8 billion in May, the Commerce Department said.

The biggest factor behind the June deficit was a 2.3% decrease in exports, the largest monthly decline since December 2008.

Stocks resume fall as debt concern moves to France

The rally in stocks did not last long. From Bloomberg:

Stocks slid, dragging the Dow Jones Industrial Average to the lowest level since September 2010, and Treasuries rose for a third day amid concern the European sovereign debt crisis is worsening. The dollar climbed versus 13 of 16 major peers, with the euro losing 1.3 percent to $1.4190. Gold futures surged to a record above $1,800 an ounce.

The Dow sank 519.83 points, or 4.6 percent, to 10,719.94 at the 4 p.m. close in New York. The Standard & Poor’s 500 Index sank 4.4 percent to 1,120.76 following its biggest jump in more than two years yesterday, when it rebounded from its worst loss since 2008. The Stoxx Europe 600 Index plunged 3.8 percent as Societe Generale SA sank 15 percent. Ten-year Treasury yields, which touched an all-time low yesterday, fell 16 basis points to 2.09 percent after an auction drew a record-low yield...

France has become the focus of European sovereign debt concern.

The cost to insure French government debt against default rose to a record 175 basis points. France’s top credit grade was affirmed by S&P, Moody’s Investors Service and Fitch Ratings amid concern that Europe’s sovereign debt crisis is intensifying.

A downgrade of France's credit rating is probably not imminent but recent reports show that the French economy is already weakening. Again from Bloomberg:

Industrial output in France, the euro region’s second-biggest economy, fell more than economists estimated in June on lower production of transport materials and electronic goods.

Output from factories, mines and utilities decreased 1.6 percent from May, when it rose a revised 1.9 percent, national statistics office Insee said today. Economists had forecast a 0.7 percent fall, according to the median of 12 estimates in a Bloomberg News survey. Output rose 2.3 percent from a year earlier...

Confidence among French executives fell to the lowest in more than 1 1/2 years in July amid concern that Europe’s debt crisis may undermine economic growth, the Bank of France’s Business Sentiment Indicator showed this week...

Meanwhile, the UK economy is also weakening. Bloomberg reported on Tuesday that UK factory output and exports fell in June.

U.K. manufacturing unexpectedly fell in June and the trade gap widened, adding to evidence that the economic recovery is faltering.

Factory output declined 0.4 percent from the previous month, when it rose 1.8 percent, the Office for National Statistics said today in London...

Exports fell 4.8 percent in June from the previous month and imports declined 2.4 percent. The goods trade deficit widened to 8.87 billion pounds ($14.5 billion) from 8.47 billion pounds in May...

The weakness in the UK economy has not gone unnoticed by the BoE. From Reuters:

The Bank of England cut its growth forecasts on Wednesday, left the door open for a second bout of quantitative easing and signalled interest rates will stay at record lows for a long while to come...

The Bank forecast that inflation would peak around 5 percent later this year -- the same as it predicted in May -- before falling steadily to 1.8 percent in two years time, a shade lower than it expected three months ago...

[I]t ... cut its growth forecast for 2011, and to a lesser degree, going forward. By the fourth quarter of 2011, the Bank now sees an annual rate of growth of 2.0 percent, down from 2.5 percent in May -- translating to full-year growth for 2011 of about 1.4 percent.

China's economy, though, shows few signs of significant slowing. From AFP/CNA:

China's politically sensitive trade surplus expanded to $31.48 billion in July as exports rose by a fifth to hit a new record high, the customs agency said Wednesday.

Exports were up 20.40 percent year on year to $175.13 billion -- a fresh monthly record -- while imports rose by 22.90 percent, the agency said on its website.

Fed to keep rates low till 2013

Finally, we get a strong rally in markets, thanks to the Fed. From Reuters:

The Federal Reserve on Tuesday took the unprecedented step of promising to keep interest rates near zero for at least two more years and said it would consider further steps to help growth, sparking a rebound in stocks.

The Fed painted a gloomy picture, saying that U.S. economic growth was proving considerably weaker than expected, inflation should remain contained for the foreseeable and unemployment, currently at 9.1 percent, would come down only gradually.

An unusually divided central bank pledged to hold benchmark rates at rock-bottom lows until mid 2013, and opened the door to other tools to support growth. The announcement demonstrated just how long the central bank expects it will take before a flagging economy can gather significant momentum...

U.S. stocks sank initially and then see-sawed wildly before a strong rally. The Dow ended up 4 percent at 429.92. Treasury yields sank with the 2-year note plunging to a record low of 0.1647 percent and the dollar sinking.

While the Fed is now set to maintain monetary stimulus, China has apparently already provided too much of it. AFP/CNA reports another rise in inflation there.

China said Tuesday its politically sensitive inflation rate rose in July to its highest level in more than three years, as the government struggles to rein in soaring food costs.

The country's consumer price index rose 6.5 per cent last month compared to a year earlier, the National Bureau of Statistics (NBS) said in a statement, the highest level since June 2008 when it reached 7.1 per cent...

Output from China's millions of factories and workshops rose 14 per cent year-on-year in July, it said, slightly slower than the 15.1 per cent recorded in June.

Retail sales, the main gauge of consumer spending in the world's second-largest economy, were up 17.2 per cent in July.

Fixed asset investment, a measure of government spending on infrastructure, rose 25.4 per cent in the first seven months of the year, the NBS said.

Stocks sink, Europe in bear market even as Italian and Spanish bond yields fall

Markets plunged again on Monday. Bloomberg reports:

U.S. stocks sank the most since December 2008, while Treasuries rallied and gold surged to a record, as Standard & Poor’s reduction of the nation’s credit rating fueled concern the economic slowdown will worsen. The Dow Jones Industrial Average plunged 634.76 points as approximately $2.5 trillion was erased from global equities.

The S&P 500 Index (SPX) lost 6.7 percent to 1,119.46 at 4 p.m. in New York, its lowest level since September, as all 500 stocks fell for the first time since Bloomberg began tracking the data in 1996. The Stoxx Europe 600 Index slid 4.1 percent to extend a drop from its 2011 high to 21 percent. A surge in Treasuries, benchmarks of the nation’s $34 trillion debt market that is more than twice the value of American equities, sent the 10-year note yield down 22 basis points to 2.34 percent, the lowest since January 2009, and the two-year rate slid to a record low. The S&P GSCI commodities index lost 3.9 percent.

While the US stock market saw a bigger drop on Monday, Europe's bigger fall since its peak in February leaves it in bear market territory.

There was some good news on the European front though. From Reuters:

European Central Bank buying of Italian and Spanish debt pushed the two countries' bond yields sharply lower on Monday, while German Bunds rose sharply as investors unnerved by a U.S. ratings downgrade ditched stocks for safer assets...

Italian and Spanish yields fell by up to a full point across the curve. Ten-year Italian yields were last 5.33 percent, off session lows of 5.18 percent -- levels last seen on July 22 after the second Greek bailout was agreed -- trading 12 bps over their Spanish equivalent.

However, contagion remains a very real risk.

The cost of insuring French debt against default hit a record high of 160 bps on Monday, up 15.5 bps on the day, as the sovereign is seen as the next in line to potentially lose its triple-A rating.

French CDS rose some 55 bps since July 22 on worries the euro zone debt crisis could spread to core countries as well. Last week, the 10-year French/German government bond yield spread hit euro lifetime highs of 91 bps.

Markets to look to policy-makers after dramatic week

Last week turned out to be a highly eventful one. It started out with the United States government establishing a deficit-reduction plan and raising its debt ceiling and ended, ironically, with Standard & Poor's cutting the US government's credit rating.

In between, US stock markets plunged. Instead of a relief rally following the resolution of the US debt ceiling impasse, investors chose to sell stocks, culminating in a 4.8-percent drop in the Standard & Poor's 500 Index on Thursday. The S&P 500 ended the week down 7.2 percent and closed on Friday at 1199.38, 12.0 percent below its peak on 29 April.

The fall in US stocks dragged the rest of the world's stocks down as well. The STOXX Europe 600 Index plunged 9.9 percent to 238.88 last week, the lowest level in 13 months and 18.0 percent below its peak on 17 February. The MSCI Asia Pacific Index fell 7.8 percent to 126.08 and is now 10.5 percent below its peak on 2 May.

The flight from stocks benefitted bonds. Prices of US Treasuries rose last week, resulting in the 10-year note yield falling 24 basis points to 2.56 percent and the 30-year bond yield falling 27 basis points to 3.85 percent.

Economic reports last week clearly damaged risk appetite.

Surveys of purchasing managers in July showed a significant deterioration in business activity in the US and Europe.

In the US, the Institute for Supply Management's manufacturing PMI fell from 55.3 in June to 50.9 in July, indicating little growth in the sector. Its non-manufacturing index fell from 53.3 to 52.7.

For the euro area, Markit's manufacturing PMI fell from 52.0 in June to 50.4 in July, again indicating little growth in the sector. The services PMI fell from 53.7 to 51.6.

The slowing growth in Europe is a particular concern because of the on-going sovereign debt concerns there. While initial concerns had mostly been over Greece's debts, the focus has recently shifted to Spain and Italy, especially the latter. Italy's 10-year government bonds now yield over 6 percent. They had yielded less than 5 percent at the start of the year.

European Commission President Jose Manuel Barroso acknowledged last week that "it is clear that we are no longer managing a crisis just in the euro-area periphery". A default in either Spain or Italy would obviously have greater consequences on the European and global economies than one in some of the smaller peripheral eurozone economies.

The European Central Bank, though, may be coming to the rescue. Following an emergency teleconference on Sunday, the ECB declared that it "welcomes the announcements made by the governments of Italy and Spain concerning new measures and reforms in the areas of fiscal and structural policies". It concluded "on the basis of the above assessments that the ECB will actively implement its Securities Markets Programme".

The ECB announcement did not specify that it would be buying Italian and Spanish bonds. Nevertheless, this appears likely, since it would be about the only action that would calm current market concerns.

The next policy move that might calm markets could be from the Federal Reserve. The Federal Open Market Committee will meet on Tuesday and announce its latest monetary policy stance. After the recent economic data and last week's market turmoil, many analysts are speculating on the possible announcement of another round of quantitative easing.

There is reason to hope that another round of quantitative easing would boost stocks. The Fed's first round of quantitative easing in 2009 launched the latest cyclical bull market. A second round of quantitative easing last year kept the bull market going.

Still, these moves cannot guarantee that markets will not continue to fall. In 2001, the Fed cut interest rates aggressively in the last few months of the year; the then on-going bear market persisted for another year. In 2007, the Fed shifted towards easier monetary policy by cutting interest rates in August as the then on-going bull market started to look shaky; stocks entered a bear market two months later.

Nevertheless, if the cyclical bull market that started in March 2009 is to continue, a more market-friendly policy stance from one or more of the major central banks is virtually a necessity.

The next week or so could be crucial in determining whether we are at a major turning point for stocks.

S&P cuts US credit rating

This was not totally unexpected. From Reuters:

The United States lost its top-notch AAA credit rating from Standard & Poor's on Friday in an unprecedented reversal of fortune for the world's largest economy.

S&P cut the long-term U.S. credit rating by one notch to AA-plus on concerns about the government's budget deficits and rising debt burden. The move is likely to raise borrowing costs eventually for the American government, companies and consumers.

"The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics," S&P said in a statement.

Earlier on Friday, US stock markets managed to end little changed after a better-than-expected employment report. Bloomberg reports:

American employers added more jobs than forecast in July and wages climbed, easing concern the world’s largest economy is grinding to a halt.

Payrolls rose by 117,000 workers after a 46,000 increase in June that was larger than earlier estimated, the Labor Department said today in Washington. The median estimate in a Bloomberg News survey called for a gain of 85,000. The jobless rate dropped to 9.1 percent as discouraged workers left the labor force. Average hourly earnings climbed 0.4 percent...

Treasuries fell, pushing yields up from the lowest this year. Yields on 10-year notes rose 17 basis points, or 0.17 percentage point, to 2.57 percent at 4:04 p.m. in New York. The Standard & Poor’s 500 Index fell to 1,199.38 at the close, down less than 0.1 percent from yesterday and extending the worst slump since 2009 as technology shares declined.

The day had kicked off with Japan providing more signs that its recovery is continuing. From Reuters:

An index gauging the outlook for Japan's economy rose in June at a record pace from May in a sign that the recovery from the March earthquake is broadening, although the government warned of risks to the outlook such as slowing global growth.

The Bank of Japan raised its assessment of the economy in its monthly report for August but also warned of potential damage from recent yen rises and heightening uncertainty over the global economy...

Japan's index of leading indicators, a gauge of the economy a few months ahead that is compiled from data such as the number of job offers and consumer sentiment, rose 3.8 points from May, the biggest increase on record, the government said on Friday...

The index of coincident indicators, comprising data measuring the current state of the economy, rose a preliminary 2.5 points. The government revised up its assessment of the index, saying that it suggested an improvement in the economy.

Bloomberg reports, however, that Italy and Spain saw sluggish economic growth in the second quarter.

Italian and Spanish economic growth remained sluggish with weak domestic demand complicating efforts to convince investors the countries can expand enough to reduce debt and avoid becoming victims of Europe’s sovereign crisis.

Gross domestic product in Italy rose 0.3 percent in the second quarter from the previous three months, when it grew 0.1 percent, Rome-based national statistics institute Istat said today. Spanish GDP expanded 0.2 percent from the January-March period, when it increased 0.3 percent, the Bank of Spain estimated today. Industrial output fell in June in both countries...

Even Germany is not immune from negative data. Again from Bloomberg:

German industrial production unexpectedly decreased in June as construction activity waned and investment goods output dropped.

Production declined 1.1 percent from May, when it rose a revised 0.9 percent, the Economy Ministry in Berlin said today. Economists had forecast a gain of 0.1 percent, the median of 26 estimates in a Bloomberg News survey showed. In the year, output rose 6.7 percent when adjusted for working days...

Factory orders unexpectedly rose for a third month in June, boosted by investment goods such as machinery, the ministry said yesterday...

Stocks plunge despite renewed action by policy-makers

After weeks of nervous trading, stock markets finally took the plunge literally on Thursday. From Bloomberg:

A global rout in equities drove the Standard & Poor’s 500 Index to its worst slump since February 2009, while two-year Treasury yields plunged to a record low amid concern the economy is weakening. The yen pared losses, recovering from the biggest drop versus the dollar since 2008 that was triggered by Japan selling its currency.

The S&P 500 tumbled 4.8 percent to 1,200.07 at 4 p.m. in New York with futures on the gauge slipping 0.2 percent as of 6:17 p.m. The S&P 500 has dropped 11 percent since July 22, the biggest loss over the same amount of time since March 2009. The MSCI All-Country World Index slid 4.1 percent as Brazil’s stocks slumped to a two-year low and Switzerland’s entered a bear market. Two-year yields declined as low as 0.25 percent. The yen sank 4.1 percent against the dollar before trimming its loss almost in half. Oil sank 5.8 percent to help the Thomson Reuters/Jefferies CRB Index of materials erase its 2011 gain.

The yen moves followed intervention action by the Japanese government earlier on Thursday. AFP/CNA reports:

Japan on Thursday intervened in currency markets to weaken the yen, the government said, in a bid to counter speculator-driven rises that had pushed the unit near its post-war high against the dollar...

Finance Minister Yoshihiko Noda confirmed that Japan intervened unilaterally in the foreign exchange market to counter what he called "one-sided" and "excessive" movements in the currency.

Also taking measures to boost the Japanese economy on Thursday was the BoJ. Again from AFP/CNA:

The Bank of Japan on Thursday said it would expand by 10 trillion yen a scheme to buy assets and boost liquidity to help safeguard the nation's post-quake recovery from the impact of a strong yen...

In what it described as a move to "enhance monetary easing", the BoJ will expand a 40 trillion yen ($511 billion) scheme to buy securities and supply funds by a further 10 trillion yen.

The bank's asset purchase fund, a key policy tool it uses to buy Japanese government bonds, corporate bonds and exchange traded funds, will be expanded to 15 trillion yen from 10 trillion yen.

It also boosted a credit facility by 5 trillion yen to 35 trillion...

The bank also said its board had voted unanimously to keep its key rate unchanged between zero and 0.1%.

Another central bank in the limelight on Thurday was the ECB. From Bloomberg:

European Central Bank President Jean- Claude Trichet said the ECB has resumed bond purchases and will offer banks more cash to stop the region’s debt crisis from engulfing Italy and Spain and hurting the economy.

“I wouldn’t be surprised that before the end of this teleconference you would see something on the market,” Trichet told reporters in Frankfurt today after the ECB kept its benchmark interest rate at 1.5 percent. “We were not unanimous but with overwhelming majority with regards to the bond purchases.”

Markets did not find Trichet's comments very assuring as those bond purchases apparently did not include Italian and Spanish bonds.

Italian and Spanish 10-year bonds declined, pushing the yields as high as 6.23 percent and 6.33 percent respectively. Irish and Portuguese bonds rose as people with knowledge of today’s transactions said the ECB bought those securities after being absent from the market for 18 weeks. That debt was at 10.4 percent and 11.3 percent as of 5 p.m. in London.

The euro slipped after Trichet’s comments, falling to $1.4161 at 6:37 p.m. in Frankfurt from $1.4202 at the start of the press conference.

The third major central bank meeting on Thursday concluded with less drama, the Bank of England leaving its interest rate and asset purchase programme unchanged.

Stocks sink in Europe but stay afloat in US on QE hopes

European stocks were pummelled on Wednesday. Bloomberg reports:

European stocks sank the most in fourth months, extending an 11-month low, amid concern the U.S. recovery is faltering and the world’s largest economy may lose its top credit rating...

The benchmark Stoxx Europe 600 Index retreated 2 percent to 251.95 at the 4:30 p.m. close in London, the biggest drop since March 15. The gauge has declined 13 percent from this year’s high on Feb. 17 as the yield on Italian and Spanish bonds surged to records amid speculation the debt crisis won’t be contained.

US stocks, however, were saved by renewed talk of quantitative easing. From Bloomberg:

U.S. stocks advanced, preventing the longest Dow Jones Industrial Average slump since 1978, amid speculation the Federal Reserve may consider another economic stimulus program to prevent a recession...

The Dow rose 29.82 points, or 0.3 percent, to 11,896.44 at 4 p.m. in New York after posting a 166-point loss earlier, which was the ninth straight drop. The S&P 500 advanced 0.5 percent to 1,260.34, snapping a seven-day decline...

Stocks rebounded after the Wall Street Journal reported that three former top officials at the Fed said the central bank should consider a new round of securities purchases to bolster economic growth...

US economic reports on Wednesday certainly provided reasons for concern. From Bloomberg:

Service industries expanded in July at the slowest pace in 17 months as orders and employment cooled, indicating the biggest part of the U.S. economy had little spark to begin the second half of the year.

The Institute for Supply Management’s index of non- manufacturing businesses, which covers about 90 percent of the economy, dropped to 52.7 from 53.3 in June. Readings above 50 signal expansion, and the median projection in a Bloomberg News survey was for 53.5 in July...

Companies added 114,000 employees to their payrolls in July after a revised 145,000 gain the previous month that was less than initially projected, ADP said. A slowdown in hiring means consumers are unlikely to boost the spending that accounts for 70 percent of the economy...

Orders placed with manufacturers dropped 0.8 percent in June, reflecting decreases in demand for machinery and computers, the Commerce Department said today...

The euro area also saw a slowing of services activity. Bloomberg reports:

European services and manufacturing growth weakened in July to the slowest pace in almost two years, adding to signs the euro region’s recovery is losing momentum.

A composite index based on a survey of euro-area purchasing managers in both industries fell to 51.1 in July from 53.3 in June, London-based Markit Economics said today. That’s the lowest since September 2009, though it exceeds an initial estimate of 50.8. A reading above 50 indicates growth...

The euro-area services indicator fell to 51.6 last month from 53.7 in June, Markit said. The manufacturing gauge decreased to 50.4 from 52 in June.

Data on retail sales in the euro area in June showed growth though. Again from Bloomberg:

European retail sales rebounded in June from a drop in the previous month, led by Germany.

Sales in the 17-nation euro region grew 0.9 percent from May, when they fell 1.3 percent, the European Union’s statistics office in Luxembourg said today. Economists had projected a gain of 0.5 percent, the median of 22 estimates in a Bloomberg News survey showed. Sales fell 0.4 percent from a year ago.

And the UK even reported an acceleration in services activity in July. From Reuters:

Activity in the dominant services sector grew at its fastest pace in four months in July, raising hopes that the economy may be picking up for now although job losses and constrained consumer demand muddied the picture.

The Markit/CIPS services PMI headline activity index rose to 55.4 in July from 53.9 in June, confounding forecasts for a slowdown to 53.2.

Markit said that taken together with a manufacturing PMI contraction shown by a survey earlier this week, the data indicated the economy grew by 0.5 percent in the three months to July -- a marked improvement on the lacklustre 0.2 percent growth recorded from April to June.

US debt ceiling raised but markets show no relief

Concerns over US debt recede for now. From Bloomberg:

President Barack Obama signed a debt- limit compromise that prevents a U.S. default on the day the Treasury had warned the nation’s borrowing authority would expire, ending a months-long debate that reinforced partisan divisions over federal spending.

The Senate voted 74-26 for the measure, which raises the nation’s debt ceiling until 2013 and threatens automatic spending cuts to enforce $2.4 trillion in spending reductions over the next 10 years. It won backing from 45 Democrats, 28 Republicans and one independent. The House passed the plan yesterday.

It may not be too long before it becomes a concern again though.

Moody’s Investors Service today confirmed the AAA rating for U.S. government bonds, citing the legislation raising the statutory debt limit.

The agreement on the debt limit is a “first step” toward maintaining the U.S. government debt metrics within AAA parameters, Moody’s said. The outlook on the rating is now negative.

Fitch Ratings said the risk of a U.S. sovereign default remains “extremely low.” Still, the U.S. needs to confront “tough” choices on tax and spending against a weak economic backdrop if the budget deficit is to be cut to safer levels over the medium term, Fitch said.

Just look at Europe, where debt concerns keep returning. From Bloomberg:

Italian and Spanish 10-year bonds dropped, pushing yields up to euro-era records versus benchmark German bunds, on concern that slowing growth will hamper efforts to tame the nations’ debt loads...

The yield on 10-year Italian bonds rose 13 basis points to 6.14 percent at 4:31 p.m. in London. It earlier surged to 6.25 percent, the most since November 1997. The 4.75 percent security maturity in September 2021 fell 0.895, or 8.95 euros per 1,000- euro ($1,422) face amount, to 90.34. That pushed the difference in yield, or spread, over bunds, to as much as 384 basis points, the most since before the euro was introduced in 1999.

However, it was not just the bonds of troubled European countries that fell on Tuesday. From MarketWatch:

U.S. stocks fell hard Tuesday, posting their longest losing streak since the heart of the 2008 credit crisis, on investor worries about upcoming federal deficit cuts and a likely stall in the recovery.

The Dow Jones Industrial Average fell 265.87 points, or 2.2%, to 11,866.62, its worst one-day loss since June 1. The eight-day losing stretch was the longest since October 2008, weeks after the collapse of Lehman Bros. and by some measures, the peak of the U.S. credit crisis.

Worries over the weakening US economy increased after consumer spending reportedly fell in June. Bloomberg reports:

U.S. consumer spending unexpectedly dropped in June for the first time in almost two years and savings climbed, adding to evidence that the slump in hiring is hurting household confidence.

Purchases declined 0.2 percent after a 0.1 percent gain the prior month, Commerce Department figures showed today in Washington. The median estimate of 77 economists surveyed by Bloomberg News called for a 0.1 percent increase. Incomes grew at the slowest pace since November.

Manufacturing near stagnation in US, Europe and China

The US debt deal got closer to approval on Monday. Bloomberg reports:

The House approved legislation to raise the U.S. debt limit by at least $2.1 trillion and cut federal spending by $2.4 trillion or more, one day before a threatened default.

The House voted 269-161 for the plan negotiated by leaders and President Barack Obama over the weekend. Ninety-five Democrats voted in favor and 66 Republicans in opposition. The measure goes to the Senate for a final vote planned tomorrow.

The US economy, however, is moving closer to recession. Again from Bloomberg:

Manufacturing in the U.S. almost stalled in July, threatening to deprive the two-year recovery of one of its main drivers.

The Institute for Supply Management’s factory index slumped to 50.9, the lowest since July 2009, from 55.3 a month earlier, the Tempe, Arizona-based group said today. Figures less than 50 signal contraction, and the July index was lower than the most pessimistic forecast in a Bloomberg News survey.

Construction turned out to be a bright spot in July.

A Commerce Department report today showed construction spending rose for a third straight month in June, led by a gain in nonresidential building. The 0.2 percent increase followed a 0.3 percent revised gain that was previously reported as a decrease.

However, the manufacturing slowdown was the main story in the rest of the world. From Reuters:

Factories in Asia and Europe expanded in July at the weakest rate since major industrial powers were struggling through the 2009 recession, adding to concerns over world growth...

The euro zone manufacturing PMI, which gauges the activities of thousands of businesses, fell to 50.4 in July from 52.0 in June -- its worst showing since September 2009 and barely above the 50 mark dividing growth and contraction.

Perhaps more worryingly, China's official government PMI dropped to 50.7 from 50.9 in June, its weakest in more than two years, while the HSBC PMI fell below the 50 mark for the first time in a year -- to 49.3 in July from 51.6...

Even in the UK, which so far has been shielded from the crisis gripping the euro zone, the manufacturing PMI fell to 49.1 from 51.4 in June -- the first time below the 50 mark since the country was in recession two years ago...

Indian manufacturing growth slowed in July for the third month in a row. The HSBC PMI dropped to 53.6, from 55.3 in June, the lowest level since November 2009.

Agreement reached on US deficit-reduction plan

It looks like the US debt ceiling will be raised in time. From Bloomberg:

President Barack Obama said tonight that leaders of both parties in the U.S. House and Senate had approved an agreement to raise the nation’s debt ceiling by $2.1 trillion and cut the federal deficit by as much as $2.5 trillion over a decade, a deal that must now be sold to Congress.

“The leaders of both parties in both chambers have reached an agreement that will reduce the deficit and avoid default,” Obama said at the White House. “This compromise does make a serious down payment on the deficit-reduction we need. Most importantly it will allow us to avoid default.”

Congressional leaders reached a bipartisan agreement to raise the debt ceiling by at least $2.1 trillion, sufficient to serve the nation’s needs into 2013. They are preparing to sell to members the deal to cut $917 billion in spending over a decade, raising the debt limit initially by $900 billion, and to charge a special committee with finding another $1.5 trillion in deficit savings by the year’s end. They confront an Aug. 2 deadline for approval of the agreement.

Initial market reaction was positive.

The dollar and oil prices climbed, and gold fell. U.S. currency rose 1.3 percent to 77.79 yen and 0.2 percent to $1.4376 per euro at 9:44 a.m. in Tokyo. Gold slid 1.1 percent to $1,610.70 an ounce. Crude oil for September delivery rose 1.6 percent to $97.19 a barrel on the New York Mercantile Exchange.

The positive reaction may be short-lived, according to PIMCO's Mohamed A. El-Erian.

While the compromise shaping up will probably assuage immediate concerns about default in financial markets, “this relief will be short,” said Mohamed A. El-Erian, chief executive officer of Pacific Investment Management Co., the world’s largest manager of bond funds.

If Standard & Poor’s “sticks to what it said, it will downgrade” the U.S. debt following the deal, El-Erian said in an interview on ABC News “This Week.”...

The agreement “does nothing to restore household and corporate confidence, so unemployment will be higher than it would have been otherwise,” El-Erian said. “Growth will be lower than it would be otherwise. And inequality will be worse than it would be otherwise.”