Global Markets Weekly 25 October 2010

• China hike surprises markets and triggers profit taking

  China’s surprise move on Tuesday to increase its one-year lending and deposit rates by a quarter point was seen by some as a threat to the growth momentum of China’s economy and the global recovery in general, triggering some profit taking, with emerging markets and most commodities down on the week. However, though the move does have some cyclical impact, we believe, more importantly, it suggests the start of an overt shift towards the rebalancing of the domestic economy. In addition, it should help China manage the large scale inflows that have begun in anticipation of the next round of US quantitative easing (QE2).

• But we still expect QE2 at the 3rd November Fed meeting, underpinning asset markets…

  Despite some regional Federal Reserve Presidents (Lacker of Richmond and Plosser of Philadelphia) downplaying the efficacy of QE and the threat of deflation, respectively, we continue to forecast that the Fed will authorise QE2 at its next meeting. This suggests that the rally in the US dollar and pull-back in asset markets that we have seen following the hike in Chinese interest rates will be contained, with the S&P 500 up 0.6% on the week.

• …with the Bank of England likely to follow suit, eventually, with substantial fiscal consolidation plans now confirmed

  While there were some tweaks, the UK government’s Comprehensive Spending Review (CSR) closely matched what was set out in the post-election budget. With retail sales falling for a second month and substantial redundancies to follow the CSR, the UK economy faces a very difficult outlook. Chancellor Osborne’s reference to the Bank of England’s freedom to deploy monetary stimulus gave a clear indication that QE2 would be used to balance the deflationary impacts of fiscal consolidation. If this balancing act keeps the economy out of recession, as we expect, the longer-term prospects are for a better-balanced UK economy.

• US dollar remains under pressure

  China’s interest rate hike triggered a two-cent jump in the US dollar against the euro. The move, while short-lived, was indicative of extreme short dollar positions ahead of the anticipated QE2. Looking beyond the current volatility, we have a positive view on the US dollar against other G4 currencies, while forecasting further depreciation against emerging currencies. This stance is at odds with the current blanket negative position, but accords more closely with US Treasury Secretary Geithner’s comments that major currencies were “roughly in alignment” as opposed to “those undervalued by any measure, including China”.

• Third quarter company results beat expectations, though profitability again outstrips sales

  With nearly a fifth of companies having reported quarterly results, the majority have beaten expectations, despite some headline-grabbing disappointments from financials. Recent lacklustre US economic data may have had an undue influence on consensus estimates, with aggregate results beating them by 8% so far. The greatest positive surprises have come from the Resources, Retail, Industrials and IT sectors, which have also tended to lead in past recoveries. Although sales growth was at its slowest pace since the trough in mid-2009, we are encouraged that the majority of companies have given positive sales guidance for the coming quarters.

• Germany continues to motor, even in the face of strong euro and weaker periphery

  The purchasing managers index for Germany rebounded to 56.0 in October from 54.7, with rising employment and an increased backlog of orders for the manufacturing sector. This underpins the relative outperformance of the Germany equity market over the last month, against both global and other euro-zone markets. By contrast the French PMI fell back to 55.3 (58.1), the weakest level for over a year, and the broad eurozone PMI dropped to 53.4 (54.1) as other economies saw output falling (PMI below 50).

Indices, Interest rates and Inflation

	Close     22 Oct 10	1 Week %	1 Month %	3 Months %	YTD %
FTSE ALL Share	2,967	0.6	3.6	8.3	7.5
FTSE 100	5,741	0.7	3.4	8.1	6.1
S&P 500	1,183	0.6	4.3	8.2	6.1
Nasdaq Composite	2,479	0.4	6.2	10.4	9.3
DJ Stoxx (Europe)	277	1.3	4.6	6.5	0.7
Nikkei 225	9,427	-0.8	-1.5	2.2	-10.6
Hang Seng	23,518	-1.0	6.7	14.2	7.5

 

Official Rates (%)				Inflation (%)	Rate announcement
	Current	Dec-10 Forecast	Mar-11 Forecast	Current	Next Date
US (Fed Funds)	0.25	0.25	0.25	1.1	03 Nov
UK (Base rate)	0.50	0.50	0.50	3.1	04 Nov
Euro-zone (Repo Rate)	1.00	1.00	1.00	1.8	04 Nov
Japan (Call rate)	0.10	0.10	0.10	-0.9	28 Oct

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