Global Markets Weekly – 11^th December 2006

Key Macro economic developments

• Highlighting the current strength of the labour market as a defence against a looming slowdown in growth can often cause controversy within the world of economics, given that the unemployment is generally seen to lag rather than lead the economic cycle. But the solid set of figures contained in the November employment report should go some way to alleviate the concerns that have arisen of late around the outlook for the US economy in 2007. Non-farm payrolls rose by a robust 132k in the month, and there are few signs yet that the well documented weakness within the construction and manufacturing industries is spreading to other areas. Income growth also looks to be rising at a reasonable rate, and although the separate household survey data showed the unemployment rate to have risen slightly last month (to a very low 4.5%), the overall message of the employment report was of a still healthy corporate sector providing substantial support to US households.
• The focus of attention is likely to switch back towards the inflationary outlook over the coming week given the release of key CPI data in the US, Euro-zone and UK, but the highlight of the week may actually be provided by the Japanese Tankan report. Given the lingering concerns over the ability of the Japanese economy to withstand a slowdown in export demand, the areas of the survey more focussed upon the domestically orientated sectors of the economy are likely to receive particular attention from analysts.

Key global market developments

• During the course of this year, the financial markets have consistently underestimated both the strength of the Euro-zone economy and, more pertinently, the European Central Bank’s (ECB) determination to push interest rates progressively higher. Judging by the reaction to last week’s move by the ECB to raise its refi rate to 3.5% - the highest level for some five years - and President Trichet’s comments regarding the outlook for a further monetary tightening, this rather unfortunate habit is threatening to escape the attention of many New Year resolution lists and persist into the course of 2007. The 2-year German bund yield, for instance, has tended to move upwards in a rather step-change fashion over the past year, as interest rate expectations were subjected to several significant but sporadic adjustments. However, yields have tended to edge lower over the past month as talk of an imminent peak in Euro-zone interest rates has gathered ground, no doubt encouraged by the recent retreat of equities and the sizeable appreciation in the euro/dollar exchange rate. Many also construed President Trichet’s commentary last week to have been less hawkish than previous statements, suggesting that interest rates may be on hold for a prolonged period, if a peak in the current cycle hasn’t already been achieved. However, we found little basis for such a view, and believe that the market may again be surprised by both the performance of the Euro-zone economy and the ECB’s intentions during the early months of 2007.
• President Trichet referred to the still ‘accommodative’ policy stance and the ‘ample’ levels of liquidity, suggesting that policymakers see interest rates as being some way below the neutral rate (one which neither stimulates nor restrains activity). Given that a broad range of ECB officials have suggested the Euro-zone economy is currently expanding by at least its trend rate, and that the ECB’s GDP estimates for 2007 & 08 were revised higher last week, some further tightening of monetary policy seems more than likely. In addition, it may be incorrect to read too much into Trichet’s refusal to provide any explicit guidance on the possible timing of this move, as the ECB are thought to reach policy decisions by way of a gradually developing consensus, and decisions cannot therefore be seen be to be pre-empted by any single member of the bank’s Governing Council. Overall, with the ECB likely to ‘look through’ any volatility created within the quarterly flow of GDP data created by the imminent German VAT increase, the market could well be forced to reassess its assumptions around the Euro-zone economy during the early months of 2007.

Indices, Interest rates and Inflation

	Close 08-Dec-06	1 Week%	1 Month%	3 Months%	YTD %
FTSE all share	3178.59	2.20	-0.56	6.07	11.65
FTSE 100	6152.44	2.17	-1.39	4.65	9.50
S&P 500	1409.84	0.94	1.74	8.54	12.94
Nasdaq Composite	2437.36	1.00	2.20	12.54	10.52
DJ Stoxx (Europe)	384.86	2.32	-0.24	8.71	17.01
Nikkei 225	16417.82	0.59	1.25	2.10	1.90
Hang Seng	18739.99	0.26	-0.38	9.30	25.97

Official Rates (%)				Inflation (%)	Rate announcement
	Current	Dec-06 Forecast	Jun-07  Forecast	Current	Next Date
US (Fed Funds)	5.25	5.25	5.25	1.3	12-Dec
UK (Base rate)	5.00	5.00	5.00	2.4	11-Jan
Euro-zone (Repo Rate)	3.50	3.50	3.75	1.6	11-Jan
Japan (Call rate)	0.25	0.25	0.50	0.4	19-Dec

	Selected Global Indicators	Consensus Forecast	Previous Result		Date	Time
UK	CPI (Nov)	2.6%	2.4%	yoy	12-Dec	09:30
GE	ZEW survey (Dec)	-25.0	-28.5	month	12-Dec	10:00
US	Trade Balance (Oct)	-$63.3bn	-$64.3bn	month	12-Dec	13:30
US	FOMC announcement	5.25%	5.25%		12-Dec	19:15
UK	Average Earnings (Oct)	4.0%	3.9%	yoy	13-Dec	05:00
US	Retail Sales (Nov)	0.2%	-0.4%	mom	13-Dec	10:00
UK	Retail Sales (Nov)	3.0%	3.9%	yoy	14-Dec	09:30
JP	Tankan survey (Q4)	25	24		14-Dec	23:50
EZ	CPI (Nov)	1.8%	1.8%	yoy	15-Dec	10:00
US	CPI (Nov)	0.2%	-0.5%	mom	15-Dec	13:30
US	Industrial Production (Nov)	0.1%	0.2%	mom	15-Dec	14:15

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