Global Markets Weekly – 5^th February 2007

Key Macro economic developments

• Last week brought a glut of US data releases and, of course, a Federal Open Market Committee (FOMC) meeting for the market to digest. But in truth the various figures failed to greatly alter the market’s perception on the US economy, and the Fed appear content to remain on the sidelines for the foreseeable future. The higher frequency data had already signalled that growth had improved during the final months of 2006, but the fourth quarter GDP report still managed to produce the most headline-grabbing report of the week. The preliminary growth figure came in at 3.5%, substantially above the consensus estimate of 3% and at a level that questions the very validity of talk of a US ‘slowdown’. That such a figure was returned even while the falling level of housing construction subtracted around a percentage point from growth was certainly impressive, and suggests that the weaker housing market has so far failed to affect other areas of the US economy. But the presence of a number of temporary, positive factors within the GDP report – most notably a strong contribution from net trade following the dip in the oil price – still points to some modest slowdown ahead and this was very much the message delivered from the FOMC’s latest statement.
• While policymakers noted that the weakness which develop ahead of the December 12^th FOMC meeting now appears to have lifted, and that a tentative improvement in conditions within the housing market appears to be underway, a more moderate pace of activity is still expected during the coming quarters. The initial data releases for January tend to support this argument, with the headline readings from the ISM and Chicago PMI surveys both falling short of expectations (and slipping below the crucial 50 level), while the non-farm payrolls data also reported some slowdown in employment growth during the month. With inflationary pressures still the primary concern for the Fed, such news will not be entirely unwelcome and we believe that policymakers will view the current profile of the US economy with a fair degree of satisfaction.
• Although underlying inflation – as measured by the core Personal Consumption Expenditure (PCE) deflator – remains above the Fed’s perceived comfort level of 1-2% (the core PCE was 2.2% in December), price pressures have shown few signs of escalating. Moreover, the orderly manner in which the housing market has slowed - thereby reducing a key threat to the stability of the US economy - should also be regarded as a key positive. Overall, the current trajectory of the US economy suggests that the Federal Reserve may be allowed to remain on the sidelines for an extended period, and this prospect should be viewed as good news for both equities and risk appetite more generally.

Key global market developments

• The broadly positive news on the US economy last week was also accompanied by stronger data from the Euro-zone (German and French labour market data) as well as the UK, but it was interesting to note the rather subdued reaction of the various government bond markets to such news. Long-term interest rates in these economies have of course experienced a significant, steady increase over the past few months but signs emerged last week that investors are beginning to be attracted by the level of valuations now on offer, with benchmark 10-year yields in the US, Euro-zone and UK all closing lower on the week.
• In particular, the shift in policy interest rate expectations that has occurred within these markets - with the US interest rate strip now effectively flat until year-end and further rate hikes priced-in for the Euro-zone and UK - suggests that economic strength, rather than weakness, is now anticipated by investors. This provides a substantial buffer to bond investors against any further upside surprises in the economic data. It will be interesting to see whether this gentle decline in yields survives the policy meetings by the Bank of England and European Central Bank next week, where no changes in rates are expected to be announced, but some further future tightening could well be indicated.

Indices, Interest rates and Inflation

	Close 02-Feb-07	1 Week%	1 Month%	3 Months%	YTD %
FTSE all share	3269.23	1.43	0.10	3.78	1.48
FTSE 100	6310.92	1.33	0.00	2.63	1.45
S&P 500	1448.39	1.84	2.12	5.93	2.12
Nasdaq Composite	2475.88	1.66	2.51	6.08	2.51
DJ Stoxx (Europe)	408.79	1.91	1.95	8.32	3.33
Nikkei 225	17547.11	0.72	1.87	7.32	1.87
Hang Seng	20563.68	1.39	1.25	9.88	3.00

Official Rates (%)				Inflation (%)	Rate announcement
	Current	Jun-07 Forecast	Dec-07  Forecast	Current	Next Date
US (Fed Funds)	5.25	5.25	5.00	2.5	21-Mar
UK (Base rate)	5.25	5.50	5.25	3.0	8-Feb
Euro-zone (Repo Rate)	3.50	3.75	3.75	1.9	8-Feb
Japan (Call rate)	0.25	0.50	0.75	0.3	21-Feb

	Selected Global Indicators	Consensus Forecast	Previous Result		Date	Time
EMU	PMI services (Jan)	56.8	57.2	month	05-Feb	09:00
UK	PMI services (Jan)	60.0	60.6	month	05-Feb	09:30
US	ISM non-manufacturing (Jan)	57.0	56.7	month	05-Feb	15:00
GE	Factory Orders (Dec)	0.5%	1.5%	mom	06-Feb	11:00
GE	Industrial Production (Dec)	0.5%	1.8%	mom	07-Feb	11:00
US	Non-farm productivity (Q4-prelim)	1.7%	0.2%	saar	07-Feb	13:30
UK	B of E rate announcement	5.25%	5.25%		08-Feb	12:00
EZ	ECB rate announcement	3.50%	3.50%		08-Feb	12:45
JP	Machine orders (Dec)	-0.7%	3.8%	mom	08-Feb	23:50

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