Global Markets Weekly – 12^th March 2007

Key Macro economic developments

• A degree of calm returned to the financial markets last week, with European equities managing to reclaim a degree of their lost ground, corporate bond spreads stabilising and policymakers at the European Central Bank (ECB) – by raising their benchmark interest rate by a further 25bp – demonstrating confidence in the medium term growth outlook. Indeed, the price action of recent days lends support to the view that the earlier, sharp declines in equities were driven as much by shifts in market positioning, and a perhaps inevitable spike in volatility from extremely low levels, than any underlying deterioration in the macroeconomic backdrop.
• However, with the recent market trends having provided a timely reminder of the perils of complacency, investors are likely to cast a much more discriminating eye to the data releases of the coming weeks, particularly those from the United States. We believe that the unusual weather patterns observed in the United States around the turn of the year have distorted the ‘true’ pattern of US data releases; firstly providing an artificial boost to the reported activity rates, and now depressing them. However, the outsize drop in US durable goods orders in January has encouraged a section of the market to speculate that something more fundamental may be amiss, and it is noticeable that Treasury yields have remained towards the bottom of their recent trading ranges despite the stabilisation of equities.
• With this in mind, the February employment report from the US, released last Friday, assumed an even greater significance than normal. In the event, the 97k gain in Non-Farm payrolls during the month, and the large upward revision to earlier months’ figures (a net 55k increase), will have gone some way to allay investor concerns over US growth prospects. Indeed, interest rate futures responded enthusiastically to the news, quickly scaling-back expectations of future monetary easing by the Federal Reserve, even though at least one interest cut before the end of the year is still ‘priced-in’.
• In the Euro-zone, meanwhile, the ECB’s intentions appear somewhat easier to read given the fairly hawkish tone of President Trichet’s commentary following last week’s rate hike (to 3.75%). With interest rates in the Euro-zone now close to most estimates of the ‘neutral’ rate – one which neither stimulates nor constrains economic activity – M. Trichet’s comments had been particularly eagerly awaited this month. A series of further interest rate rises appears less warranted now, and analysts had speculated over whether or not the ECB President would indicate that a peak in rates was close. But M. Trichet’s assertion that monetary policy is still on the ‘accommodative side’, while downplaying the significance of the recent dip in headline inflation, points to the maintenance of a clear tightening bias. However, it should still be seen that the ECB are no longer on ‘auto-pilot’, with the extent and timing of the ECB’s actions about to turn much more data-dependent.

Key global market developments

• The performance of the yen perhaps best demonstrated the calmer conditions that developed across the financial markets last week, with its softer tone helping to stimulate debate over the sustainability of carry trade activity, where funds in a low-yielding currency, such as the yen, are borrowed to invest in higher-yielding assets. A carry trade can hit the rocks through two main channels - either through unhelpful developments on the funding side (rate hikes) or through the poor performance of the assets that have been purchased at the end of the trade. After the muted reaction to the latest Bank of Japan rate hike, the coast had seemed clear for the carry trade, but this second possibility (poor asset performance) looked to be dominating as the markets wobbled, causing a sharp appreciation of the yen as speculative positions were reduced. Given the subsequent stabilisation of riskier assets, it was perhaps unsurprising to see the yen to surrender some of its gains last week. But we still believe that the sheer weight of the speculative position that has accumulated against the yen presents ample scope for the currency to experience further periods of strength during the remainder of 2007.

Indices, Interest rates and Inflation

	Close 9-Mar-07	1 Week%	1 Month%	3 Months%	YTD %
FTSE all share	3243.79	2.25	-1.96	2.05	0.69
FTSE 100	6245.23	2.11	-2.16	1.51	0.39
S&P 500	1402.85	1.13	-2.45	-0.50	-1.09
Nasdaq Composite	2387.55	0.83	-2.94	-2.04	-1.15
DJ Stoxx (Europe)	398.73	1.97	-3.01	3.61	-0.78
Nikkei 225	17164.04	-0.31	-1.94	4.55	-0.36
Hang Seng	19134.88	-1.58	-7.46	2.11	-4.16

Official Rates (%)				Inflation (%)	Rate announcement
	Current	Jun-07 Forecast	Dec-07  Forecast	Current	Next Date
US (Fed Funds)	5.25	5.25	5.00	2.1	21-Mar
UK (Base rate)	5.25	5.50	5.25	2.7	5-Apr
Euro-zone (Repo Rate)	3.75	3.75	3.75	1.8	12-Apr
Japan (Call rate)	0.50	0.50	0.75	0.0	20-Mar

	Selected Global Indicators	Consensus Forecast	Previous Result		Date	Time
GE	ZEW Survey (Mar)	3.2	2.9	month	13-Mar	09:00
US	Retail Sales (Feb)	0.3%	0.0%	mom	13-Mar	12:30
US	Business Inventories (Jan)	0.1%	0.0%	mom	13-Mar	14:00
UK	Average Earnings (Jan)	4.0%	4.0%	yoy, 3mth av	14-Mar	09:30
US	Current Account (Q4)	-$203.0bn	-$225.6bn	quarter	14-Mar	12:30
EZ	ECB Monthly Bulletin (Mar)				15-Mar	09:00
US	Net Long-term TIC flows	$45.0bn	$15.6bn	mom	15-Mar	12:30
US	Empire Manufacturing (Mar)	17.5	24.4	month	15-Mar	12:30
US	Philly Fed Survey (Mar)	4.0	0.6	month	15-Mar	16:00
US	Consumer Price Index (Feb)	0.3%	0.2%	mom	16-Mar	12:30
US	Consumer Price Index - Core (Feb)	0.2%	0.3%	mom	16-Mar	12:30
US	Industrial Prodn. (Feb)	0.2%	-0.5%	mom	16-Mar	13:15
US	Consumer Sentiment (Mar)	90.0	91.3	month	16-Mar	13:45

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