Global Markets Weekly – 26^th March 2007

Key Macro economic developments

• There has been much talk amongst investors of late about the reduced dependence of global growth upon a strong US economy, and for the most part we agree with this argument. The performance of the European and Asian economies have generally beaten expectations over the past year or so, even while US demand growth has slowed. The emerging economies also look to be assuming an increasingly important role within the global economy. This is perhaps one reason why commodity prices, and other indicators of global activity (such as shipping rates), have remained at elevated levels even while questions have arisen over the prospects for the US economy.
• But whilst the focus of global growth may have turned to a less US-centric basis over the past year or so, this process - for the moment at least - looks to be rather less well advanced across the financial markets. Developments Stateside appear to be dominating investor sentiment at present, as events in the UK demonstrated last week. There was plenty of domestic news on offer, such as important retail sales and inflation data releases, and of course a Budget statement. Yet the reaction to all of this was muted, with UK equities saving by far their most enthusiastic response for a subtle change in tack from the Federal Reserve (see below).
• The muted response of the UK markets to the contents of the Budget, however, does seem appropriate. Although attention-grabbing reductions in the headline rates of business and personal taxation were revealed, the less well-publicised means of financing these measures will ensure that the fiscal position is little changed overall as a result of last week’s announcements. Indeed, once the changes in taxation from the November Pre-Budget Report are considered, a fairly sizeable tightening of the fiscal stance is still pencilled in for the next couple of years.
• One interesting feature, however, could result from the decision to reduce the tax benefits on certain types of business investment from April next year (capital allowance falling from 25% to 20%). A similar measure, when announced in the 1984 Budget by the then Chancellor Nigel Lawson, prompted businesses to ‘bring forward’ planned investment in order to maximise the still available tax benefits. This led to some volatility within the GDP data of the time, and although the scale of the tax changes are smaller this time around, it will nevertheless be interesting to see if a similar spike in investment expenditure occurs over the coming year.

Key global market developments

• The apparent soft patch of activity in the US economy, the problems within sub-prime lending and the recent increase in financial market volatility are all likely to have featured heavily in the deliberations of policymakers at last week’s Federal Open Market Committee (FOMC) meeting. As was universally expected, these problems were not viewed as sufficiently worrisome to force a change in interest rates. But a small and possibly significant change in the Committee’s policy statement did occur, encouraging investors to look for some shift in rates before year-end.
• While inflation was still described as the FOMC’s predominant concern, the earlier explicit suggestion that some additional tightening yet may be required (to ensure price stability) was removed from the statement. The more mixed nature of the recent activity indicators was also acknowledged, particularly within the housing market, as the monetary policy outlook was effectively moved to a more neutral stance. We still believe that an interest rate cut will only become a possibility towards the end of 2007, and the recent communications of Fed officials appear to support this view. Nevertheless, by deciding upon this subtle shift in communication, the Fed has undoubtedly provided itself with a degree of added flexibility – or ‘wiggle room’ in market speak – should conditions deteriorate further, all of which last week helped equities to recapture a sizeable chunk of their recent losses.

Indices, Interest rates and Inflation

Disclaimer

Issued by Coutts & Co, which is authorised and regulated by the Financial Services Authority.

The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.  Past performance is not necessarily a guide to future performance.  Where an investment involves exposure to a foreign currency, changes in rates of exchange may cause the value of the investment, and the income from it, to go up or down.

The information in this document is not intended as an offer or solicitation to buy or sell securities or any other investment or banking product, nor does it constitute a personal recommendation.  The information shown is believed to be correct but cannot be guaranteed.  Any opinion or forecast constitutes our judgement as at the date of issue and is subject to change without notice.  Any Coutts company, or a connected company, its clients and officers may have a position or engage in transactions in any of the securities mentioned.

The research and analysis in this document have been procured, and may have been acted upon, by Coutts & Co and connected companies for their own purposes, and the results are being made available to you on this understanding.  Neither Coutts & Co nor any connected company accepts responsibility for any direct or indirect or consequential loss suffered by you or any other person as a result of your acting, or deciding not to act, in reliance upon such research and analysis.

Not all products and services offered by the individual Coutts companies are available in all jurisdictions, and some products and services may be available only through particular Coutts companies.  Investment services for US residents are provided by Coutts & Co Investment Management Limited, an Investment Advisor registered with the Securities and Exchange Commission under the Investment Advisors Act 1940 and authorised and regulated by the Financial Services Authority in the UK.

None of the overseas Coutts companies or offices is an Authorised Person subject to the rules and regulations made under the Financial Services and Markets Act 2000 for the protection of investors and depositors, and compensation under the Financial Services Compensation Scheme will not be available in respect of business transacted with them.

Coutts (Cayman) Limited. Registered Office: Coutts House, 1446 West Bay Road, PO Box 707, Grand Cayman KY1-1107, Cayman Islands.  Licensed under the Banks and Trust Companies Law (2003 Revision). Coutts (Cayman) Limited is not regulated by the Cayman Islands Monetary Authority in its conduct of securities investment business.

Coutts Offshore Europe Limited.  Registered office: 23-25 Broad Street, St Helier, Jersey JE4 8ND.  Regulated by the Jersey Financial Services Commission for carrying on investment and trust company business. Regulated by the Guernsey Financial Services Commission for carrying on investment business.  Trading in Jersey as Coutts Channel Islands.  Business address in Isle of Man: PO Box 59, Royal Bank House, 2 Victoria Street, Douglas, Isle of Man, IM99 1DU.  Licensed by the Isle of Man Financial Supervision Commission for Investment and Corporate Service Provider business.  Trading the in Isle of Man as Coutts Isle of Man.