Global Markets Weekly - 1st October 2007

Key global market developments

• Money market crisis abates -good news for the economy...
  Money markets have begun to normalise again, reducing the risk that the credit crunch will trigger a recession. Since early August, $271 billion of asset-backed commercial paper (ABCP) has been replaced by bank lending. In one week in mid-August alone, almost $80 billion of ABCP was taken on to banks’ balance sheets. That pushed the difference between three-month and overnight dollar LIBOR – usually just a few basis points (bps) – above 50 bps.
• …though concerns linger over European and UK banks.
  But the flow of ABCP on to banks’ balance sheets has slowed considerably over the past two weeks, and the US money market spread has fallen to normal levels. UK and European money markets have also started to normalise but more slowly, reflecting concerns that their banks may be holding the sub-prime debt which remains unaccounted for. Unlike many US banks, they have not yet reported third-quarter earnings.


• US growth forecasts to fall, amid housing weakness.
  The consensus forecast for US growth in 2008 is currently around 2.0%; we think 1.5% looks more realistic. Last week’s figures suggest that housing is yet to bottom. Prices are now 14% below their peak five months ago. As the stock of unsold homes has risen to 8.2 months, more than double the boom-time level, house prices are likely to keep falling.
• We await next week's payroll report and ISM.
  Meanwhile, last week’s US consumer confidence survey suggests unemployment is on the verge of rising. We await Friday’s payroll report with interest. Consumer confidence fell to a two-year low in September, and buying plans were weak for cars, homes and appliances. This week’s other key release is the ISM manufacturing survey. So far, it has been holding up well, and we think it will continue to do so, thanks to the weak dollar and economic strength elsewhere in the world.
• Fed cut favours Asia and EM equities...
  We expect Asian and emerging equity markets to outperform in the wake of September’s cut in US interest rates. In the past, these markets have tended to perform strongly in the year after the Federal Reserve (Fed) starts cutting. History also shows that the next leg of a bull market after a correction is usually led by the markets that were outperforming beforehand – in this case, Asian and emerging markets. In addition, the sources of the present financial turmoil and economic slowdown are western and developed markets, leaving Asian and emerging markets looking fundamentally sounder.
• …notably Hong Kong.
  Hong Kong looks particularly interesting, as it was already booming and should benefit from having its rates cut in line with the Fed. Historically, the Hong Kong market has gained 30% on average in the 12 months after the Fed has started cutting. It shows every sign of following that pattern, after recently hitting its all-time high.
• Gold to gain further.
  After gaining steadily for over a year, the price of gold spiked upwards in September.Many commentators attributed the gains to inflation concerns. Yet we think slowing growth will keep inflation contained. In short, we favour gold, but for other reasons.

  First, the dollar is weakening, which generally supports the gold price. Second, cautious investors are seeking safe havens amid the current market volatility. And, third, demand is rising among the developing economies, whose increasingly affluent consumers and investors traditionally favour gold. Coincidentally, technical factors could push inflation higher in the short term - and that certainly wouldn’t hurt the gold price.

Indices, Interest rates and Inflation

	Close 28-Sep-07	1 Week%	1 Month%	3 Months%	YTD %
FTSE ALL Share	3,317	0.1	5.3	-2.1	3.0
FTSE 100	6,467	0.2	6.0	-1.6	4.0
S&P 500	1,527	0.1	6.6	1.4	7.6
Nasdaq Composite	2,702	1.1	8.0	3.6	11.9
DJ Stoxx (Europe)	420	0.3	4.4	-2.8	6.1
Nikkei 225	16,786	2.9	3.1	-6.4	-2.6
Hang Seng	27,142	5.0	16.2	23.7	36.0




Official Rates (%)				Inflation (%)	Rate announcement
	Current	Dec-07 Forecast	Mar-08  Forecast	Current	Next Date
US (Fed Funds)	4.75	4.50	4.50	2.0	31-Oct
UK (Base rate)	5.75	5.50	5.25	1.8	04-Oct
Euro-zone (Repo Rate)	4.00	4.00	3.75	1.7	04-Oct
Japan (Call rate)	0.50	0.50	0.75	0.0	11-Oct

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