Global Markets Weekly - 12th October 2007

Key global market developments

• The markets are calling the Fed’s bluff, looking for further rate cuts…
  At the end of October, the US Federal Reserve (Fed) stated that the upside risks to inflation roughly balance the downside risks to growth. That effectively signalled that, unless the activity numbers deteriorate markedly, the Fed doesn’t intend to cut rates again. Now, just ten days after that hawkish statement, the market is calling the Fed’s bluff. Since the end of October, the global financial sector has fallen 9%, the dollar is down 2% to a new tradeweighted low, bonds are rallying (especially at the short end), gold is up 5% to new record highs, and oil is approaching $100 a barrel.
  
• …as worries increase over sub-prime’s impact on the economy.
  These market moves are being driven by two concerns: the first over a late-cycle outbreak of inflation; and the second over the impact of further sub-prime mortgage related write-downs on both the financial sector and, perhaps more importantly, the wider economy. Of these two factors, we think the second is the biggest worry and, consequently, it’s becoming more likely that the Fed will be forced to swallow its hawkish statement and cut again at its December meeting.
• Equities haven’t suffered too much, especially in Asia and emerging markets...
  So far, equity markets have been less hard hit in this sell-off – which has been induced by the credit crunch – than they were in the summer. That’s particularly true of our favoured emerging and Pacific Basin equity markets, thanks to their lower exposure to the US sub-prime sector and their stronger growth prospects. Indeed, some emerging markets – notably commodity producers, such as Russia – have actually risen in value.
• …but equities now face an uphill climb.
  For equity markets to make more progress this year, the Fed would probably have to shift back to a more dovish stance. Mature bull markets not only tend to be very liquidity-driven but also generally have narrow sector leadership and are very volatile. So any further gains from equities are likely to be driven by a handful of sectors and will not
  be for the faint-hearted..
  
• Mortgage defaults shouldn’t be enough to trigger a US recession…
  We estimate that, from now to the end of the decade, between $160 billion and $260 billion will be lost on US mortgages that foreclose. The difference between the two figures comes down to whether US house prices fall by 10% or 20%. For a $12 trillion economy, that represents between 1.4% and 2.2% of one year’s output. So, given that it will
  be spread over several years, the impact will be painful but not terminal.
• …but should have a larger impact on bank lending.
  More worryingly, that figure represents twice that percentage of the asset base of the US banking sector. A contraction in their asset base on that scale will make banks less willing to lend to households and companies. It is always difficult to quantify the precise economic impact of credit crunches. But the quarterly surveys of bank lending from both the Fed (which was published last week) and the European Central Bank provide evidence that banks in the US and in the eurozone are becoming more cautious about lending.
  
• After oil’s recent surge, we could see some profit-taking.
  Oil looks vulnerable to a near-term correction. Sentiment is very bullish and both momentum and speculative positioning are near extreme levels. If – as looks increasingly likely – the oil price hits $100 a barrel, it will have increased almost tenfold from its 1998 low, closely paralleling its gains in the energy bull market of the 1970s. Yet reaching a large round number such as $100 will probably provide an excuse for some profit-taking.

Indices, Interest rates and Inflation

	Close 8-Nov-07	1 Week%	1 Month%	3 Months%	YTD %
FTSE ALL Share	3,278	-3.3	-2.5	-0.9	1.8
FTSE 100	6,382	-3.1	-2.4	-0.2	2.6
S&P 500	1,475	-2.2	-5.0	-1.5	4.0
Nasdaq Composite	2,696	-3.5	-3.3	3.2	11.6
DJ Stoxx (Europe)	418	-1.8	-2.4	-0.4	5.6
Nikkei 225	15,772	-6.5	-7.6	-7.4	-8.4
Hang Seng	28,760	-8.7	3.6	27.6	44.1




Official Rates (%)				Inflation (%)	Rate announcement
	Current	Dec-07 Forecast	Mar-08  Forecast	Current	Next Date
US (Fed Funds)	4.50	4.50	4.50	2.0	11-Dec
UK (Base rate)	5.75	5.75	5.50	1.8	06-Dec
Euro-zone (Repo Rate)	4.00	4.00	4.00	1.7	06-Dec
Japan (Call rate)	0.50	0.50	0.75	-0.2	13-Nov




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 should not be taken as 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 analysis in this document has 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. To the extent permitted by law ad without being inconsistent with any applicable regulation, 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 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. Certain aspects of the service may be performed through, or with the support of, different members of The Royal Bank of Scotland Group, of which Coutts & Co is a member.

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 KY1-107, Cayman Islands. Licensed under the Banks and Trust Companies Law (2007 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.