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Business • October 10 2004


International markets commentary - September 2004

Financial markets
During the last three months equities have had a difficult time. High oil prices caused fears that inflation would rise significantly, thus forcing central bank around the world to intervene. In addition, economic and corporate data coming out of the US and Europe indicated that the respective economies have slowed down their rate of growth. Alan Greenspan has defined this as a “soft patch.” Markets during this difficult period hit their yearly lows. From the main indices around the world, the Nasdaq was the most severely hit losing over 10 per cent. Technology and semi conductor stocks did not welcome the news that the economy could be slowing down.
In early September equities bounced back hard and regained much the losses made throughout the summer. Whilst they have not broken new highs, investors welcomed the news that inflation fears were unfounded. In fact, even though the price of oil has significantly risen it has not penetrated the core inflation figures. This was reassuring. Following this news, the Fed Reserve Bank raised its inter bank rate to 1.75 per cent an increase of 0.25 per cent.
China was the biggest gainer over the month following almost 6 months of drawdowns. During September the Shanghai China index gained an impressive 5.5 per cent. European markets all performed well with the German Dax and the FTSE 100 leading the gainers board. Japan a very sensitive country to fluctuations in the price of oil was the worst performer with the leading Nikkei 225 falling just over 2.5 per cent. American markets on the other hand had mixed performance with the S&P and the Nasdaq recovering whilst the Dow Jones lost ground. Companies that are sensitive to oil such as energy, construction and steel firms led the drop.
Even though interest rates in the US and the UK are likely to increase further in the coming months, bond prices were trading at high levels. In fact bonds rallied over the month of September. Whilst this rally has contradicted economic fundamentals, markets have priced into the bond market most of the short term interest rate increases. What has caused this rally was in fact investors placing positions on the strength of the economy. Investors that believe the economy will slowdown as a result of the above mentioned problems have placed long positions raising bond prices. In line with analysts expectations American Treasuries gained ground this month even though the US Federal Reserve raised interest rates. Over the month of September Yields fell from 4.35 per cent to roughly 4.05 per cent.

Main economic highlights
With the economy moving ahead albeit at a slower pace, stable inflation and the nation's payrolls picking up a bit, Federal Reserve policy-makers boosted short-term interest rates for a third time this year but it left economists split about when the next increase might come. As anticipated, the FOMC hiked its Fed funds rate by 25 basis points, from 1.5 per cent to 1.75 per cent. The Fed’s anxiously awaited accompanying press release also confirmed expectations that the American central bank continues to perceive optimism with respect to the economic picture. Moreover, taking into account the latest inflation data, the Fed has adopted a somewhat more upbeat stance in this regard as well. While the international bond markets have reacted slightly positively to the news, the dollar gave up considerable ground. Market participants are likely to call into question a move on the interest-rate front in November as well as scrutinise the Fed’s general rate-hiking pace again. Rates along the money-market curve could therefore decline a little, thereby paving the way for pleasant trading on the capital market.

The Fed will take a breather in November, especially to garner sufficient evidence for the anticipated slight acceleration in the US economy. But this, coupled with the slightly favourable news emanating from Asia, should lead to a correction in interest-rate expectations in the course of autumn. The Fed is also likely to adopt a more aggressive stance toward year-end regarding the inflation picture, underpinned by negative inflation surprises.
The US final reading for Q2 GDP report was revised to 3.3 per cent from last month’s preliminary estimate of 2.8 per cent, with the upward revision mainly emanating from an upward revision in inventories to $61.1 billion from $57.5 billion and a push up business fixed investment to 12.5 per cent from 12.1 per cent. Final sales were revised up to 2.5 per cent from 2.3 per cent. Nonetheless, the 3.3 per cent GDP reading is the lowest since Q1 2003 and remains well below the 4.5 per cent and 4.2 per cent GDP growth rates in Q1 and Q4 2003 respectively. It’s also worth noting that the 1.6 per cent reading in personal consumption was the lowest quarterly increase since Q2 2001.
The ECB in line with economic analyst’s expectations left its key interest rate unchanged at 2.0 per cent. Since this seemed to be a sure thing, the focus was as usual on President Trichet’s comments at the press conference. Staff projections for Eurozone inflation and economic growth in 2004 and 2005 took centre stage. At its meeting in June, the ECB announced it will publish the staff projections on a quarterly basis (and not only semi-annual) as of September. In fact, the ECB made some adjustments to the June projections for both 2004 and 2005.
The ECB expects inflation of 2.1 per cent-2.3 per cent in 2004, and 1.3 per cent -2.3 per cent in 2005. The lower band of the ranges is slightly higher than in the June projections. Trichet argued that an inflation rate below 2.0 per cent in 2004 is not likely after the development in oil prices seen recently. The ECB also communicated a slight adjustment in growth projections to 1.6 per cent-2.2 per cent in 2004 (after 1.4 per cent-2.0 per cent in June) and 1.8 per cent-2.8 per cent in 2005 (after 1.7 per cent-2.7 per cent in June).
In conclusion, the ECB’s concerns on inflation seem to have increased slightly. Furthermore, the ECB sticks to the view that the global recovery supports euro area export growth, although Trichet mentioned that there are temporary fluctuations in the robust growth. The ECB seems to feel comfortable with its current wait-and-see policy which thus far has been rewarded. The above confirm the view that the ECB will remain on hold for the time being. Its is expected that the ECB will make a first rate hike in Q1 2005 at the earliest.
Jean-Claude Trichet, president of the European Central Bank, delivered his strongest warning yet to Eurozone members not to embark on a "dangerous" weakening of the stability and growth pact that underpins the single currency. Mr Trichet also warned of the "enormous problem" posed by countries giving inaccurate assessments of their economies, after Greece admitted understating the size of its budget deficit for years. The ECB president fears that the integrity of the euro, and the central bank's efforts to hold down inflation, could be undermined by indiscipline among national governments in the 12-country bloc. Mr Trichet's unusually strong words reflect the anxiety at the ECB that member states want to break out of the fiscal straitjacket imposed on them by the stability pact. He criticised some of the European Commission's proposed reforms to the pact, which seeks to keep budget deficits below 3 per cent of gross domestic product. Mr Trichet warned of the threat posed by the Commission's proposal this month that Eurozone governments could be given a more flexible timetable for cutting big deficits, according to national circumstances.
In the foreign exchange market, the best performer of the month was the Euro gaining 2.4 per cent on the Dollar, over 3.9 per cent against the Yen and 1.2 per cent against the Sterling. The Determinants of this month’s movements were high oil prices which negatively affected the Yen and the USD as well as the fact that expectations of possible increases in interest rates in the UK have slowed down.

Commodities
Opec increased its oil production quotas by 1m barrels this month in a response to high oil prices, but the move was overshadowed by weekly data showing a sharp fall in US commercial crude oil stocks. The increase follows intense lobbying by Algeria and Kuwait to lift the quotas to better reflect actual production by the Organisation of the Petroleum Exporting Countries and send a signal to oil markets that the oil cartel is uncomfortable with oil prices above $40. Some Opec ministers privately described the quota increase as cosmetic and intended to deflect criticism from oil consuming countries. Delegates said after Opec's policy meeting that leaving quotas unchanged could have been interpreted as signalling lack of concern about high oil prices.
Opec's market analysts have forecast increased demand for the group's oil during the fourth quarter. The cartel's decision was overshadowed by a sharp fall in US commercial crude inventories. Crude stockpiles fell by more than 7m barrels to their lowest level since March, the seventh week in a row that the inventories of the world's largest oil consumer and importer have dropped. That was largely due to the hurricanes in the Gulf of Mexico and the Caribbean, which have hit oil tanker traffic to the US and domestic oil output. Lower inventories sent crude futures higher.
The latest inventory report contradicted the views of many Opec members who before their meeting cited fears about a large increase in global oil inventories as a reason for their reluctance to change the quota. "We did this to narrow the gap between real production and the quota and this is what it took to get the consensus," Ali Naimi, the oil minister of Saudi Arabia, said yesterday. However, Mr Naimi said the kingdom had no plans to increase production from its current rate of 9.5m b/d. Saudi Arabia is the only country with significant spare capacity to increase output. Other Opec members are producing at their maximum rate as global oil demand rises at its fastest rate in 28 years.
Traders said unrest in Nigeria's oil producing region was the main reason for the latest price rises. Analysts are indicating that $50 oil is just another step on the road to much higher crude prices. Other factors holding prices high included the slow return of US output after Hurricane Ivan, low US stocks and fears about interruptions to Iraqi supply. Also cited recent clashes between Saudi Arabian police and suspected Islamic militants in Riyadh as a destabilising influence on markets.
This commentary has been compiled by Gregory Inglott B.Com (Hons) Econ, M.A.(Fin Serv )who is a Financial Analyst at Jesmond Mizzi Financial Services Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. Readers are encouraged to seek professional advice regarding their personal financial situation. The value of investments can go down as well as up. Past performance is no guarantee for future performance. Jesmond Mizzi Financial Services Limited is licensed to conduct investment services by the Malta Financial Services Authority.





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