Europe bulging at the centre

The US FOMC (Federal Open Market Committee) increased its funds rate by a quarter-percentage point last Thursday as expected to 3.25%, following on its slow and measured path of more credit tightening and restating its confidence in the expanding US economy. The rate increase was the ninth consecutive increase and brought rates to the highest level since June 2001.

The strong US economy when compared to Europe’s struggling economy and political upheaval, have helped the dollar rally as well, driving the currency up 12% against the euro and nearly 7% against the yen so far this year.

Rising US interest rates certainly helped the dollar as they make dollar-denominated securities more attractive to foreign investors, but the higher dollar also weakens the strength of US exports by making them more expensive, thus slowing growth.

Also on the currency front, the European Central Bank (ECB) and the Bank of England (BoE) will both deliver rate decisions today. The Pound has sunk to near 14-month lows against the greenback and held near one-month lows against the euro on concerns that the Bank of England may start cutting rates.

EU’s hiccup

The recent charge forward of the US Dollar may be seen by some as a step in the right direction and a return to normalcy. However, investors should remain cognisant of some likely long-term scenarios. The weakness in Europe, although difficult at this time, will find resolution and once again return to economic growth. The EU political upheaval will also find some direction. We believe there is good reason for the EU to succeed, but not in the format of "a one for all and all for one" policy which was recently rejected.

Clearly the common currency, open borders for trade and reduced immigration controls will be beneficial.

United States

In a final revision, it was announced that the US economy grew at a 3.8% annual rate in the first quarter, matching the pace in the previous three months. The final figure compares with the 3.5% growth rate estimated in May. In economic news, consumer spending was unchanged in May, slightly weaker than expected, according to Commerce Department data. Also, the Labor Department reported that new unexpectedly fell last week.

On the US corporate front, Oracle, the world’s third-largest software maker, announced that fourth-quarter earnings increased by 3.2%, bolstered by CEO Larry Ellison’s $11.2 billion acquisition spree and rising demand in North America.

Net income rose to $1.02 billion from $990 million a year earlier. Now that is a big company. And the tech story of the year continues. Google’s shares rose above US $300 after less than a year as a public company, cementing the most-used internet search engine’s status as the world’s largest media company by market value.

United Kingdom

In the UK, equity markets rose over the week, lead by the FTSE 100 Index, which hit a new 52 week-high. The FTSE Mid 250 Index also logged some pretty stellar gains. The FTSE Smaller Companies Index closed the week down by 0.3%, as that segment of the market continued to surrender earlier gains to larger companies. The UK Government ten-year Gilt Index fell slightly, after a relatively volatile week.

The European Union:

Finally some good news. The European Commission’s economic sentiment indicator rose from 96.1 in May to 96.3 in June after declining since last October. It was helped by a strong increase in France. And Germany’s IFO business sentiment index registered its first increase in five months. The index rose from 92.9 in May to 93.3 in June. However, the news failed to lift investors’ spirits and we suspect until some employment figures change to the positive, it will be difficult to get German economic statistics to improve. Remember unemployment in the world’s most expensive economy is still up around 12%.

Japan

Last week’s record oil prices caused the Japanese market to fall early in the week, but equities recovered to close the week higher once again. This was the sixth week in a row the Japanese market generated a positive return, the longest succession of gains since September 2003. Towards the end of the week, stocks benefited from a quarterly review of business confidence from a survey that showed business optimism increased for the first time in three quarters.

Looking Ahead:

More stories this week in the media over the effects of the housing bubble in the economies. There is either that of a self fulfilling philosophy or early warning to mitigate the impact. Based on benchmarks from a recent IMF study comparing the stock and housing market bubbles in the United States, there are about 15 states that are vulnerable to a housing market correction. This represents about 35 percent of GDP. Just a reminder that earnings season is coming and the second quarter is generally the worst. Summer attitude and the fact that it is a slow time of year always have an effect.

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