¤ Financial markets had a very tough month, characterised both low trading volumes and fears that the global economic recovery has slowed down.
¤ The main stimuli pushing down markets were both fears and an actual weakening in earning reports. Markets have begun discounting future economic slowdown.
¤ Technology stocks tumbled on worries of a cyclical slowdown. The Nasdaq hit new lows for the year near the end of the month.
¤ Markets waited patiently for the Fed to issue its report to Congress on the state of the American economy. Alan Greenspan, Federal Reserve Board chairman, said the main economic indicators show that the Fed may be justified to increase rates at a moderate pace. Greenspan also maintains that economic growth will remain robust with moderate inflation.
¤ In general, US data on the economic and corporate front set the tone for the world equity and bond markets.
¤ The European Central Bank left interest rates unchanged for the month.
¤ Oil remained in focus during July, increasing once again to record highs.
Financial markets overview
Markets had a very difficult month. Most main market indices around the world gave up their yearly gains and dipped into negative territory. The Nasdaq and the Nikkei 225 were the greatest losers of the month, closely followed by European and other US indices.
Worries about corporate earnings and spiking oil prices set the tone for equity performance. Stocks remained under pressure, dissuading investors from diving back into the market.
Disappointing reports from blue-chip companies such as Microsoft Corp. (Nasdaq) and Coca-Cola Co. (NYSE) added to choppy trading and violent swings, pushing the Dow Jones industrial average below the psychologically important 10,000 mark.
The Dow then pushed back past the 10,000 mark towards the end of the month on the back of a modest rally.
The Standard & Poor's 500 was down nearly 5% last month, with one trading week left. Assuming there was no change, the loss for the month will be the largest since December 2002 when the S&P 500 shed around 6%.
This did not occur however since all the main indices in Europe and the US rebounded during the final week of July to cut back some of the losses incurred. The loss over the month stood at 3.43%.
Overall, equity markets responded to these losses towards the end of the month, bouncing back from these lows. However, the month remains negative, with many indices having turned into negative territories on a year-to-date basis.
The stock market's weakness is likely to continue, if more companies give poor outlooks or miss their earnings guidance.
US Treasury yields fell throughout last month amid a modest rally on the news that the Fed would maintain a measured policy stance vis-à-vis interest rates. The yield curve as at the end of the month is illustrated in the graph below.
Main economic highlights
America's economic recovery appears to have hit a soft spot with consumer spending and job growth slowing under the weight of higher energy costs and market interest rates. But economists do not foresee a return to the sluggish pace of 2002 and 2003 so much as a welcome moderation of the expansion to strong from very strong.
It will ensure the Federal Reserve can be 'measured' as it raises interest rates, avoiding the risk of an economic swing from boom to bust if runaway growth sparks inflation and prompts the Fed to hike rates more aggressively.
Jobs growth slowed sharply in June, with the Labour Department reporting that 112,000 jobs were added to payrolls last month, less than half the 250,000 that Wall Street analysts had forecast.
In April and May, underlying consumer spending weakened and durable goods orders staged back-to-back declines. Consumer confidence has risen but major retailers like Wal-Mart and Target cut their forecasts for June sales, citing cooler weather.
Alan Greenspan reiterated that the Federal Reserve is likely to be able to raise interest rates at a measured pace, but said the economy appears well-prepared if rising inflation pressures demand "a more dynamic adjustment".
In upbeat testimony, Greenspan said a self-sustaining recovery appeared to be under way, and welcomed a broader recovery and stronger employment growth that should support consumer spending.
He played down the importance of recent weaker consumer spending, which he said probably reflected the impact of higher energy prices. The Fed chairman said that stronger demand growth had contributed to higher than expected inflation in the first half of the year. He stressed that transitory factors including higher energy prices had boosted the inflation rate.
But, in the twice-yearly testimony before Congress, in which Mr Greenspan speaks on behalf of the Fed's policymaking open market committee, he stressed that the central bank remained ready to "respond promptly and flexibly as situations warrant".
The Fed raised interest rates by a quarter point last month to 1.25%. Markets have interpreted its statement that it is likely to be able to raise interest rates at a measured pace as an indication it will raise rates in quarter point increments.
Mr Greenspan said businesses, households and financial markets appeared well prepared for a measured pace of tightening, pointing to refinancing of debt at low fixed interest rates and an unwinding by financial institutions of trades that rely on low short-term interest rates.
"Even if economic developments dictate that the stance of policy must be adjusted in a less gradual manner to ensure price stability, our economy appears to have prepared itself for a more dynamic adjustment of interest rates," he said.
Along with the testimony, the Fed released its governors and regional presidents' economic forecasts for 2004 and 2005. Policymakers have revised down forecasts of growth this year from a central tendency of 4.5-5% in February to 4.5-4.75% this year, and expect it to slow to 3.5-4% in 2005. Unemployment is expected to fall to 5.25-5.5% by the end of the year, to 5-5.25% by the end of 2005.
The recent decision to raise US interest rates by 0.25 percentage points to 1.25% has confirmed to investors that the Federal Reserve believes the economy is expanding at a pace which justifies monetary tightening.
US employment figures for June were slightly weaker than expected, although personal spending rose more than expected. The next few months should further clarify whether these figures signal a pause in an improving labour environment and if US inflation is sufficiently transitory to justify measured increases in interest rates.
Investors are likely to feel relieved that some of the uncertainty on monetary tightening has been reduced. However, the timing and size of further rate hikes remains of significant interest.
The current interest rate environment remains firmly rooted. The US and UK are set to increase rates with what has long been described as a measured pace. Switzerland and Australia had already begun to raise their interest rates before the US and the UK. The Eurozone as well as Japan will leave interest rates unchanged until economic fundamentals become more robust.
The Federal Reserve found economic conditions around the country worsened in June and early July, while the Commerce Department said orders for big-ticket manufactured goods rose by only 0.7% last month. They were the latest signals the economy was slowing in the early summer.
The US economy slowed dramatically in the spring to an annual growth rate of 3%, as consumers, worried about higher petrol prices, cut back their spending to the weakest pace in three years.
The April-June advance in gross domestic product, the country's output of goods and services, was below the 3.8% increase many economists expected and was significantly down from a revised 4.5% growth rate in the first three months of the year.
The administration, counting on a rebounding economy to bolster President George W. Bush's re-election prospects, insisted the second-quarter slowdown was only temporary and forecast that growth would rebound in the second half of the year.
Treasury Secretary John Snow noted the upward revision of the first-quarter GDP figures with the lower-than-expected second quarter figure. If the two figures were averaged together, he said, it gave evidence of an economy growing at a solid 3.75%.
"We're on a positive track, and the fundamentals are solid for the future," Snow said in a statement.
The Fed's survey, compiled from reports from its 12 regional bank districts, showed that retail sales, especially for cars, weakened over the last two months. That followed a big jump in consumer activity in the early spring.
Meanwhile, the Commerce Department reported that orders to American factories for big-ticket durable goods eked out a small 0.7% gain in June, reflecting a surge in orders for military aircraft, following declines in April and May.
The two new reports were the latest evidence of what Greenspan told Congress was a "soft patch" developing in the economy in June. However, Greenspan indicated he believed the slowdown would be temporary, based on a rebound in hiring that could bolster consumer spending in the months ahead.
In Europe, German business confidence rose for the first month in three in July as exports drove growth in Europe's largest economy and helped compensate for stagnating consumer spending.
The Munich-based Ifo institute said its confidence index, based on a survey of 7,000 executives, rose to 95.6 from 94.6 in June. Optimism among manufacturers in Italy also rose, a separate report showed.
With the global economy growing at its fastest pace in four years, German companies including BASF AG and Siemens AG are relying on the US and China to boost sales.
Exports will drive German economic growth to the fastest pace in five years in 2005, Wolfgang Wiegard, chairman of the government's panel of economic advisers, said in an interview.
In general, last month continued to show that the core economies of the Eurozone are weak. France, Germany and Italy have had relatively weak consumption figures and overall consumer demand is being underpinned by the smaller periphery economies.
Analysts have continued to stress that the Eurozone cannot rely solely on export lead growth as the primary driver.
Foreign exchange markets
Important to the US dollar, the US trade deficit narrowed in May for the first time in six months as exports surged to a record, led by aircraft, engines and other capital goods.
US imports also were a record. The $46 billion gap in goods and services trade followed a record deficit of $48.1 billion in April, the Commerce Department said.
The 4.5% reduction in the deficit in May was the largest since October 2002.
Exports increased as a drop in the value of the dollar made US products cheaper abroad. At the same time, Japan and other countries are likely to grow faster this year.
Foreign sales at US manufacturers such as Boeing Co. and Parker Hannifin Corp. are improving as a result, which may help underpin the US expansion. This news supported the dollar throughout the month.
Commodities
Oil prices hit their highest level in at least 21 years on July 28 after bailiffs ordered the beleaguered giant Russian oil company Yukos to stop sales, threatening further strain on tight international supplies.
The news intensified concerns over the lack of spare capacity in the international oil system, as the OPEC cartel pumped at its highest level for a quarter of a century to meet strong global demand growth.
US light crude settled up $1.06 at $42.90 a barrel after hitting a high of $43.05 a barrel, topping peaks hit in early June and the highest price since the New York Mercantile Exchange launched the contract in 1983.
London Brent crude settled up 99c to $39.53 a barrel after hitting $39.68, its highest level since October 1990, ahead of the first Gulf War. Prices jumped after a company source said Russian bailiffs told Yukos' production units, which together pump around a fifth of Russia's crude supply, to halt sales of property including oil.
Yukos has said it faces imminent bankruptcy as courts seek to enforce a $3.4 billion tax debt for 2000. It was not clear whether the order might force Yukos to halt shipments of oil or simply bar the company from signing new supply contracts. Oil brokers said Baltic and Black Sea loadings of Yukos crude were going ahead normally.
Gold had a relatively quiet month but still lost value over the month. Gold recorded a loss of 1.5%, having being traded across a wide range ($388-$405/oz). The small loss was a result of the dollar strengthening by over 1% last month versus other currencies.
Gregory Inglott, B.Com. (Hons.) Econ., MA (Fin. Serv.) is a financial analyst at Jesmond Mizzi Financial Services Ltd. This article does not intend to give investment advice and its contents should not be construed as such. Readers are encouraged to seek professional advice on their personal financial situation. Jesmond Mizzi Financial Services Ltd is licensed to conduct investment services by the Malta Financial Services Authority.