US Home Price Downtrend Set To Persist

Until the decline in home prices is halted, the battered housing market won't be able to recover nor will the economy be able to return to sustainable trend-like growth.

It's all about real home prices. And home prices won't recover until housing becomes more affordable - and that will require a prolonged decline in mortgage rates. That's the conclusion that Lakshman Achuthan, managing director at the Economic Cycle Research Institute in New York, draws from the recent behavior of ECRI's U.S. Leading Home Price Index. "We expect this price trend to continue on a downward swing," he said. "This will continue until the Federal Open Market Committee can drive mortgage rates lower and boost housing affordability."

The Key Role Of Home Prices

Home prices are currently playing two important economic indicator roles: -They reflect the health of the residential real estate sector itself. Rising real home prices signal a healthy, thriving real estate market. -An increase in home prices bolsters household wealth since home equity represents the largest portion of household wealth. It still accounts for more than 36% of net worth at the end of June, down from 37% in March. An uptrend in home prices is desirable as it increases the wealth effect and consumers' ability to maintain spending - a key element of economic growth. But nominal home prices have been on an accelerating downtrend in recent months. Nominal existing median home prices were down 2.4% for the month in August and down 0.3% from a year earlier, and new median home prices were down 8.4% month-to-month, and 7.5% year-to-year. September data are due Wednesday and Thursday respectively. ECRI combines new and existing home prices (there are roughly seven times as many existing home sales as new home sales) and deflates the result to get a composite measure of real median home prices. The August reading for that composite measure hit a three-year low and the September reading of ECRI's U.S. leading home price index pointed to continued declines. Moreover, the declines in real home prices occurred in all four regions of the country - Northeast, Midwest, South and West. An upturn in real median home prices is seen as a precondition for a resumption of a sustained overall growth rate. That is still a development that is a hope, not yet a reality. Higher home prices will reflect stronger demand for housing which would signal a turnaround in one of the weakest sectors of the economy. In addition, it would accompany a further increase in household wealth that would supplement income gains and fuel consumer spending.

The Fed's Role In Housing

The Federal Reserve has no direct control over mortgage rates, which, in the case of fixed rates, are tied to the 10-year Treasury note's yield. Indeed, in the past years, the Fed has been stymied by the behavior of long-term rates, which remained low even as the central bank embarked on a campaign to raise short-term rates. Now, however, long-term yields have risen back above short-term yields as the market prices in rate cut expectations and concerns about inflation push yields higher on longer-dated maturities. What the Fed can do, in Achuthan's view, is use the communication of its policy intentions to investors as a way to influence the direction of long-term rates. He points to the statement following the Sept. 18 policy meeting - at which the Fed cut the federal funds and the discount rate each by 50 basis points to 4.75% and 5.25% respectively. That statement said that "economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally." If the Fed keeps the housing market front and center in its assessment and continues to play down its inflation concerns, Achuthan believes that financial market participants may feel more comfortable with lower long-term rates - including mortgage rates. Moreover, Achuthan points out that the Fed should be able to lessen its inflation concern given that ECRI's future inflation gauge is showing that "underlying inflation pressures remain in a cyclical downtrend." The FOMC next meets for a two-day meeting that ends Oct. 31. Markets are expecting a 25 basis point rate cut and another cut in the discount rate - which, if that rate is brought in line with the funds rate, could help push lower the London interbank offered rate that forms the base for adjustable rate mortgages. Fed officials have played an even hand as the next meeting approaches, acknowledging the decline in price pressures excluding the volatile food and energy sectors, and the dire state of housing, while at the same time affirming the Fed's focus on inflation. Chairman Ben Bernanke, speaking in New York last week, noted the central bank stands ready to act if the downdraft in housing and related credit market turmoil hurt the economy. But he also stressed that the Fed is ready to reverse September's rate cuts if inflation gets out of control.

Bernanke: Hard For Policy To Address Market Bubbles

Central bankers are limited in identifying and addressing asset price bubbles, and such disruptions are in any case a hard-to-avoid side effect of having a dynamic financial sector, Federal Reserve Chairman Ben Bernanke said Monday.

"It is very, very difficult to ascertain whether a bubble is in progress early enough in the process to address it effectively using macro and monetary policy," the central banker leader said. Bernanke was speaking at a gathering of the Economic Club of New York, and his comments came in response to questions from Henry Kaufman, of Henry Kaufman & Co., and Bear Stearns Chief Economist David Malpass. The chairman's remarks arrive at a challenging time for the central bank. The Fed responded last month to the recent market trouble and its negative implications for growth with an aggressive half-percentage-point rate cut last month, and for some time, most on Wall Street have expected to see further easing. But a string of recent economic data, from jobs numbers through to retail sales, has shown surprising resilience in the face of the gyrations of the financial sector. For some, the data are calling into question the need for additional rate cuts, and futures markets have largely priced out of the market any additional move lower in what is now a 4.75% fed funds rate. In his formal remarks, the central bank leader had said "the improved functioning of financial markets is a positive development in that it increases the likelihood of achieving moderate growth with price stability." But Bernanke had also warned it remains "uncertain" what impact the market troubles will have on overall economic growth. He added the Fed "will continue to watch the situation closely and will act as needed to support efficient market functioning" along with promoting growth and price stability. Bernanke's post speech remarks were wide ranging, and addressed the limits central bankers have in remedying market problems. "One of the downsides of innovation is that sometimes you make mistakes and have problems," Bernanke said, referring to some of the troubles that have beset financial markets over recent months. On the matter of technological change and the rise of things like subprime mortgage lending, he said "if we want to have innovation and growth and productivity and change and dynamism, we have to let the system work and we have to sometimes have problems."

Important For Flexible Exchange Rates In Large Economies

Referring to the root of the current troubles, namely understanding the pricing and risk profile of many types of securities, Bernanke said "there is no totally satisfactory solution" to the problem. "The best answer" to a better valuation process "is that the firm or vehicle in question needs to be as transparent as possible about what it is and how it values its assets." Bernanke added some of the current stress in markets represents an "information problem, and it will take a while for investors to appropriately value" the assets they hold. The central banker also said it was particularly valuable the insights the Fed has gained into banks' health as a result of the Fed's regulatory activities. The Fed chairman also commented on the dollar's shifting value on U.S. inflation dynamics. Bernanke said, "it is important that we pay attention to (exchange rates) and figure them into our calculations." "One cannot deny that all else equal, when the dollar depreciates there is some inflationary effect," Bernanke said. But, "our experience over the recent decade has been that those effects are relatively small." He also said it's important for large economies to have flexible exchange rates. The Fed chief also said in his post speech remarks that while there does appear to be somewhat of a short-run tradeoff between growth and inflation, "over the longer period, we now understand low inflation is essential for solid economic growth to persist and be sustained." Bernanke added "we at the Federal Reserve will be very focused" on achieving that low inflation goal. Bernanke also said that in the long running debate over the low savings rate in the U.S., it's more important to weigh overall wealth levels, rather than just how much money is saved.

Greenspan: Economic Data Look Good Through Third Quarter

While U.S. economic data look good in the third quarter, the growth rate will continue to slow and the housing market will weaken further, former U.S. Federal Reserve chairman Alan Greenspan said Wednesday.

Greenspan said that the economic growth rate should continue to slow through the rest of the year and into the first quarter of 2008. The "critical issue" now for the U.S., as well as globally, he said, is where home prices are headed, and he expects a "significant decline." Greenspan was speaking before attendees at the World Business Forum, held Wednesday and Thursday at Radio City Music Hall in New York. "The critical question is the price level of homes in the U.S., which are almost certainly going to fall," Greenspan said, as the hefty inventory of unsold homes continues to drive down prices. "What we don't know at this stage is whether in fact the decline in home prices will be a large one or a modest one," he said. Greenspan said that given the current climate, the odds that the U.S. will skirt a recession now look to be better than 50/50. In March he put the odds of a recession over the next six to nine months - at one-third. That could be offset though by stock market prices, he said, if they continue to rise. In his remarks, Greenspan also addressed the credit crisis that roiled markets this summer, noting that credit changes were "an accident waiting to happen" given the low level of credit spreads for such a long period of time. "History always suggests that that does not last," Greenspan said. "If it wasn't subprime, it would have been something else." Greenspan though noted that the U.S. came into the credit crisis amid a "fairly strong" global upside move," adding that talking about the U.S. economy without the global context is "no longer relevant." Turning to China, Greenspan said that growth there has been "quite remarkable," adding that "nobody is fully cognizant or understands why they have done so well for so long. China has moved "very dramatically toward capitalism," he said, and even though it appears to be "overheating," the country continues to progress. Greenspan also said that rising Chinese inflation was "not all that significant" noting that much of that increase was due to rising food prices. But, he added, "at some point, they've got to slow down" and it's conceivable that other areas of eastern Asia could begin to be successful in competing with the country. But as yet, "they're still the dominant force and at least through the Olympics, China "should do very well."

BOJ Fukui's Bearish Words Suggest Hike Will Be Months Away

Bank of Japan Gov. Toshihiko Fukui Thursday emphasized global economic risks and unstable markets at a news conference after the BOJ's board voted once again to keep interest rates steady.

His bearish remarks suggest that a rate hike in Japan remains months away. It was the fourth consecutive month that the BOJ board voted 8-1 to keep interest rates on hold, despite their desire to gradually raise rates to around 2% from the current level of 0.50%. "We must carefully examine developments of the global economy and financial markets as they are still unstable, although the global economy is likely to keep expanding," Fukui told reporters Thursday afternoon. Before the meeting, speculation had centered on whether Atsushi Mizuno, the board's most hawkish member, would convince any colleagues that an immediate rate hike was needed. His failure to do so suggests the extent to which the BOJ is concerned about the economic fallout from the U.S. housing crisis, which wreaked havoc on global financial markets this summer. Most board members believe Japan's economy and prices are still moving in line with the bank's outlook from last April, Fukui said. But he noted that adjustments in the U.S. housing sector remain the primary factor in determining the outlook for the U.S. economy -- the main outlet for Japanese exports -- and they may take a long time to play out. "Although some improvements are seen in the U.S. and European economies since the Bank of Japan's policy board meeting last month, uncertainty still remains on the whole," he said. Analysts had wondered if the unusually long meeting meant the BOJ board was torn over a rate hike, but the tenor of Fukui's comments suggested otherwise. "If the vote had been 7-2, market participants would have started speculating about an early rate hike in October or November. Even if the results were 8-1 but Fukui had said something hawkish, hinting at a possible rate hike within this year, the market would have paid attention to it," JP Morgan chief JGB strategist Akihiko Yokoyama said. "But we didn't see anything hawkish relative to his previous press conference or his previous comments. I didn't see any step-up in terms of hawkishness." A Credit Suisse survey indicated that markets only expect a 16% chance of the BOJ lifting rates next month.

Notes Markets Still Unstable

Indeed, Fukui noted that volatility in global stock markets has lessened, but financial markets are still unstable and corporate bond spreads remain wide. "Money markets are regaining function, but borrowing costs or interest rates among banks remain at high levels," he said. "It's premature to say that the functions in money markets have recovered." As for Japan's economy, Fukui said that "long-lasting economic growth will likely continue, as a favorable cycle led by production, income and expenditure remains intact." Despite their concern over downside risks, the policymakers maintain that Japan's economy and prices continue to move in line with their April forecast of 2% growth. Fukui acknowledged that wage growth has been slow, but said CPI should turn positive soon. Board members likely will discuss whether they need to alter their view at their next meeting Oct. 31, when they'll compile a new semiannual outlook report. Many analysts feel the BOJ can't possibly raise rates while the Federal Reserve Board and European Central Bank remain concerned about liquidity. The Fed cut its federal funds rate in September to 4.75% from 5.25%, its first rate cut in more than four years, and some market players expect it to cut rates again when it meets this month. But Fukui said the BOJ would set its own course, and wouldn't bow to the wishes of other members of the Group of Seven industrialized nations, who are expected to discuss recent market instability when they meet this month. "We will determine policy based on our own view of the economy and prices," he said. Not everyone buys that. "They want to keep the door open to tighten credit, but they don't want to back themselves into a corner where they're doing it too soon," Royal Bank of Scotland strategist John Richards said. "Out of deference to the Fed and global financial insecurity, they've postponed it until markets settle down. He's saying that as long as there are serious financial strains, we don't want to add to them."

UK Price Pressures Signal Stagflation Risks

The U.K. faces the risk of stagflation with the economy set to slow significantly against a backdrop of relatively strong pricing pressures, a report by a leading business lobby group found Thursday.

The British Chambers of Commerce's quarterly economic survey also recommended that the Bank of England's Monetary Policy Committee cut interest rates at its meeting next month to avoid the need for sharper rate moves ahead. "Relatively strong price pressures, though below the peaks (seen in the fourth quarter of 2006), signal risks of stagflation," the BCC survey found. "The U.K. economy is set to slow markedly, and small firms could face problems," it said, adding that prospects for the economy had worsened following the credit crunch. Economic growth in the U.K. hit an annual 3.1% in the second quarter of this year, and the government expects it to average a robust 3.0% over 2007 as a whole. But in his pre-budget report published Tuesday, U.K. Chancellor of the Exchequer Alistair Darling tipped economic growth to slow markedly to between 2.0% and 2.5% in 2008. The BCC tips gross domestic product to grow 2.0% next year. But, Deutsche Bank U.K. economist George Buckley, who was present at the BCC press briefing as guest analyst, said stagflation was a loaded term that conjured up images of runaway prices and little or no growth. The reality, for the moment at least, is below-target inflation and above-trend economic growth. "This may be the end of the so-called NICE (non-inflationary, consistently expansionary) decade," Buckley said. "To my mind this is not a period of stagflation, but the tradeoff between inflation and growth will likely worsen," he said, adding he predicted a 15%-20% chance of recession in the U.K. over the coming cycle. Buckley tips a rate cut in the middle of the first half of 2008. The BCC survey highlighted an increase in demand in the manufacturing sector, where the net domestic sales balance lifted to 36% in July-September from 31% in the previous quarter. That result matched a record high in the series, which began in 1989. But figures for the dominant U.K. services sector were less upbeat, with the net domestic sales balances dropping seven points to 29%. Domestic orders also worsened somewhat in both manufacturing and services, and the services export orders and sales balances fell to their lowest levels since the fourth quarter of 2004. "The results of this survey show that the MPC must cut interest rates in November," said David Kern, economic advisor to the BCC. "An early cut in interest rates will reduce the need for larger and riskier cuts later on."

Stronger Pricing Pressures On The Manufacturing Sector

The BOE has raised the policy rate five times since August 2006, most recently in July to 5.75%. Most economists tip the central bank's next move in rates to be to the downside, but growing market expectations that a cut could come as soon as November have receded after hawkish-sounding comments from BOE Governor Mervyn King Tuesday. King has expressed concerns about capacity pressures in the U.K. economy, and the BCC survey backed up that view, with the proportion of manufacturing firms running at full capacity rising seven points to a balance of 45%. The balance for services companies gained two points to 42%. In what may pose another headache for the MPC, there were also indications of sharply stronger pricing pressures in the manufacturing sector, the balance for which rose eight points to 32%. "We suspect that the BCC survey will reinforce the Bank of England's concerns that companies' pricing power and capacity constraints still pose a significant inflationary threat," said Howard Archer, chief U.K. economist at Global Insight. Despite financial market turmoil at the time the survey was conducted, services sector business confidence improved in the third quarter, with the turnover confidence balance rising four points to 59%. But the manufacturing sector balance dropped nine points to 52%. When it came to investment, however, the tables were turned. The balance of manufacturing firms planning to boost investment in plants and machinery lifted five points to a record high of 33%, but the balance for service sector firms fell two points to 17% - the lowest reading since the second quarter of last year. The BCC survey polled more than 4,700 companies across the U.K., employing around 300,000 people. It was conducted between Aug. 27 and Sept. 19.

Earth To G7: China Doesn't Care What You Say

Beijing has been keeping a super-tight leash on the yuan in the run-up to its Communist Party Congress, and will keep doing so despite giving Group of Seven nations extra fodder to complain about its currency regime.

The yuan has barely budged against the U.S. dollar since China markets reopened from a week-long holiday.

That's despite a pickup in complaints, especially from European quarters, about the snail's pace with which Beijing has been letting the yuan rise.

On the over-the-counter market, the dollar ended at CNY7.5115 Wednesday, not far from its pre-holiday close on Sept. 28 of CNY7.5061.

Expect this to become the topic de jour at the G7 talks next week.

There's a lack of consensus among European politicians about the causes (and impact) of a stronger euro, and a very clear lack of inclination on the part of the U.S. or Japan to do anything about it in terms of their own currencies.

When in doubt, blame China. Easiest way to score some political points at home. But Beijing won't care about all the rhetoric that comes from the G7. That is background noise.

The real focus for officials is the Communist Party Congress. It is held once every five years and is a sensitive time. The Congress determines changes in top party posts and Beijing will want to tout to party members its focus on income distribution and improving conditions for the rural sector.

Not a time to be messing around with the currency, or China's booming stock market. Also, there have been signs that while Beijing will continue to let the yuan tick higher, it is relying more on interest rate and reserve requirement ratio hikes to slow the economy and limit asset bubbles.

Data coming out in the next week or so will likely point to the need for further tightening, but don't expect China to respond with anything exciting on the currency front.

A Dow Jones Newswires poll forecasts a September trade surplus of US$21.2 billion, narrower than the surplus of $25.0 billion in August, but wider than $15.3 billion in September last year.

Year-on-year export growth likely sped up to 24.0% from 22.7% in August, while import growth likely quickened to 21.3% from 20.1%. As well, M2 money supply is expected to have grown 18.1% from a year earlier, in line with the 18.09% gain posted at the end of August.

The economy is still powering ahead, flush with liquidity, despite a slew of rate hikes and other tightening measures taken this year.

But there is very unlikely to be major policy changes coming from China in the next few weeks, regardless of what the data show. Beijing will want to wait until the Congress is well past and it has got the headlines it wants from the gathering.

Any G7 muttering about the yuan, in turn, will likely elicit a polite response but not much else.

Japanese Investors Join Flight to Quality

Japanese investors' move into foreign bonds last month was unusual for September and likely was driven by the flight to quality sparked by the subprime-loan crisis and expectations that the U.S. economy would slide into recession.

Japanese bought a net Y3.3 trillion of foreign bonds last month, their first net purchase since May. It marked the largest net purchase of foreign bonds by Japanese investors since October 2005, according to Ministry of Finance data.

Japanese also were net buyers of foreign stocks in September, but on a much smaller scale, taking a net Y74.1 billion.

Such moves are unusual for September, when books for the first half of Japan's fiscal year are closing and investors tend to stand on the sidelines. It likely reflected the fallout from the subprime-mortgage crisis this summer, which sparked a flight to quality in markets around the world, with sovereign bonds seen as a much safer investment than stocks.

"The swing is quite large and I think it reflects the flight to quality that we saw around the world, including among Japanese running their foreign bond portfolios," said John Richards, a strategist for Royal Bank of Scotland in Tokyo. "They tried to jump on the bandwagon."

If so, their timing wasn't great: The Federal Reserve's 50-basis-point cut in the federal funds rate in mid-September stabilized the U.S. market and helped bolster share prices, sending bond prices tumbling. In addition, recent data has shown unexpected resilience in the U.S. economy, damping the chance of a recession that would take the air out of the stock market.

"I think they were probably somewhat disappointed by the subsequent data and the markets' reaction," Richards said.

At the same time, foreign investors were selling their Japanese holdings, selling a net Y647.8 billion of Japanese bonds and a net Y580.3 billion of Japanese stocks.

"Foreigners probably got the Fed game right and recognized that the flight to quality was over," Richards said.

But foreigners did buy short-term bonds, he said, a move to take some profits and park their money in the short end of the market, where it is less exposed to duration risk.

"They probably escaped a good part of the sell-off that we saw in Japan," as JGB prices also fell and the Nikkei rose after the Fed easing.

MAS Tightening Puts Singapore Dollar On Track For New Record

A surprise monetary tightening by Singapore's central bank Wednesday vaulted the Singapore dollar up sharply and put it on track to rise to its all-time high set during the 1990s boom.

The stronger Singapore dollar will help cap mounting price pressures in the city state but won't cause exporters to lose their competitive footing against regional rivals because other Asian currencies are also on an upward course against a swooning U.S. dollar, analysts say. "The stronger Singapore dollar is not going to put a massive downward pressure on exports," said Prakriti Sofat, an economist at HSBC in Singapore. "The appreciation is still going to be very gradual and we think the government is going to be very cautious about maintaining economic growth." The Singapore dollar sprung to a 10-year high against the U.S. currency early Wednesday after the Monetary Authority of Singapore said it would "increase slightly" the slope of its undisclosed trade-weighted currency band. The U.S. dollar fell to S$1.4631 - a point last reached in July 1997 - from S$1.4720 just before the central bank issued the statement. Citigroup economist Chua Hak Bin said the new policy may allow the trade-weighted currency to rise an extra 0.2-0.5 percentage point each year beyond the estimated 1.9% rate allowed previously. He now expects U.S. dollar to finish 2008 at S$1.3900 compared to a previous forecast of S$1.4100. That target is just above the Singapore dollar's record high set in May 1995, when the U.S. currency fetched only S$1.3835. And the local currency may approach the record more quickly if Singapore's red-hot economy maintains momentum, Chua said. "Further MAS tightening may be necessary next year, via more 'slight' fine-tuning," Chua said. "Lower Singapore dollar interest rates, following the Fed rate cuts, have moreover exacerbated demand pressures."

Bid To Tame Inflation

The more hawkish stance by Singapore's central bank stems from concerns that rising inflation could pose a growing risk to the economy, which has been booming on growth in financial services and surging output of pharmaceuticals and offshore oil rigs. The central bank's statement noted the local three-month interbank interest rate has fallen to about 2.5% from 3.5% in February. It forecast inflation will stay within a 1.5%-2% range this year and 2%-3% in 2008, but warned about the impending impact of rising residential rents and property prices. That means Singapore, which uses the foreign exchange rate to influence prices because external trade dwarfs the domestic economy, is likely willing to let its currency rise at a moderately faster pace. "Against a robust growth backdrop, the MAS is clearly taking no chances when it comes to the inflation outlook, hence the tightening step," Rabobank said in a note to clients. Rabobank now forecasts the U.S. dollar will drop to S$1.4300 by the end of 2008, lower than its forecast of S$1.4400 before the MAS policy statement. To be sure, the central bank will be vigilant against sharp swings in foreign exchange rates. It has demonstrated a willingness to keep a tight grip on the currency. JPMorgan Chase Bank and Societe Generale noted unconfirmed talk in the market Wednesday that the Singapore authorities had intervened to cushion the U.S. dollar's early plunge, though other traders played down such speculation. Still, traders have said the MAS was active in the market during periods of heightened volatility last month to prevent drastic appreciation. And late last year the central bank added tens of billions of U.S. dollars in currency forward exposure in an apparent effort stem the local currency's rise. HSBC's Sofat said the strength in the Singapore dollar is in line with gains in other Asian currencies. The Singapore dollar has gained about 5% against the U.S. dollar in 2007 while the Chinese yuan has risen 4% and the Malaysian Ringgit is up nearly 10%. "The Singapore dollar has been appreciating, but the rest of the currencies across Asia are also moving higher," Sofat said. "The MAS is keeping a conservative view and it's unlikely we'll see exports threatened," she added. She said Singapore's economy may decelerate only slightly next year from the MAS's 7%-8% target for 2007.

Asia Economic Outlook: From Great To Good In Asia

Things may slow from great to good in Asia, but certainly not to disastrous.

The initial estimate of Singapore's third quarter gross domestic product, out earlier Wednesday, is a good barometer of the health of the Asian economy.

To be sure, Singapore is buffered by a booming property market and by a rise in financial service business, but it also remains an export-oriented economy, mostly of pharmaceutical and technology goods.

That means it reflects how things are going in other parts of the region, given Asia's broad reliance on exports - to the U.S., to Europe and within the region.

If there's an impact being felt from a slowdown in U.S. demand, it would likely be showing up in Singapore's figures.

But data show that third quarter GDP increased a solid 9.4% on-year. That compares with the average forecast of a Dow Jones Newswires poll of seven economists for GDP to increase 9.1% on year, and against a 8.6% rise in the second quarter.

On an annualized and seasonally adjusted basis, the economy expanded 6.4% versus a forecast 5.6% rise, though that was slower than the 14.4% growth in the second quarter.

Construction, manufacturing and service sector output readings were all solid. That indicates Singapore's economy is holding up well in the face of offshore headwinds.

The data may not cover the worst of the recent volatility in financial markets (and some say more is to come), but there are positives here.

Other key Asian economies will start releasing preliminary third quarter data in the coming weeks. Readings so far on manufacturing output, exports and the like have shown resilience, and there's no reason to expect GDP data to be any different.

Intra-Asian trade is helping shield economies around the region from a downturn elsewhere.

Asian consumer demand hasn't deteriorated sharply. Recent data from Australia showed August retail sales were up a higher-than-expected 0.7% (the market had been looking for 0.4%). In Hong Kong, August retail sales grew at the strongest pace in six months, with sales by value up 15.0% on year versus a 12.3% gain forecast.

Also, despite the negative headlines and much concern about the U.S. housing market, there are no major signs that U.S. consumers are curtailing spending.

More reassurance on that front could come on Friday with the release of U.S. September retail sales data. A Dow Jones Newswires poll forecasts overall sales to have risen 0.3%, the same as August, with sales, ex-autos, 0.4% higher after a 0.4% decline in the previous month.

Americans have long spent beyond their means, leading to a national savings problem. To be sure, bad news could still come on the U.S. economic and credit-market front, and the real impact from August's subprime-related financial market woes may not be felt for some months.

It is dangerous to presume no headwinds remain. The U.S. consumer could finally catch a cold. The commodity cycle could break if demand slows from China in particular.

It's worth noting that Singapore's central bank warned in its policy statement earlier Wednesday that the economy is expected to moderate. But that doesn't imply a major regional downturn. So far, the indications are that Asia is coasting along in acceptable fashion, and will continue to do so.

India's Economic Growth To Slow In Near Term

Higher interest rates and a rising rupee will likely drag down India's economic growth in the near term, but strong domestic demand and a robust farm sector will help cushion the blow, according to two separate reports by Standard and Poor's and the Organization for Economic Cooperation and Development Tuesday.

S&P forecast India's economy will grow 8.6% this fiscal year, which began April 1, while the OECD said the country's economy will grow 8% in 2008. India's gross domestic product grew 9.4% in the last fiscal year - its fastest pace in 18 years. In the last four years, it has expanded at an average of 8.6%, making India one of the fastest-growing major economies in the world. "While global developments have made the environment more risky, the strength of domestic demand is expected to keep the Indian economy on a relative high-growth trajectory," S&P said. The OECD said India's current expansion has been aided by spare capacity in the economy, and rapid credit growth has fueled demand. S&P expects India's agriculture sector to grow 3.4% this fiscal year, higher than last fiscal year's 2.7%, helped by a good south-west monsoon Industrial growth will likely ease to 9.2% from 11.3% in the previous fiscal year, reflecting the cumulative impact of higher interest rates and a stronger rupee, S&P said. Interest rates in India have risen to around five-year highs after the Reserve Bank of India embarked on a rate hike cycle January 2006, raising its benchmark lending rate six times to the current 7.75% to curb inflation and prevent the economy from overheating. The rupee is currently hovering at a nine-and-a-half-year high against the U.S. dollar, powered by strong inflows of foreign funds into the country. "The pressure on the rupee to appreciate remains. Notwithstanding the widening trade deficit, the current account deficit remains well within the boundaries of expected capital inflows," said Subir Gokarn, S&P Asia Pacific's chief economist. S&P, however, expects the rupee to fall to 40.50 to a U.S. dollar by the end of this fiscal year. At 0805 GMT, it was trading at 39.51 to a dollar. India's inflation, measured by the wholesale price index, is likely to end the year with an average of 5%, S&P said. The WPI-based inflation for the week ended Sept. 22 was 3.42% on year, well below the 5% upper limit that the RBI has said it would be comfortable with for this fiscal year. "The Reserve Bank has lowered its desired medium-term inflation rate to 4%-4.5%, as measured by the wholesale price index, and this should help contain inflation expectations," the OECD report said. "In this respect, they are being helped by the appreciation of the currency." India's current account deficit at 3% of GDP is sustainable on the back of foreign inflows, which have gained momentum following reforms through the last past few years, the OECD said. "This shows how sound policies and courageous reforms can change the economic prospects for millions," OECD Secretary-General Angel Gurria told reporters. The OECD report also stressed on the need for further reforms across financial and labor sectors to boost growth.

The Sound Of Euro Silence At The ECB

If a Trichet falls in the forest, does anyone hear?

Amid the clamor from European voices on the euro, as the currency becomes more politicized, the European Central Bank chief is keeping quiet.

That silence is unlikely to make a difference, though, given the squawking and squabbling among European politicians in the run-up to this month's Group of Seven industrialized nations meeting of finance ministers.

Sensing a chance to log political mileage, some (though it must be noted, not all) lawmakers from Europe, led by the French, are starting to get more overt in their complaints about the euro's strength, and pressing the European Central Bank to do something about it.

Trichet, quite rightly, is keeping mum. The euro is not an issue for the ECB. And where the euro is trading shouldn't really have a bearing on what the central bank does with rates, given its primary focus on inflation fighting.

Asked about the euro repeatedly at a press briefing last Thursday, Trichet refused to be drawn on how he viewed the current euro level, or what should be done about it.

Asked again Monday, he just said the G7 was the platform to communicate views on foreign exchange movements.

Trichet is not a person who is shy about coming forward, and he has vigorously defended the ECB in the past, but in this case he would realize there's nothing to be gained by answering the critics.

It's easy to score some political points at home by kicking the ECB.

The Europeans know that when it comes down to it, they can complain all they want, but when the G7 meets it is very unlikely there will be a concerted agreement among all those present on the need for a weaker euro.

The U.S. has remained implacable in the face of previous attempts, and the Japanese would not tolerate any sort of statement which suggested they were keeping the yen artificially or unnecessarily low - i.e. that the yen did not reflect fundamentals.

Expect a fair amount of rhetoric this week from European Union finance ministers, who are holding several days of talks where the euro will take top billing.

The "EcoFin" meetings will be a good chance for politicians to point the finger at the ECB for their currency woes.

A statement released a few hours ago by the group of finance ministers shows they are also targeting China for its undervalued yuan, with Beijing remaining a convenient scapegoat on the euro issue.

The statement was a perfunctory nod to the U.S. and Japan. It called for China to untether the yuan, while noting U.S. "authorities have reaffirmed a strong dollar is in the interest of the U.S. economy." It added Japan's economy is on a "sustainable recovery path," implying the yen should be stronger.

There is some truth to each of those claims, but in the end there is no single culprit for what is happening right now to the euro.

That shows again that the ECB couldn't - and shouldn't - step in. There would be little-to-no upside for the ECB and little-to-no downside for the euro, from any solo intervention.

Some aren't that convinced the euro - which has climbed 3% against the dollar since the start of September and touched a record high of 1.4283 earlier in October - is really starting to bite into European economic growth.

Sunday, ECB Executive Board Member Lorenzo Bini Smaghi told the Turin daily La Stampa the strong euro had benefits, like making energy imports cheaper for euro-zone countries. He also cautioned politicians against making the euro debate public, warning their comments can be misleading for markets.

And Dutch Finance Minister Wouter Bos said Monday that "I haven't seen any extreme volatility (in the euro) recently." "I have seen a gradual increase, and strong economies are going to adjust to that," he added.

Sukuk Blossoming In Pakistan; More Innovation Ahead

Five years after Sitara Chemical Industries Ltd. sold Pakistan's first local sukuk, the market for Islamic bonds in the 97% Muslim nation has finally perked up.

Bankers say the stream of new deals is likely to continue apace as borrowers tap into demand from the country's swelling number of Islamic financial institutions. They also forecast an increase in the variety of structures on offer. Pakistan is one of only a handful of countries to have issued Islamic bonds on the international market, raising US$600 million from five-year sukuk in 2005, but has left the domestic scene to private and state-backed corporations. Nevertheless, a trickle of deals in the last year or so has swelled to a wave recently. Accurate numbers are hard to come by since the vast majority of offerings are private rather than public deals but according to the Islamic Finance Information Service, Pakistan companies raised PKR17.225 billion last month alone out of the total PKR39.4 billion sold since Sitara kicked off issuance in July 2002. Last month also saw power company Attock Gen Ltd. raise PKR8.580 billion from the country's first syndicated Islamic project financing. Companies are preparing to hit the market with at least PKR24.5 billion more sukuk in coming months. Islamic bonds are structured in accordance with Shariah, or Islamic law, and differ primarily from their conventional counterparts in that they don't pay interest, which Muslims consider to be usury. Instead, lenders receive a regular payment linked to the performance of underlying tangible assets. In recent years, sukuk issuance has exploded in places like Malaysia and, more recently, the Middle East but has been slower in countries like Indonesia, the world's most populous Muslim nation, and Pakistan although both governments have said they are keen to bolster Shariah financing. The Pakistan borrowers headed to the market include cement manufacturers Javedan Cement Ltd. and Kohat Cement Co., textile companies Shahraj Fabrics Pvt Ltd. and Amtextile (Pvt) Ltd. and real-estate firm Eden Developers (Pvt) Ltd. But in the absence of a central government benchmark, the government is also encouraging state-backed companies to tap the market. Many of these have or are pursuing a crucial government guarantee which is especially attractive to Islamic banks looking for investments eligible for inclusion in their statutory liquidity reserves. Conventional banks typically invest in standard interest-bearing Pakistan government bonds but compliance with Shariah means Islamic banks can't do that. In the wake of two deals from state utility Wapda, Karachi Shipyard & Engineering Works, National Industrial Parks Development and Management Co. and House Building Finance Corp. are in the market for a combined PKR9.2 billion and there is talk that Pakistan Agricultural Storage & Supplies Corp. is seeking PKR10 billion in funds through Islamic bonds.

Innovation On The Way

Most of the deals have been structured using the ijarah leasing structure or the diminishing musharakah principle, whereby ownership of a joint venture passes from one partner to another. Coupon-style payments are derived from the leases or the profits generated from the joint venture. However, bankers say new structures are on the way in Pakistan. The cash-strapped national carrier Pakistan International Airlines, for one, is looking to follow up a recent PKR2 billion sukuk, backed by aircraft, with another Islamic bond as part of its bid to raise PKR26 billion to support restructuring and modernization. Meezan Bank, which expects to get the mandate for a PKR6 billion offering, promises a new structure since the airline has insufficient tangible assets to back another deal. Fear that the idea may be snatched by rival bankers means details are scant, however. A wider variety in maturities, beyond the typical five-years, is also on the way. "We are gearing up to take care of longer tenors primarily for the power sector," said Irtiza Kazmi, head of syndications and capital markets at Dubai Islamic Bank in Karachi. "We are also looking at different currencies. It's not that far away. It's a matter of months, if not weeks," he said, adding the bank was looking at structuring a U.S. dollar-denominated sukuk for a Pakistan company that would be targeted at Middle East buyers. Behind the recent flurry in sales is the recent establishment of Islamic banks and windows - Islamic units of conventional banks - all ravenous for Shariah-compliant assets to put their cash to work. Pakistan awarded the country's first Islamic banking license in January 2002 to Meezan Bank and the country now has 19 Islamic banking providers with five fully fledged Islamic banks, according to the State Bank of Pakistan. It also has five Islamic mutual fund operators worth around PKR11 billion, although more are on the way. Companies are also keen to expand while the Pakistan economy is blossoming. Pakistan's economy grew 6.6% in 2006 and is forecast by the Asian Development Bank to expand by 7.0% this year.

The M&A Wave Hasn't Ended In Asia

If the merger and acquisition boom is over, someone forgot to tell deal makers in Asia.

Certainly there has been a slowdown in global dealmaking over the past two months that Asia hasn't fully escaped. In September, the total value of mergers and acquisitions announced fell just below $200 billion, according to Thomson Financial, a drop of nearly 57% from the average for the first seven months of the year. But when it comes to M&A, global figures are dominated by trends in the U.S. and Europe - where both the number and size of deals remain far larger than they are in the rest of the world. So when deals targeting Asian companies (including Japan) are isolated, the drop is far less dramatic. There were about $37 billion worth of acquisitions of Asian companies announced in September. That's down from a monthly average of about $50 billion in the first seven months of the year, but September may prove to be a short-term dip. Asian firms are flush with cash and backed by a banking sector that seems to have escaped the global credit crisis without any major damage. The sector played only a minor role in underwriting bridge loans for the many leveraged buyouts that are starting to look shaky. Only one week into October, there have been more than $14 billion in deals announced in Asia. That of course is skewed somewhat by a single $4.6 billion offer by Citigroup for the piece of Nikko Cordial Corp. (8603.TO) it doesn't already own. Still, it is good news for Asian stockholders, and if a recent spate of bids for foreign companies by Asian buyers is the start of a new M&A trend, it could give investors in the rest of the world something to cheer about as well. There is one caveat. Even if Asian firms keep on buying and turn towards the U.S. and Europe in search of targets, the deals are likely to remain small. The average size of a deal for a firm based in Asia, so far in 2007, is about $50 million, according to Thomson Financial data. That compares with about $150 million for deals in the U.S. Plus, clear-thinking Asian buyers are unlikely to make outsize bids for U.S. and European firms for fear of resurrecting the protectionism experienced by CNOOC and Dubai Ports World.

Some Sectors To Perform Better

Some sectors look like set to fare better than others. For example, with shares of Australian resources companies rising to new heights, these companies have been behind a spurt of recent deals. Australian resources companies were buyers in four of 18 deals announced in the last two weeks of September, according to a count by Credit Suisse. One of those four was the $1.5 billion acquisition of Chicago recycling company Metal Management Inc. (MM) by Sims Group Ltd. (SGM.AU). Another of the eighteen deals was an offer from Australia's Macquarie Bank Ltd. (MBL.AU) for privately held Canadian investment bank Orion Financial. In fact, there have been several deals over the past few months involving Asian buyers and foreign targets. Among the highest profile of these recently are Doosan Infracore Co.'s (042670.SE) $4.9 billion deal for Ingersoll Rand Co.'s Bobcat business, Acer Inc.'s (2353.TW) $710 million bid for Gateway Inc. (GTW), and even the recent $2.2. billion bid for 3Com Corp. by private equity firm Bain Capital and China's Huawei Technologies Co. It's a trend that local bankers think will continue. "I expect to see more of these types of transactions in the coming months," said Mark Renton, head of investment banking Asia Pacific for Citigroup. "Asian companies increasingly have the confidence and management expertise to pursue their global ambitions via overseas acquisitions," he said.

IMF Chief Says USD Is Undervalued

International Monetary Fund Managing Director Rodrigo Rato said the U.S. dollar is "undervalued", according to The Financial Times.

"Right now the dollar is undervalued" on many measures used by the IMF to evaluate currencies, said Rato according to the report. He added that the U.S. currency was "certainly overvalued a few years ago." The remarks by Rato, who hands over the leadership of the IMF to Dominique Strauss-Kahn at the end of this month, follow a sharp drop in the dollar against the euro and some other freely floating currencies in the aftermath of the credit squeeze and Federal Reserve interest rate cut, according to the report. Rato said these financial and economic developments create a "new scenario for global imbalances" that policy makers need to "keep an eye on," said the report, which was seen on the FT's Web site Monday. Rato warned against excess volatility in currency markets - a standard IMF mantra, but one that takes on added significance in times like these, the report said. "Sudden movements in the currency markets are not what we need," he said, according to the FT. Rato also said that, "independent of the value of the dollar," it would be "in the interest of China" to adopt a more flexible exchange rate to help it manage its domestic economy and that this case is "becoming stronger." The outgoing IMF chief also hinted at unease about the Japanese yen, which remains weak in part because of ultra-low interest rates, the report said. "Normalization of monetary policy in Japan is an important medium-term objective," he said, according to the report.

High-Yielder Frenzy: Please Don't Feed The Risk Monster

U.S. jobs data Friday and a rise in risk appetite for things like higher-yielding Asian currencies will create a fresh dilemma for the Federal Reserve - and it would do well to keep moral hazard in mind.

The September nonfarm payrolls do not yet take another U.S. interest rate cut off the table, even if the odds for an October move have faded.

Quite a few economists are still looking for a further 25-basis point reduction by the end of the year, as the Fed looks to put on some further insurance against an economic slowdown in the wake of the U.S. subprime mortgage-related mess.

But officials at the Fed should think very carefully about the prudence of another move, especially as the market seems to be moving back into risk-seeking mode.

Part of the appetite for risk stems from the view the Fed will continue to bail markets out as needed, as the "Bernanke put" replaces the "Greenspan put."

Moral hazard was always going to be an issue when the Fed initially cut rates last month. The somewhat aggressive 50-basis point move has helped create a false sense of security in the Fed's actions, and may be perpetuated if the central bank cuts again.

To be sure, markets are less sure how much the Fed may reduce rates by the end of the year.

September payrolls were reassuring, rising 110,000 last month, largely in line with forecasts. Upward revisions to August data nullified the surprise initial 4,000 fall which no doubt had contributed to the Fed's decision to cut rates last month.

Now, the November federal-funds futures contract is pricing in about a 48% chance the Fed cuts rates to 4.5% at its meeting on Oct. 30 and 31, down from a 72% chance before the jobs data came out.

March 2008 Eurodollars are fully priced for a 4.5% rate in the first quarter of next year, with about a 74% chance for a further ease to 4.25%. Before payrolls, the March contract was fully priced for a 4.25% first quarter rate.

The jobs data have spurred the U.S. dollar and the euro higher against the yen, as interest flows to higher-yielding currencies out of Japan. The euro is now trading around Y165.80.

The Australian and New Zealand dollars are also perky against the dollar and the yen with the Australian dollar hovering around 23 year highs, having briefly nosed over US$0.90 earlier in Asia.

A solid rise in Asian share markets Monday will further stoke the interest in taking risk, especially if markets continue to look for some form of further Fed easing by the end of the year.

That could be a potent mix. It is not that some interest in riskier investments is a bad thing. And it is not that the picture is hugely bearish from an economic standpoint. Rather, it depends on how complacent investors become.

This has been said several times before, but unbridled risk is what got markets into trouble in August in the first place. The Fed would do well to remember that in, in its rate calculations later in the month. Give markets another "Get Out Of Jail Free" card and the August market tumbles could quickly become a distant memory in investors' minds.

The Credit Crunch May Hurt Capital Spending

While the tighter credit atmosphere caused by the subprime-mortgage crisis has improved recently, some economists warn the experience has left companies a bit gun-shy about future capital expenditures.

The earthquake that was the summer's credit crunch has eased, but companies are still feeling the aftershocks. While the tighter credit atmosphere caused by the subprime-mortgage crisis has improved recently, some economists warn the experience has left companies a bit gun-shy about future capital expenditures. Some large companies have already said they may scale back capital-spending budgets for 2007 or 2008. Of course, other factors are also weighing on capex, from a sluggish economy to companies' strategic decisions. It's hard to separate out any effect the credit crunch may be having. And as the credit atmosphere has improved, aided by the Federal Reserve, companies' willingness to spend may improve as well. Still, concerns linger, bolstered by fears that the credit crisis may not yet be done roiling markets and curtailing liquidity. If that were to happen, capital spending could slow further - and the slowdown could hamper economic growth. "There's no question senior management in most corporations are being very cautious right now," said Nariman Behravesh, chief economist at Global Insight, a Lexington, Mass., economic forecasting and consulting firm. Behravesh is less concerned about capital spending now than he was during the heart of the crunch, but he still sees capex moving "sideways" for the next year or so. "We don't see capital spending being any sort of major engine of growth right now," he said. "A lot of these guys are not going to cut back, but they're not going to make huge bets, either." Economic indicators covering the period of the worst of the crunch are starting to show the impact on capital spending. Factory orders declined 3.3% in August and durable-goods orders fell 4.9%, according to the Commerce Department. Both were worse than expected. In addition, a recent survey from Duke University's Fuqua School of Business and CFO Magazine indicated that out of 154 chief financial officers who said their companies were affected by the credit crunch, 30.5% plan to delay or reduce capital spending. Some of the biggest, most prominent companies around have said since the crunch began that they may cut back on their capital spending, though they tend to cite other reasons rather than blaming the credit problem directly.

Auto, Housing and Construction Capex May Suffer The Most

Wal-Mart Stores Inc. (WMT), for instance, said last month that its capital spending may be less than the $15.5 billion it had forecast for the year - an amount that itself had been reduced in June from a previous forecast of $17 billion. The company has portrayed the reduction as a move to cut construction costs, use capital more efficiently and slow expansion into new stores in favor of boosting sales at existing stores. A Wal-Mart spokesman declined to comment. FedEx Corp. (FDX) said last month that its management "is reviewing the timing of capital outlays, which could result in lower spending for the year." Spokesman Jess Bunn blames "a general sluggishness in the economy, especially in the freight sector," though he added the company is still "confident" in the sector for the long term. General Motors Corp. (GM) said in late July that it was lowering its 2007 capex target to the $8 billion range from a previous target of $8.5 billion to $9 billion. Renee Rashid-Merem, a GM spokeswoman, said the move "reflects more of a lean approach" to costs other than those specifically targeted to GM's products, as well as a "re-timing" of some expenditures. Global Insight's Behravesh said "anyone associated with housing and construction" may see capex suffer the most, along with the auto sector. To be sure, many of these announcements and other indications of lower capex came before the Fed cut interest rates by half a percentage point last month, in an effort to prod the economy out of its subprime-induced troubles. But Jan Hatzius, chief U.S. economist at Goldman Sachs, said "money markets still aren't back to normal," though the Fed did help. Hatzius wrote in a note this week that while market liquidity has improved recently, if it were to tighten anew "it may get harder for corporate borrowers to finance projects. Such a financing constraint could weigh on capital spending and real GDP (gross domestic product) in 2008." Expect those concerns to persist for some time. The credit markets may be recovering, but optimism about the future may take a while longer.

NY Gold Bounces As Dollar Turns Lower

Gold futures bounced sharply from two-week lows Thursday as the U.S. dollar gave up initial gains and the metal generated technically based momentum, traders and analysts said.

Traders now will be watching to see how the greenback reacts to Friday's employment report. December gold rose $8.10 to $743.80 an ounce on the Comex division of the New York Mercantile Exchange. As pit trade was closing, the December contract at the Chicago Board of Trade was up $7.90 to $743.70. Comex December silver rose 3 cents to $13.50. As it was closing, CBOT December silver was up 1.6 cents to $13.495. Gold eased early in the morning, a move that traders at the time linked to continued consolidation of the strong run-up from the middle of August through Monday, as well as a firmer U.S. dollar around the Comex open. In fact, when the Comex December futures bottomed at $726.30, it was their weakest price since Sept. 18. But the greenback subsequently sagged again, and traders and investors often buy gold as a hedge against dollar weakness. "The bulls came in and bought with a vengeance," said Ralph Preston, senior market analyst with Heritage West Financial, citing the decline in the dollar and chart-based considerations as reasons. Shortly before the gold pit closed, the euro had risen to $1.4131 from $1.4090 late Wednesday and the dollar index was down 0.128 to 78.445. A "mini bear flag" may be emerging in the dollar index, Preston said. "If we can't close above 79, the dollar is going to roll over and play dead on us," he said. Additionally, November crude was up $1.32 to $81.25, which also tends to underpin the metal. More speculative buying occurred, Preston said. Technicians said both gold and silver dipped below their 20-day moving averages, then attracted buying as they got back above the averages. This stands at $731.40 for December gold and $13.256 for December silver. Silver also managed to close back above its 200-day average of 13.457. The monthly employment report is due out Friday at 8:30 a.m. EDT and is expected to show a rise of around 100,000 non-farm jobs during September. The unemployment rate is expected to edge up to 4.7% from 4.6%. Traders will be watching to see whether a stronger-than-forecast report damps further expectations for a rate-cut from the Federal Reserve and thus supports the dollar, pressuring gold, or whether a weak report will undercut the U.S. currency and thus support the yellow metal. The November federal-funds futures are factoring in a 72% probability of a 25-basis-point rate cut at the Oct. 30-31 meeting of the Federal Open Market Committee. "The Fed may be looking for more reasons to cut interest rates," Preston said. "If we get a bad jobs report tomorrow, this is going to play into their hands." The Bank of England and European Central Bank both left interest rates unchanged Thursday. This was expected and didn't prompt a massive reaction in the markets, traders said at the time.

Platinum and Palladium Run Impressive

On the U.S. economic front, first-time weekly jobless claims rose 16,000 to 317,000, more than the forecast of 310,000. Factory orders fell 3.3% in August, more than the 2.6% drop that analysts forecast. A major news story in the gold world was damage to a mine shaft that trapped 3,200 workers deep underground at Harmony Gold Mining Co.'s (HMY) Elandsrand mine in South Africa. By mid-morning New York time, a rescue effort had already recovered three-quarters of the miners and expectations were that the remainder would be rescued as well. The South African government has ordered the mine to be closed for up to six weeks for an investigation. During the course of the day, a couple of analyst research reports suggested the news didn't have an immediate impact on gold prices, since there is still much above-ground supply of gold held for investment purposes, meaning it doesn't disappear when consumed, as with agricultural commodities. "The bigger story (in the gold market) is the dollar and gold are moving lock-step right now in different directions," Preston said. Meanwhile, January platinum rose $9.50 to $1,378.40 an ounce, while December palladium gained $9.65 to $371.30 an ounce. "With gold's rise, we saw both platinum and palladium make an impressive run," a trader said. "Relatively speaking, the palladium run is probably even more impressive than the platinum." Fund and investment-type buying has occurred in both metals, the trader added. Another trader said some of palladium's strength was tied to options-related activity. Some technical buying may have emerged in December palladium. The metal not only poked above a double-top high so this week at $363 and $363.50 but moved above its 100- and 200-day moving averages, which as of the close were at $363.20 and $364.75, respectively. Platinum was already above these averages.

Japan's New M&A Rules Unlikely To Deter Foreign Investors

Japan has tightened its rules on investments by foreign investors in local companies engaged in strategic industries, giving it a broader say in mergers and acquisitions that could affect national security.

The changes, which took effect Friday, will bring Japanese rules closer to those in other large industrial nations like the U.S., the U.K., France, and Germany, which have safeguards in place to protect strategic industries from potentially hostile foreign owners. The new regulations come as M&As involving Japanese companies grow rapidly, and coincide with huge growth in pools of capital that can be deployed by growing ranks of foreign buyout firms, sovereign investment funds, and oil-rich investors. Over the last two years, the Japanese government has introduced guidelines on implementing "poison pill" takeover defenses and a scheme that limits the ability of foreign acquirers to use shares in buying Japanese firms. Both sparked criticism that Tokyo was putting up barriers to investment by foreign private equity firms and well-capitalized overseas corporations. Bankers say the new rules are unlikely to hamper most deal activity in Japan, though some transactions may require more time and paperwork. "It should not be taken as a more stringent (and anti-reformist) regulation, which would shackle hedge fund activity," Morgan Stanley economist Takehiro Sato wrote in a note to clients. Spearheaded by the Ministry of Economy, Trade and Industry, the new framework will give the government veto power in potential deals involving companies that make specialty steel, carbon fiber, machine tools, and other products deemed strategically important because they could be diverted to military use, such as the production of nuclear weapons or missiles. Scores of Japanese companies will be governed by the new rules, including Nippon Steel Corp., Sanyo Electric Co. and Toray Industries Inc., the world's largest maker of carbon fiber, which is used in Boeing Co.'s next-generation 787 passenger jet. The changes mark the first revision to Japan's safeguards on foreign direct investment since 1991. The new rules identify 137 items considered sensitive from a national security standpoint, clarifying the previous rules, which only named industrial sectors such as nuclear power, defense, and aerospace. Many of the old rules have been retained. A foreign investor seeking to buy a 10% or larger stake in an affected Japanese company must report the purpose and size of its planned investment 30 days before the transaction. If the buyer is targeting a listed company through a tender offer bid, it can file for clearance either when it announces the TOB or before it makes the bid public, a Japanese trade ministry official said. Both France and Germany require overseas investors to report about a month in advance and gain approval when buying into sensitive firms. In the U.S., foreign investment rules cover all industries. Washington, which is set to further tighten its rules this month, can even force changes to investments up to three years after the initial approval. In the U.K., the rules cover all mergers in all industries.

Changes Target: China, Russia

The impact of the changes is unclear. The old system didn't appear to be a large barrier. Of the 936 inward-bound M&A deals between 2000 and 2005, only 23 cases required prior approval and all got the green light, according to data from Thomson Financial and the Japanese government. Some foreign investors have already have made filings because of the expanded list of items that require them, a Japanese trade official said, adding that he couldn't disclose further details. Even deals announced before the changes could fall under the new system. That's because the filing has to be done 30 days before the actual or planned investment date and not the date the deal is announced, another trade official said. But he didn't know of any instances. If an investment falls through because of the new system, it may never become public because the government is supposed to keep the information confidential and investors may be reluctant to announce a failed deal. The stricter requirements will increase the time to complete some deals. At best, the vetting process will likely take about two weeks. But if Tokyo takes issue with a proposed transaction, it can extend the review period up to five months. That might be the case if, for example, the government wants significant changes to the deal, such as the divestiture of a sensitive business unit of a target company. Bankers said the prospect of more paperwork hasn't deterred potential acquirers. "Our overseas clients are also looking at Japan for acquisitions. As far as we can tell, METI's new rules really haven't changed their attitudes," said Tadashi Sato, an investment banking director at Nikko Citigroup. Indeed, Tokyo's security concerns aren't focused on traditional investors in Japan, namely corporations and funds from the U.S. and Western Europe, which account for the vast majority of investment. Rather, the authorities are wary of China, Russia, and Middle Eastern nations, said a government official, who spoke on the condition of anonymity. "The direction would be to approve (applications) from advanced, industrial nations," he said. Another official said there is concern that many of Japan's most technically advanced companies have relatively small market capitalizations, making them easy targets for investors with deep pockets. Cash-rich, sovereign wealth funds are becoming more acquisitive too. China recently launched a state-backed fund with an initial capitalization of $200 billion.

Government's Top Priority To Increase National Productivity

To be sure, some investors have expressed concern the changes may be aimed at thwarting foreign private equity firms, hedge funds, and other profit-seeking players from buying large holdings in Japanese companies. They have cause for concern. Japan's most powerful business lobby, Keidanren, and some conservative politicians have pressured, sometimes successfully, for steps to restrict the freedom of foreign capital out of fear that marquee corporate names and key technologies could be gobbled up. "I don't blame them (activist funds) if they interpret the new provision as a discriminatory measure to drive them away," said Hiroshi Motoki, chief investment officer at AIG Global Investment Group in Tokyo. Still, most bankers say such concerns are overblown. What's more, curbing inward investment would hardly be in Japan's best interest, they add. With Japan's labor force shrinking and population aging rapidly, a top priority of the government is to increase the nation's productivity. Encouraging foreign direct investment, which brings better corporate governance, new technology and financial know-how, forms part of Tokyo's long-range plan: Japan aims to double the stock of direct investment to over Y25 trillion ($217 billion) by 2010. "If implemented too strictly, (the new rules) might affect foreign investors, who are a must (for the trading volume on the Tokyo Stock Exchange)," said Dalton Investments KK chief executive Junichiro Sano. "My worry is, then, what do you do?"

Wall Street Hopeful Credit Crisis Easing

With stocks rallying to record highs at the outset of the fourth quarter, and signs of easier conditions in credit markets, a feeling of hope is sweeping Wall Street, suggesting that the worst of this summer's crisis is in the past.

Fueling those hopes, Citigroup Inc. (C) on Monday put a figure on its third quarter credit-market-related pain: earnings will be 60% below the year-earlier quarter. And CEO Charles Prince said business conditions are likely to return to a more normal level in the fourth quarter. Swiss bank UBS AG (UBS), followed by Deutsche Bank AG (DB) on Wednesday, Europe's largest bank, also reported huge write-downs. "Multibillion-dollar write-downs by some of the major global banks are being widely viewed as a sort of capitulation that all the bad news has been priced in, or at a minimum, that there is now more certainty over the extent of the losses," said David Rosenberg, chief economist at Merrill Lynch in a note. The debate is still underway among investors about whether this is over or not. While there are signs that the credit crunch is easing, there are plenty of market observers who say the evidence, including a reduced appetite for junk bond deals and what appears to be a permanently smaller commercial paper market, suggests the markets are not yet out of the woods. The reports from UBS and Citi helped to ease Wall Street's sense of helplessness at figuring out how many subprime-mortgages-gone-bad might be out in the global financial system. The Dow Jones Industrial Average jumped more than 190 points to record highs Monday. And speaking in London on Tuesday, former Fed Chairman Alan Greenspan kept up the upbeat tone: "Is this August-September credit crisis about to be over? Possibly," the Times of London quoted him as saying. Yet, after whistling past the graveyard of subprime mortgages until August - when uncertainty about the amounts and whereabouts of bad home loans in portfolios saw lenders close the door to many borrowers - Wall Street now remains leery of declaring victory too soon. "We seem to have weathered the storm but everybody's outlook is pretty guarded," said Kim Rupert, managing director of fixed income at Action Economics. "There's still a lot of nervousness, even if there are no reports of the illiquidity that we saw in asset markets back in August."

Signs Of Life

Many analysts have reported signs of improvement in credit markets ever since the Federal Reserve began injecting liquidity in the system and then cut official interest rates by a hefty 50 basis points on Sept. 18. Risk aversion throughout the summer sent riskier corporate bonds sharply lower, lifting their yields, which move inversely to price, sharply higher. Corporate spreads, which measure the difference between yields on business loans and those on safe government bonds, widened accordingly. But spreads have now narrowed from 76 basis points in mid-August to 63 basis points at the end of September, signaling investors are embracing more risks, according to Bear Stearns. Meanwhile, investment-grade corporate bond issuance last month reached the highest level for any September, according to Merrill Lynch. "Hence, the credit market is now functioning in a way that is conducive toward economic expansion, certainly much better than was the case in early August," said Tony Crescenzi, fixed-income strategist at Miller Tabak. After nearly drying up in August, the market for commercial paper, or short-term business loans, has also shown signs of life. Back in August, the unwillingness to lend new money caused the price of outstanding commercial paper loans to plunge, sending their yields sharply higher. For instance, the yield on 30-day commercial paper, had surged to above 6% in August. It has now fallen back below 5% and traded Tuesday at 4.97%. Meanwhile, the overall size of the commercial paper market has continued to fall sharply, though at a slower rate. It slid 16.6% from its historic peak of $2.2 trillion in July to $1.857 trillion at the end of September, according to IDEAGlobal. The drop was led by a 22% plunge in commercial paper backed by certain assets, such as mortgages, which are at the very heart of the crisis. But "the rate of decline in asset-backed commercial paper has slowed, after sliding 4% on average on a weekly basis in August," said John Atkins, corporate bond strategist at IDEAGlobal. The London interbank offered rate, or Libor, which is the rate banks charge each other for short-term loans, shot sharply higher to above 5.7% in early September. The three-months Libor now trades at 5.24%. In his London speech, Greenspan cited those improvements to back the possibility that the credit crisis may be over.

Still Whistling

But many of these so-called improvements have to be put in proper perspective, said IDEAGlobal's Atkins. "It's an improvement from horror but it doesn't mean it's encouraging," he said. "Those that say it's over are still whistling past the graveyard." Putting an initial estimate on subprime-related losses, as Citigroup and UBS have done, " is just an initial foray into assessing where we stand, and there is nothing concrete to justify calling the crisis over apart from sheer optimism.," Atkins said. With the size of the overall commercial-paper market having shrunk by nearly 17%, it would take a surge in optimism about credit conditions to reverse the trend and return to an expansionary credit mentality. While issuance of investment-grade, or higher quality, corporate bonds has come back, the market remains wary of risky junk-bond issuance, indicating that the days of 'easy-money' might be over, said Action Economics' Rupert. Merrill Lynch estimates that credit markets have only come back one-third of the way from their peak crisis level in August. The firm noted that the "distress ratio," which measures the high costs of credit for riskier corporate borrowers, tripled in August, possibly signaling corporate credit defaults to come.

Sugar Rush For Stocks?

So are stocks on Wall Street now powered by a false sense of relief? "From our lens, the stock market is doing what it always does in the month after the first cut in the Fed funds rate - and that is to rally on the sugar rush of the liquidity infusion," said Merrill's Rosenberg. The stock market, he said, has risen 100% of the time in the first month following a Fed rate cut and the average increase is about 4%. With stocks up only 2% since their August lows, the rally may therefore have more legs in the short term. But Rosenberg is quick to point out that how the stock market does three, six and 12 months later has to do with how the economy is faring. "And those who believe that [Monday's] huge write-downs mean there are no more skeletons in the closet could be in for a rude surprise," the economist said. "After all, at the root of the market volatility and weakness this summer was the U.S. housing market, and everything from sales to starts to inventories to pricing has become much worse in recent months." On Tuesday, stocks gave back some of Monday's strong gains after news that the mortgage crunch led the pending home sales index, a forward-looking gauge of home sales, to drop 6.5% in August to its lowest level since its inception in 2001. In his October investment outlook, bond giant PIMCO's managing director Bill Gross said that the Fed's rate cuts may help favor corporations and Wall Street, but it will do little to help consumers facing stagnating incomes and tighter credit conditions. "Whereas current yields are not restrictive to investment grade corporations with global opportunities, they are far too high for homeowner Jane Doe and two million of her neighbors facing higher and higher monthly payments in adjustable rate mortgages," he wrote. But Wall Street will likely continue to monitor economic data amid hopes that it will be weak enough to keep the Fed in a cutting mode, while not weak enough to suggest a recession is in the making. The Fed's rate cut followed an unexpected decline in employment in August. "Right now everybody is waiting for Friday's [September] employment report to see if that August decline was a reflection of contagion from the crisis to other parts of the economy, or an aberration," said Action Economics' Rupert. According to IDEAGlobal's Atkins, a key question remains whether economic conditions will deteriorate first, exacerbating conditions in credit markets, or whether new credit problems at financial institutions will surface, tightening credit conditions and further pressuring consumers and the economy.

EU CO2 Price Forecast To Rise 7.5% In 2008

European Union Emissions Trading Scheme carbon prices are expected to rise to EUR23.33 a metric ton next year due to participants holding back from making full use of Certified Emissions Reductions, and utility buying, according to a Dow Jones Newswire poll published Wednesday.

The poll of 14 analysts, trader and brokers forecasts an average price for carbon in 2008 of EUR23.33/ton, compared to current over-the-counter levels of EUR21.70/ton. The forecast is 1% higher than a similar prediction made in a Dow Jones Newswire poll in July and 7.5% up on current prices. The range of forecasts in this latest poll for the benchmark December 2008 contract is from EUR19/ton to EUR26.90/ton. Under the E.U. ETS system, E.U. member state governments and the European Commission set limits to the amount of carbon dioxide industry can emit. Companies that stay below these CO2 limits can sell their surplus, in the form of credits worth one metric ton of carbon, to companies that have overshot their quotas. This creates a financial incentive to cut carbon emissions, blamed for causing climate change. Utilities are the companies that are set the strictest limits under the scheme, as according to the commission they can easily pass on their additional costs to consumers. The expectation that participants will not make full use of the CER mechanism and heavy buying from utilities, were cited by participants in the poll as the main reasons for the expected rise. "CER imports will not yet be maximized due to the market education process," Emmanuel Fages, carbon analyst at investment bank Societe Generale told Dow Jones. CERs are carbon credits generated by emissions-cutting projects like wind farms in developing countries. The U.N. approves these projects and then issues the project owners with CERs, which can be used for compliance by countries under the Kyoto Protocol and the E.U. ETS. Because they are linked to projects which may experience trouble meeting their output goals, and because of lower construction costs in the developing world CERs are cheaper than carbon prices under the E.U. ETS. Consequently if a large number of CERs was to enter the market the price of carbon in the E.U. ETS would likely drop. Kris Voorspools, an analyst at investment bank Fortis, said: "In the beginning of Phase Two (of the E.U. ETS which runs 2008-2012), utilities will be more active than industrial players who prefer not to act before they have sufficient verified emission data. As utilities are short, the price in the beginning of Phase Two should be above the theoretical equilibrium." A London-based trader who asked not to be named said that the possibility of banking 2008-2012 allowances for use after 2012 could also help boost price levels. "There's the potential to bank into Phase Three (post 2012) as well as the potential for higher auctioning (and therefore higher carbon prices) in the third phase," he said. The World Bank estimates that the E.U. ETS was worth nearly $25 billion in 2006.