The Federal Reserve vigil lasted into Wednesday afternoon when the FOMC announced another 25-basis-point rate increase as expected. The fed funds rate is now 5 percent. However, interpretations of their announcement varied as analysts parsed the statement looking for definitive guidance on future moves. They didn't find it. Although the statement said further increases might be needed, the FOMC no longer said that growth and inflation risks were in balance. This implied to some that the greater risk might be to price stability. Economic growth was strong in the first quarter but the Fed recognizes that it will probably moderate going forward. The statement said the timing and extent of future rate increases would depend on incoming economic data. That underscores for the financial markets the importance of the monthly employment report along with other market-moving indicators such as the producer and consumer price indexes.

The prospect of higher interest rates did not sit well with equity investors. Indexes tumbled especially in Europe and in North America. And Japanese indexes and exporters' stocks in particular were punished as the yen climbed. Only the Kospi and all ordinaries were up on the week.

Global Stock Market Recap

Europe and the UK
European stocks experienced their worst drop in two years Friday. Investors fretted over surging commodity prices and a sinking dollar. They were concerned that accelerating inflation would lead to higher interest rates. The sinking dollar took the stocks of export-dependent companies such as Royal Philips Electronics and Siemens down with it. A weaker dollar erodes the value of their global sales. Michelin, the world's largest tire maker, was down after the company said it will be harder to meet a profit target given the higher value of the euro. According to Goldman, Sachs & Co, for every 10 percent decline in the dollar versus the euro, earnings at European companies decrease by an average of 3 percent. And inflation can impact profits when companies have a difficult time passing increased costs on to their consumers. Previously, soaring commodity prices helped bid up commodity and energy companies stocks. However, in the past week, investors have dumped these same companies as commodity prices eased somewhat. The CAC and DAX were down 2.6 percent and 3.2 percent respectively and are now at levels not seen since early March.

The FTSE plummeted through the 6000 level to end the week down 3 percent and at a two-month low. The FTSE experienced its worst sell-off in two years on Friday as resource stocks and dollar-earners sank. European stocks along with the FTSE were also unnerved by the big drop in New York, which continued into Friday.

Bank of England Inflation Report signals a possible rate increase
Now it is unanimous. All the major central banks are thought to be in a tightening mode! The latest quarterly Inflation Report from the Bank of England said that interest rates were likely to climb to keep inflation from overshooting the Bank's target. Its quarterly projections indicate that inflation would overshoot the 2 percent target if the Bank failed to increase their policy rate that currently stands at 4.5 percent. In determining its interest-rate policy, the Bank of England assesses inflation risks two years out. Mervyn King, the Bank of England governor, pointed to oil and commodity price increases as posing upside inflationary risks. It should be pointed out that the Bank refused to give specific guidance, but the majority of analysts and investors took the report as a signal that the next move will be up.

Asia/Pacific
Asian stocks dropped last week. Investors there are also concerned that soaring commodity prices will increase costs for manufacturers, push global interest rates higher and profits lower. Exporters such as Toyota and Samsung were also hard hit. On Friday, the Nikkei dropped for the fourth day to end the week at its lowest level in seven weeks. The declines were provoked by the ever-climbing yen. However, the all ordinaries managed to turn in the best performance, climbing 1.5 percent on the week.

Currencies
The dollar had been declining against all major currencies prior to the FOMC meeting on the assumption that the Fed would probably halt after this interest rate increase. The dollar has been dropping with greater intensity since the Group of Seven meeting in April when finance ministers called on Asian countries to allow their currencies to appreciate to help narrow global economic imbalances. It was interpreted by some as a mini-Plaza - a reference to the 1985 Plaza Accord when leading industrialized nations agreed to unite to weaken the dollar.

The dollar is currently at a one-year low against the euro and an eight-month low against the yen. And the U.S. dollar is at a 28-year low against the Canadian dollar. The yen has risen almost 5 percent against the dollar since last month's G-7 meeting. A rising yen imperils the Japanese recovery by making exports more expensive and reducing repatriated earnings.

The escalating value of the euro has in part been due to interest rate expectations. With stronger growth in the EMU, analysts expect the ECB to increase rates at their June 8th meeting. Council members have added to these expectations in recent remarks including those by ECB governing council member Nout Wellink who said that interest rates are too low. He signaled support for a 50-basis-point increase in June.

Indicator scoreboard
EMU - First quarter flash gross domestic product was up 0.6 percent and 2 percent when compared with the same quarter a year ago. This is an improvement on the fourth quarter when GDP was up 0.3 percent and 1.8 percent on the year. As with all flash releases, no detail is available. Detail will be available in Eurostat's June 1 preliminary release.

Germany - March seasonally adjusted industrial output dropped 1.7 percent but was up 4.1 percent when compared with March of last year. The weakness was blamed on poor weather. Manufacturing output also sank, by 1.4 percent but was 4.7 percent higher on the year. Basic and capital goods output were down 0.5 percent and 2.5 percent respectively on the month. However, both were up 7.1 percent and 4.2 percent respectively on the year.

March seasonally adjusted merchandise trade surplus eased to €11 billion from €12.3 billion in February. Exports declined by 3.2 percent while imports dropped 1.6 percent.

First quarter flash gross domestic product was up 0.4 percent and 1.4 percent when compared with last year. This was an improvement over the fourth quarter's readings of unchanged on the quarter and up 1.4 percent on the year. While the Federal Statistics Office indicated that both private consumption and investment contributed to growth, no data for components were available in the flash release. These data will be available on May 23.

France - March seasonally adjusted industrial output was up 1.6 percent and 1.9 percent when compared with last year. Manufacturing output was up 1.6 percent and 2.4 percent on the year. Auto output rebounded, climbing 2.1 percent after plummeting 4.1 percent in the previous month. Capital goods output was up 2.8 percent after sinking 1.5 percent in February.

March merchandise trade deficit eased to €1.957 billion from €2.186 billion in the previous month. Imports were virtually unchanged while exports were up 0.8 percent. Exports of capital goods and agriculture were up while auto and pharmaceutical exports were stable.

Italy - First quarter flash gross domestic product was up 0.6 percent and 1.5 percent when compared with last year. This is a marked improvement over the fourth quarter which was unchanged on the quarter and up 0.5 percent on the year. As always, no detail is available for flash reports.

March seasonally and workday adjusted industrial output edged down 0.1 percent but was up 4.2 percent when compared with last year. All sectors with the exception of consumer goods were up. Capital goods output was up 0.8 percent while energy goods output increased by 1.3 percent. However, consumer goods dropped 2.3 percent on the month.

Britain - Unadjusted producer output prices gained 0.6 percent from March when they rose 0.3 percent, the Office for National Statistics said today. It was the fourth straight month of gains and the biggest since September. Producer input prices were up 1.9 percent and 15.7 percent on the year.

March global merchandise trade goods deficit improved to £5.455 billion from February's record deficit of £7.047 billion. Exports were up 2.3 percent while imports were down 4.2 percent. The trade deficit for both goods and services eased to £3.837 billion from £5.383 billion in February.

March industrial production was up 0.7 percent and 0.3 percent when compared with last year. Manufacturing output was also up 0.7 percent on the month and was up 1.1 percent on the year. Ten of 13 manufacturing sectors were up on the month with the largest increases occurring in the transport and optical and electrical equipment sectors. Electricity, gas and water production was up 2.8 percent on the month and 3.3 percent on the year. Mining and quarrying output dropped 1 percent and sank 8.5 percent on the year.

Asia
Australia - March retail sales were up 0.3 percent and 4.8 percent when compared with last year. Food sales gained 0.9 percent as did spending at hotels and restaurants. First quarter clothing sales were up 3.2 percent while household goods were up 1 percent.

April employment was down by 3,200 jobs. Full-time jobs were up by 22,700 while part-time employment, which is common in sectors such as retail and hotels, dropped 25,900. The unemployment rate inched up to 5.1 percent from 5 percent in March. The participation rate ebbed to 64.3 percent from 64.4 percent in the prior month.

Americas
Canada - March merchandise trade surplus dropped to C$5.143 billion from C$5.857 in the previous month. Exports were up 1.1 percent while imports soared by 3.6 percent. Exports were up primarily due to increased exports of machinery and equipment and especially for aircraft, engines and parts. Exports were up for agricultural and fishing products also. On the downside were exports of forestry products and automotive products. Imports were driven by increased demand for crude petroleum, machinery and equipment, consumer goods, and automotive goods. Exports to the United States were flat in March but imports jumped by 2.5 percent from south of the border. As a result, the trade surplus with the United States narrowed from C$9.0 billion to C$8.5 billion.

Bottom line
Although the recent cycle of central bank meetings is drawing to a close for now, analysts are already anticipating the June meetings and their possible outcomes. There is no doubt that most of the major central banks (European Central Bank, Banks of Canada, England and Japan, and the Reserve Bank of Australia) are expected to increase their policy interest rates in the next several months. The Bank of Japan meets this week but any further policy changes appear to have been discounted by BoJ watchers. The Bank continues to reduce excess liquidity and has indicated that there is normalization in its interest rate policy in the future. Meanwhile, government officials are watching the value of the yen very carefully and have already begun their rhetoric to control any further increase that could harm exporters and economic growth.

Looking Ahead: May 15 through May 19, 2006

Looking Ahead: May 22 through May 26, 2006

Looking Ahead: May 29 through June 2, 2006