Western markets are still in summer mode and, historically, the last two weeks of August are amongst the quietest as investors and traders take vacation ahead of the new school season. Volumes will therefore again be low this week. But markets everywhere will remain volatile with another batch of important economic indicators scheduled for release in the US (see below). Even though the 2nd Qtr earnings season was better than expected, the benefit from that has already been displaced with worries over the 3rd Qtr numbers to be released from early October. This period of indecisiveness and fragility in markets still has some way to play out.

Metals & Mining

The metals and mining sector will remain in focus again this week. The steel names, in particular, were the most volatile last week as their price action exaggerated the shifting mood amongst global market investors. Most fell sharply on Friday and that weakness is expected to continue on Monday. How they trade later in the week will depend on the economic data scheduled for release in the US on Tuesday and where the dollar trades. The banks, especially Sberbank, are the proxy for the oil price, the ruble and the country’s general economic well-being. They are also likely to come under pressure at the start of the week as a result of expected further weakness in the oil price.

Vimpelcom will undoubtedly be the headline story on Monday after several weekend media stories said that talks are talking place about a merger with the telecom interests of Egyptian investor, Naguib Sawiris. These include Orascom telecom, one of the biggest North African and Gulf States operators, and Wind Telecom in Italy. Investor concern has been focused on the level of debt in Sawiris’s group and the effect of merging that may have on Vimpelcom credit rating.

Magnit and Dixy are scheduled to report 1sh half numbers on Tuesday, Comstar will report on Wednesday and MTS will release 2nd Qtr US GAAP numbers on Thursday.

On Sunday, Rosneft announced that it will invest $630 million to jointly explore for gas with Crescent Petroleum in the United Arab Emirates. No a big investment in itself but another step in Rosneft’s quest to be a more global energy player. It also further illustrates the difference between the “insider” state companies and the others. If you are in the former camp you benefit from political bartering. If not, you don’t.

Global Currency Markets

The main interest in global currency markets this week is expected to be speculation about action that the Japanese government may take to halt the appreciation of the yen. The currency has risen by 14% this year and that is hurting export competitiveness and earnings growth. The euro might have been the beneficiary of any move out of the yen but comments by the ECB council member considered to be the strongest candidate to be the next ECB President, have undermined support for the euro. Axel Weber said that the ECB should take action to head off any risk of a liquidity squeeze later this year. That sent the dollar higher against the euro on Friday to close at $1.2712. That was a gain of 0.7% for the five days. The dollar is expected to extend that gain at the start of this week simply because it is the lesser of three risks (i.e. with the euro and the yen) in the major currencies market.

The ruble held reasonably stable against the basket last week, gaining 0.1%. It lost 0.2% against the dollar, to close Friday at $30.56, while adding 0.7% against the euro to end at 38.99.

The strengthening dollar also adds pressure on the price of oil. The dollar rally was one of the factors that cut the price of crude by $1 p/bbl on both Nymex and ICE during Friday. But it was not the only reason. Inventory levels in the US continue to rise as end-user demand remains sluggish and because the most recent economic indicators point to a much slower recovery rate than previously hoped for. In addition, OPEC compliance again slipped last month as member countries continue to add more oil. The next meeting to review production and quotas is not scheduled until October. Brent, for October settlement, ended Friday at $74.26 p/bbl while WTI crude closed at $73.82 p/bbl. The discount is again emerging, as Cushing storage gets tight. Urals last traded at $72.73 p/bbl.

Global Equity Markets

Global equity markets fell for a second week as investors reacted to evidence of slowing growth in the US economy. A bout of M&A activity, especially the bid by BHP to take over Canada’s Potash Corp, had raised hopes of a market revival in the middle of the week but Thursday’s worse than expected initial jobless claims Philadelphia region manufacturing update, killed that off. The FTSE All-World Index ended last week down 0.7% and if off 5.6% year to date.

The MSCI Emerging Markets Index performed better than their developed market counter-parts. The Index closed 0.8% better for the five days after a series of strong earnings reports. India was the star performer, closing at a 30-month high. Investors in Korea were buoyed by several profit growth reports from major companies. The Kospi Index gained 1.7% last week. Investors in China were less convinced and remain concerned that the yen appreciation may change the economic dynamic in the region. The Shanghai Composite Index fell 1.7% over the past week.

Russian equities have been following the global market trend all summer and last week was no different. The RTS lost 1.4% on Friday to bring the loss for the week also to 1.4% and a close at 1,425.0. MICEX lost 0.6% on Friday and ended the week down 0.4% at 1,366.3. The worst performing index on Friday was the IOB Index of London traded GDR prices. That measure fell 2.0% on Friday as high-beta names in the steel sector fell sharply as a reaction to global growth worries.

The same drivers that moved equity markets also drove most commodity prices last week. The price of industrial metals rose at the start of the week but finished off with price weakness as investor worries about slowing global growth increased.

Gold initially rose as investors bought more of the haven asset. But, as more broadly based worries emerged by the end of the week, gold was also sold down. The rally in the dollar also cut the need for the alternative safe play. Gold fell 0.5% on Friday albeit, over the five days, added 1.2%.

The latest weekly fund flow report from EPFR Global showed the biggest week of inflow to EM Balanced Funds in 2010. The total last week was $2,249 mln and that brings the year to date total for this fund category to $25,747 mln (see more detail below). But while investors remain optimistic about the asset class in general, they are increasingly unsure about which country to back. Russia was a major beneficiary of that switching in the 1st half but has been losing out since the start of the 2nd half.

This week

Currency markets are even more uncertain. With the end of the holiday season in Europe is still 10 days away and US Labour Day is 2 weeks off the market psychology is still stuck in summer mode. That means that while volatility will continue as investors react to economic reports, there is unlikely to be any major volume increase again this week. Market sentiment has become very sensitive to economic updates since early August with very clear indecision as whether the US and the EU are facing a double-dip recession or just a slower pace of growth than seen in the 1st half of this year. Apart from the specific economic updates scheduled for the week, a more negative backdrop has been created with the comments by the ECB and the Bank of Japan. The ECB council member considered most likely to be the next bank president said that there may have to be more intervention to head off a liquidity squeeze later this year. The Japanese government said that there will be a major review of currency policy this week and that action may be taken to reverse the recent strengthening of the yen. All of which adds additional uncertainty in already nervous markets.

Tuesday is a big day for economic reports. Amongst the specific US economic reports that have previously had an impact on global markets, three will be published on Tuesday. These are the July existing home sales report, the Richmond Fed Manufacturing Index and the Conference Board consumer confidence survey. Wednesday’s schedule will be equally testing and important. The July durable goods and new homes sales reports are on the list for that day. The initial jobless claims report will sustain the nervous mood into Thursday while, on Friday, the 2nd reading of Q2 GDP growth will be printed along with the final reading of the University of Michigan consumer confidence survey. All of which will ensure that markets will have something to worry about all week and right up to the weekend. No wonder the last week of August is the most popular week for vacations on Wall Street and London City.

Inflation is the big issue in Russia. In Russia, the main economic report will be the weekly inflation update. That report is expected to acquire much greater significance over the nest few weeks as investors wait to see what is the impact on the economy from the summer’s extreme weather conditions. Last week’s inflation growth was 0.2%, and almost twice the weekly rate of the preceding several months. The year to date growth rate is 5.1% which means that, unless the inflation rate is checked, the full year growth rate in course for +8.5%. Our full year forecast is for a full year growth rate of +7.5%. Inflation control is the most important priority for government because, apart from aiding economic recovery, a low inflation rate allows the Central Bank to keep the current benchmark rate at 7.75%. Affordable borrowing rates for mortgages, consumer goods and small businesses is an important part of the government’s strategy for economic growth in election year 2011. Hence, if we do see inflation pressures rising in the food sector, the government may respond with pressure to keep price growth in other areas, e.g. regulated tariffs and fuel prices, as low as possible. It may also lead to inflation targeting using the ruble exchange rate. Our year-end target for the ruble-dollar is 28.2.

July data was generally good. The July monthly macro indictors for the Russian economy were published mid week and showed that recovery remains on track. The numbers were particularly positive for the consumer sectors with real wage growth at 6.8%, year on year, and the value of retail sales up 6.6% over the same month last year. The unemployment rate did surprise on the upside, coming in at 7.0% from 6.8% in June. That was at least partially linked to the unusually hot weather in July, albeit the full effects on the economy of the extreme weather and drought will not become clear until the August and September data. It is simply far too early to speculate about the effect on GDP and industrial production growth or the effect on retail sales.

FDI report was very bad. The 2nd Qtr Foreign Direct Investment report showed a still bad picture of foreign investor interest in Russia. The report showed how little money Russia is attracting from international investors and how tough is the task facing the government to attract funds into new industries and projects. The total of FDI for the 2nd Qtr was only $5.5 bln. That was 11% less than the total received for the same quarter in 2009 and, annualised, represents less than 1.5% of GDP. Compare that with the almost 10% of GDP reported previously for the other so-called BRIC countries. And most of the money coming into Russia is from locations that are traditionally sources of round-tripping Russian money, e.g. Cyprus and Dutch Antilles. The amount of actual non-Russian sourced FDI is currently negligible.

Chris Weafer is the Chief Strategist for Uralsib group