Week Ahead In US Financial Markets August 18-22 2008
The week of August 18-22 will see a very light week of economic data on the calendar. Aside from Dallas Fed President Fisher's comments on the US Economy on Wed, the only potentially market moving macro data for the week will be the Monday release of the PPI and Tuesday publication of the Housing Starts series for July. The remainder of the major data for the week will be released on Thursday when the weekly jobless claims series, the August Philadelphia Fed survey and the June index of leading economic indicators are published.
Fed Talk
The week ahead will see a light schedule of Fed speakers. On Tuesday Dallas President Richard Fisher will speak on the US economic outlook in Aspen, Colorado at 10:00 AM EDT.
Producer Price Index (July) Monday 08:30 AM
The producer price index in July should partially pick up the sharp decline in the cost of oil during the sampling period. We do not think that the market will observe a fall in headline prices associated with the cost of commodities in full until the August sampling period. Thus our forecast implies that a 0.6% m/m and 9.4% increase in headline costs, while the core should see a 0.2% m/m and 4.0% year over year rise in inflation. We expect to see a slight moderation in the cost of gasoline that should be completely offset by an increase in demand for residential electricity. Perhaps more interesting is the pressure that has been building in intermediate costs. On an annual basis, total intermediates were up 14.5% in June, with the core ex food and energy up 8.4% during that same time frame. If oil prices remain at current levels, the market will observe some relief in headline inflation, but the problems in the core will persist for some time to come.
Housing Starts/Building Permits (July) Tuesday 08:30 AM
After a solid June in starts we expect the data to fall back slightly to 965K for the month of July, which would be a multiyear low in the series. Our long term forecast for starts anticipated a decline near the 900K mark. It is our assessment that the starts series should begin to flatten and stabilize in early 2009. The excessive capital stock built up in the housing sector will take years to burn off and housing prices will have to fall well below their long run equilibrium to speed up the adjustment period in the housing sector for starts to see a meaningful recovery. That being said, the flattening out of the trend in starts should begin to reduce the net drag on overall growth later in this year, which is one of the few positive signs in the residential investment sector in some time.
Initial Jobless Claims (Week ending Aug 16) Thursday 08:30 AM
Initial claims over the past two weeks has surged well above the critical threshold of 400K and the less volatile four week moving average has increased to 440K. The strong move to the upside may partially be a function of legislative changes that have enabled continuing files to be identified and initial filers. This implies that the market should see the headline moderate over the coming weeks towards the four-week moving average. Thus we expect a 440K print for the upcoming week.
Philadelphia Fed (August) Thursday 10:00 AM
We anticipate that the general business activity index inside the Philadelphia Fed's survey of manufacturing activity in the region should see a modest advance and arrive at -11.18 for the month of August. The headline is not a composite of the underlying questions, but a single stand-alone question that is a fairly solid indicator of purchasing managers sentiment inside the region. The fall in the price of oil should provide a modest boost to sentiment in the survey, but that will partially be offset by lingering concerns over domestic demand for manufactured goods, slowing orders from abroad and still difficult environment for new orders.
Leading Economic Indicators (July) Thursday 10:00 AM
The Conference Board's index of leading economic indicators should arrive flat for the month. The recent volatility in equities and the difficult macro environment provide little suggestion that there has been a material turn for the better in the overall economy. Aside, from what may prove to be a transitory decline in the cost of imported oil, the net contributors to the leading index are all still painting a very dreary economic picture. Our forecast implies that the headline reading for the month of July will be 0.0.
Joseph Brusuelas
Chief Economist
Merk Investments
http://www.merkfund.com/
The views in this article were those of Axel Merk as of the newsletter's publication date and may not reflect his views at any time thereafter. These views and opinions should not be construed as investment advice nor considered as an offer to sell or a solicitation of an offer to buy shares of any securities mentioned herein. Mr. Merk is the founder and president of Merk Investments LLC and is the portfolio manager for the Merk Hard Currency Fund. Foreside Fund Services, LLC, distributor.
Economic Outlook: Cold Winds Blowing Over the Eurozone
The European PMI data may send shivers down your spine. Particularly the South European PMI data - Spain, Italy and to some extent France - where the temperature has fallen below the freezing point. For instance, the index for the service sector is a t the lowest level ever in France, Italy and Spain (however, the level was a bit lower in June than in July) but the industrial index is the lowest in Spain and only twice has it been lower in Italy. The French index is also low - even though for a period it was lower in 2001.
The weak development of the PMIs seen over recent months, has once again in Europe shifted focus to growth - even though the inflation rate is still above 4%. However, this development has not prompted the ECB to surrender completely. But then, the bank's clear mandate is that, above all, it must ensure price stability - i.e. an inflation rate below, yet close to 2%. The ECB has, however, begun to acknowledge that the economic growth will be weaker than it previously expected, and of course that gives rise to concern on the part of the bank.
And rightfully so, as the PMI data signal that growth will also be very weak in Q3 and perhaps also in Q4. The somewhat forward-looking indices among the PMIs (order inflow, order book and inventories) do not indicate any encouraging development for the coming months.
Therefore we also assess that we shall see even weaker PMI data for August for service as well as industry. That will be so even though the oil price has fallen and the EUR has weakened. It may, however, bring a bit of relief to the European companies. And to the consumers, this may have the implication that once again there are prospects of a positive trend in real wages in early 2009. The reasons will be stronger wage increases and that inflation may very well have peaked this time around and will begin to fall.
Of course, we will see focus on the general indices, but more importantly, it will be interesting to see how the forward-looking indices develop. There is a not inconsiderable risk that euro zone will see weak growth figures for a longer period than initially expected. We do, however, still expect that the economic growth during the middle quarters of the year will be weakest and then improve slightly.
This week's other highlights
- The US: Residential construction, Philly Fed and producer prices
- Germany: ZEW indicator
- The UK: Minutes from monetary-policy meeting and retail sales
- Japan: monetary-policy meeting at the BoJ
- Norway: GDP
Monday
The US: NAHB housing market index, August
Home builders' gauge of sales and expectations, NAHB, is interesting, since it gives an impression of the situation in residential construction - the sector of the economy which was definitely hit the hardest.
The home builders have been similarly pessimistic as the housing market index has hovered at a level just below 20 for quite some time while the historical average is just above 50. The fact that sentiment has not improved lately is seen from the decline in July to index level 16 - the definitely lowest level ever.
Conditions for residential construction have not improved lately. The short as well as the longterm mortgage rate have risen and banks have tightened even more, particularly with respect to home loans. This development may prolong the crisis that we have seen in the housing sector since the autumn of 2005.
Moreover, the prospects for the construction companies deteriorate as one of the - even though uncertain - leading indicators for the index is the construction companies assessment of home sales in the six-month term. This assessment shows further deterioration in July. On the other hand, it should also be noted that the index is at a very low level. On the whole, we expect an unchanged or negative development.
Japan: monetary-policy meeting at the BoJ
We expect the BoJ to leave interest rates at 0.5% at which they have stood since the hike in February 2007.
Economic growth in Japan is in the doldrums. The export sector is affected by the global slowdown in growth, and there are no prospects that the domestic economy will take over the part as growth engine as personal spending as well as investments are under pressure. Even though consumer prices have risen significantly by Japanese standards (2.0 % y/y in June) and now are the highest they have been for ten years, there are no signs that inflation is generally on the rise and core inflation (exclusive of food and energy prices) remains at about zero.
On that background, we expect the BoJ to keep interest rates unchanged for the rest of the year. A hike is not likely until H2 2009 and will not be made until the economy is back in swing or core inflation begins to show a convincing, positive trend.
For the first time, the BoJ will now issue a statement together with the interest-rate decision; in this statement the reasons behind the decision as well as the growth and inflation prospects will be discussed. Until now, the BoJ has only issued detailed explanations in connection with changes in the interest rate and when the interest rate was kept unchanged, the BoJ has only stated whether or not the decision was unanimous.
Tuesday
The US: producer prices - July
This time the producer prices are not quite that important as the consumer prices have been released and as the producer prices do not reflect the major declines in the oil and food prices that we have seen lately.
The strong increase in producer prices have primarily been fuelled by the rising energy and food prices, but undoubtedly the July figures will not reflect much of the fall in the oil prices and other commodity prices, as normally producer price data are gathered during the week including the 13th day of the month. Because oil prices, as a matter of fact, peaked at about that time in July, we may actually risk seeing further increases in producer prices. Moreover, the companies also react with some delay when commodity prices increase as many companies only change their prices fairly seldom (according to Blinder, about a third of the companies only change their prices once a year). However, it should be noted that several of the prices included in the producer prices have fallen over a longer period of time than the oil prices and that may have a lowering effect on producer prices for July.
We may therefore see moderate increases in the producer prices for July.
The US: Home construction - July
Building permits and housing starts are among the most important economic indicators this week. Residential construction has fallen massively, which is reflected by the fact that the number of building permits for single-family homes has fallen by no less than 65% since late 2005. This is the steepest fall ever.
Residential construction and building permits rose steeply in July, but that can solely be attributed to changes in the New York building regulations for multi-storey buildings valid as of 1 July and due to which construction companies have accelerated construction as well as applications for building permits from July to June. If we adjust for this effect, residential construction fell in June by 4%. Therefore, residential construction and building permits will fall very steeply in July - probably by more than 10%.
At this development will solely affect construction of multi-storey buildings in the New York area, focus will primarily be on singlefamily homes in and outside the north-eastern area. The development in the construction of single-family homes has in recent months been that of some stabilisation and therefore it will be most interesting to see whether this trend will continue. When we look at the development of the housing market index the likelihood of such a development is not, however, very strong.
Therefore we expect a steep decline in housing starts in July.
Germany: ZEW
For quite some time now, the ZEW has signalled a significant weakening of the German economy - yet this has not materialised. In H1, growth was on average at 0.4%, q-o-q - with an increase of 1.3% in Q1 and -0.5% in Q2. For quite some time, the ZEW has signalled recession in Germany, which we will not rule out will take place in Q2 and Q3 - at least in technical terms - as growth may fall in both of these quarters. We still assess, however, that the ZEW reflects a considerably weaker German economy than we are actually seeing and therefore we do not consider the level indicative of the economic development - what is more important is the change in the ZEW. We expect that ZEW will increase in August - particularly when bearing in mind the falling oil prices - and also because at the moment the ZEW is at a historically low level.
Wednesday
The UK: Minutes of the BoE interestrate meeting held on 6-7 August
The BoE decided to hold interest rates at 5% at the meeting earlier this month. This was not surprising, given the BoE's dilemma over sharply rising inflation and economic slowdown. A more detailed explanation for the interest-rate decision will be provided in the minutes.
The inflation report that was just released still indicates that the BoE will opt not to increase its interest rate to fight the rising inflation and that there are prospects of further interest-rate cuts, yet not in the next few months. The growth expectations were reduced further relative to the May report, and the BoE now expects flat growth over the coming year, and also growth expectations for the coming years were downgraded. Also, the BoE upgrades its expectations of the inflation in the short term.
Now it is expected that inflation will peak at about 5% at the end of the year and then it will gradually decline to a level below the 2-year target. The BoE does, however, emphasise that the uncertainty of the growth and inflation estimate is higher than normally and that the risks relating to growth is primarily on the downside while for the inflation they are on the upside.
The most interesting point of the minutes will be how the members of the monetary policy committee voted. We expect that once again the monetary-policy committee will be undecided having three different views. At the July meeting, Besley voted in favour of an interest-rate hike and given the recent strong increase in inflation, it cannot be ruled out that one or more members will jump on this bandwagon. Also, it is very likely that Mr Blanchflower voted in favour of a cut as he has done since October last year.
Thursday
The US: Jobless claims - week 33
Initial jobless claims are an indicator of how many new people join the unemployment queue. The claims are used as an indicator of developments in the labour market based on the following: the more claims, the weaker employment growth.
Jobless claims are also one of the best indicators of the trend in employment, and this week we see extra focus on the data since this is the week when the data for the job report are collected. The figures have not become less interesting since they have risen sharply over the past two weeks, but part of the increase is due to technical matters in the form of an extension of the cash benefit period. Consequently, unemployed who have received daily cash benefits over a period of time, have applied again. In addition, it is approx. the time when the car factories lay off their employees on a temporary basis, because they adjust their machinery to the new models. This factor always makes the jobless claims figures uncertain at this time of the year.
The US: Philly Fed August
Philly Fed is one of the regional indicators of industrial confidence which are used as a gauge of how the economy is doing at state and federal level. There is a good correlation in the longer term between Philly Fed and ISM, although Philly Fed shows wider fluctuations than ISM in the short term. The development of Philly Fed has been much weaker than that of ISM in the past six months. In addition to the overall index, focus will be on new orders, employment and the price index.
The euro zone: PMI August
See This week's highlight.
The UK: retail sales - July
The highly volatile retail sales grow constantly, but growth in on the decline, and the rate of increase y/y is now at 2.2%. We anticipate that retail sales will decrease even further in the coming months, but following the very sharp decline in June, retail sales may make a slightly upwards correction again in July.
The UK economy is slowing down, and consumers are under pressure from rising inflation, falling house prices as well as tighter credit conditions. Retail sales have long been surprisingly strong, but it now seems to flag off in line with the indications received from various surveys of retail sales. British Retail Consortium announced a fall again in July, and the CBI index for retail sales dropped back in July to its lowest level since 2005.
Norway: GDP, Q2
The solid economic boom for more than four years has been replaced by an economic slowdown since global economic growth is on the decline, the credit conditions have been tightened and Norwegian consumers are under pressure on several fronts. Growth was, however, surprisingly sluggish in Q1 (0.2% q/q), and we expect that growth will in Q2 be somewhat higher (around 0.4%-0.7% q/q), and the growth will gradually decrease in the coming quarters. We anticipate, however, that Norway will see a soft landing with continued moderate growth.
Since 2007, households have shown a negative savings ratio. The higher interest expenses and the falling house prices will contribute to putting a damper on the demand from households and contribute to a higher savings level. The rising inflation also squeezes consumers although we still see fair growth in real wages due to the high wage increases, and the sustained tight labour market is also supportive. All in all, we expect to see moderate growth in private spending.
The volatile fixed investments plunged in Q1. We anticipate that they will regain some of the lost ground in Q2, supported by the high oil prices and continued thick order books. Also housing investment dropped back in Q1 (due to high building costs and lower house prices), and in this respect we expect to see a sustained sluggish development in Q2. We also expect that the slowdown in growth at Norway's trading partners will leave its mark on exports.
Friday
The UK: Q2 GDP - 2nd announcement
According to the first announcement of GDP data, growth for Q2 fell to 0.2% q/q and 1.6% y/y which is the lowest growth rate since 2002. This statement includes the demand components and a revision of growth. However, we do not expect a sharp revision.
The tightening of credit standards hits both companies and households, and the latter is under further pressure due to slow real wage growth and falling house prices. Therefore, we anticipate that the growth in private spending slows down although retail sales are still showing fair but decreasing growth rates. Due to the prospects of slower economic growth globally as well as in the UK, businesses will presumably be more cautious about making investments. The lagged effect from the exchange-rate weakening over the past year contributes to the fact that, despite the global economic slowdown, there are still prospects of export growth, and imports will presumably be under pressure due to lower domestic demand. Therefore, net exports rather than domestic demand will be boosting the UK economy.
Jyske Markets - FX Research
http://www.jyskebank.dk/finansnyt
Weekly Focus : Weak Growth in Euroland Set to Make its Mark on Denmark
The euro economies have been weakened by high inflation, the financial crisis, weaker growth in export markets and a strong currency - and growth is weak almost right across Euroland. GDP fell by 0.5% from Q1 to Q2 in Germany and by 0.3% in France and Italy, while Spain reported its lowest growth for 15 years of just 0.1%.
Economic indicators have also deteriorated substantially in Euroland. Most notably, Germany now looks set to become the last of the big euro economies to be hit hard. Indicators suggest that the economy is teetering on the brink of recession.
Bad news for the German economy is also bad news for the Danish economy, as Germany is still our largest export market. Although its relative importance has declined somewhat in recent years, there is no doubt that Danish industry will be hurt when Germany comes under pressure, as the German market accounted for 17.5% of Danish goods exports in H1. Danish exports to Germany actually performed surprisingly well in Q2, climbing 14.7% (excluding oil), and have grown by 16.7% over the past year. However, even though exports to Germany are still growing, it is probably only a matter of time before the slowdown in our big neighbour to the south makes its mark at home..
Euroland: Slight growth downgrade from the ECB
The final inflation numbers for July saw the preliminary figure revised down from 4.1% to 4.0%. Core inflation remains in check - excluding energy, food, alcohol and tobacco, consumer prices rose 1.7% y/y, which is 0.1 percentage point less than in June. According to the ECB definition (ie, total minus energy and non-processed food), prices increased by 2.5%, which is the same as in June.
Euroland growth is clearly weakening. GDP in Q2 was down 0.2% on Q1. The downturn is in part due to corrections in the wake of temporary effects that boosted growth in Q1 - we estimate that underlying growth in Euroland was 0.2% q/q in Q2. The correction hit all-four Euroland majors: German GDP fell 0.5% relative to the previous quarter, France and Spain saw a fall of 0.3%, and Spain experienced its slowest growth in 15 years - just 0.1%. Thus, the ECB's comment in connection with last week's rate meeting that “there is some materialisation of these (downside) risks (to growth)” now clearly applies to the national accounts of the member countries. We expect more weak data in the coming months, and low growth and the risk of recession will remain themes until at least the end of the year.
In the coming week this will be reflected in weaker numbers in Germany, where we expect that manufacturing PMI will fall below 50, ie, indicating contraction. As regards German service PMI, we expect a fall to 51. This marks a resumption of the downturn after the largely sideways movements of recent months. The ZEW indicator is also due, and we estimate it will come out at 64. Thus our view of the German economy is more pessimistic than consensus, and this has had a spill-over effect on our forecast for Euroland PMI, where we also expect greater falls than consensus.
Key events of the week ahead
- Tuesday: Negative outlook for German economy. We expect ZEW indicator at around 64, which is lower than consensus.
- Thursday: PMI for Euroland and Germany. We are slightly more downbeat than consensus. We forecast Euroland manufacturing PMI will fall to 46 and service PMI to 47.5. As regards Germany, we expect manufacturing PMI at 49.5 and service PMI at 51.
UK: Bank of England softer than expected
The Bank of England (BoE) released its August Inflation Report on Wednesday 13 Aug. As expected, the BoE revised its growth path downwards and the inflation path upwards compared to the May Inflation Report. Although such revisions were generally expected, markets were surprised by how negative the report was and also how downbeat BoE Governor Mervyn King was at the press conference afterwards. Market reaction to the Inflation Report was quite strong: EUR/GBP rose from 0.7860 to 0.7930, before falling slightly back, and the yield on the 2Y UK gilt dropped around 15bp to 4.52%. These movements were significant, as reaction to the May report, which also had a concerned tone and some controversial content, was rather limited. In our view, the Inflation Report depicts a pretty fair picture of the challenges confronting UK policymakers. Growth prospects are unusually bleak due to the downturn in house prices threatening to suppress consumption, but the BoE cannot justify resuming the easing cycle while inflation is soaring. However, as soon as inflation has peaked and starts coming down to more tolerable levels, the BoE can again cut rates. Accordingly, we expect the BoE to lower the base rate to 4% by end-09 (base rate currently 5%) to stimulate the economy and to ensure that inflation does not undershoot its target. Our outlook of GBP underperformance remains intact. We expect EUR/GBP will return to territory above 0.80 (GBP/DKK below 9.32), though higher (lower) levels cannot be ruled out when the magnitude of the slump in the UK economy becomes clearer.
In the past week we also had numbers for housing in terms of the RICS survey. The survey rebounded a bit and was better than expected. However, it is still at a very low level, highlighting the current weakness of the UK housing market (see chart). Unemployment data showed a stronger than expected rise of 20.1k (consensus 17.1k). Finally, inflation jumped to a new high of 4.4% (consensus 4.2%), highlighting the dilemma for the Bank of England. Core inflation rose to 1.9% from 1.6% last month.
Key events of the week ahead
- Monday: Rightmove house price index. Has shown pronounced declines recently.
- Wednesday: Minutes from the latest Bank of England meeting. Focus on how the votes were cast this time. We go for a 7-1-1 decision.
- Wednesday: CBI industrial trends should weaken.
- Thursday: Retail sales will give more information on the state of the UK consumer. We see downside risks to the number.
Switzerland: New interest and exchange rate forecasts
As a consequence of the current development in economic data and at the financial markets we have revised our view of the Swiss National Bank (SNB). As the growth forecasts for Europe have worsened and inflation have spiked we don't see any changes for interest rate hikes within the next 12 months.
A change in interest rates does not normally impact fully on the economy for about 18 months. An interest rate hike at the next rate-setting meeting in mid-September would only worsen the outlook for the real economy, which is already facing a downturn. The KOF leading indicator suggests GDP growth of less than 1% y/y in six months' time, down from 3.1% y/y in Q1 this year. Furthermore, the recent downward trend in commodity prices, which had hitherto been a major factor in the rise in inflation in Switzerland, suggests that the pressure on inflation is only temporary. In its latest inflation forecast, the SNB forecasts that inflation will move below the target of 2% y/y in Q2 09. Adding these factors together means that we now expect the SNB to leave interest rates alone.
Since the SNB's last rate-setting meeting in June there has been a marked shift in the focus of central banks. At the beginning of June there was a lot of focus on inflation, but now the focus is also on the negative growth outlook - the inflation-obsessed ECB in particular has recently expressed concern about the growth outlook for Euroland. The SNB has not been particularly forthcoming since the June rate meeting, when it put out a relatively neutral press release. There has also been a marked shift in the market's focus. At the time of the June meeting, rate increases of 75bp over the next 12 months were priced into the OIS curve, whereas now just a single 25bp hike is priced in for the next 12 months.
Relative to Euroland the key figures have been better in Switzerland and as we expect this trend to continue in the near future, we still expect to see a stronger CHF vis-à-vis EUR and DKK. A stronger CHF is also consistent with our expectation of an appreciation of JPY, as defensive currencies as usual track each other. Our forecast is still EUR/CHF 1.60, 1.58 and 1.56 in 3, 6 and 12 months, respectively.
The past week has brought consumer confidence data that confirms that Swiss private consumption is beginning to look weaker. The coming week brings producer and import prices. Given recent movements in commodity prices, these figures are expected to mark a provisional peak in inflation. The week also sees retail sales figures for June. The series is highly volatile, but could well surprise on the upside this time around thanks to the EURO 2008 soccer tournament.
Key events of the week ahead
- Monday brings retail sales figures for June, which will naturally be boosted by the EURO 2008 soccer finals.
- Thursday sees the publication of producer and import prices for July.
- Thursday also brings trade figures for July.
USA: Housing construction still looks weak
Credit standards are becoming increasingly stringent for a broad range of loan types - something confirmed by the past week's Senior Loan Officer Survey, which is published by the Federal Reserve on a quarterly basis. The survey covers the period from May to July and revealed a clear trend towards further tightening of credit standards for mortgages, consumer loans and business loans. With regard to mortgages, credit tightening has spread in recent quarters from sub-prime and non-traditional loans (typically given to borrowers with a lower credit rating) to also hit borrowers with better credit ratings who would qualify for prime loans (see graph below).
Tighter credit standards will in themselves dampen demand for housing and put downward pressure on prices, but it is difficult to quantify the direct effect on, for example, new housing starts or house prices. However, there is no doubt that the ongoing tightening of credit is a contributing factor to the US housing market remaining weak. In addition, the turmoil surrounding the two largest mortgage institutions in the US, Fannie Mae and Freddie Mac, has added to the upward pressure on US mortgage rates, which again puts additional pressure on the housing market.
Recent months have seen a stabilisation in a number of housing market indicators, such as home sales and new housing starts, which could be the first signs that housing construction has bottomed out. However, there is a risk that tighter credit standards and rising mortgage rates could spark another episode of downward pressure on prices and construction activity. We expect that the coming week's figures for new housing starts and building permits will see a resumption of the downward trend, while we expect that NAHB (builder confidence) will stabilise, but at a level that suggests further negative contributions to GDP from housing construction in the coming quarter.
Key events of the week ahead
- Monday: We expect a small increase to 17 in the NAHB housing market index for August
- Tuesday: Data new housing starts and building permits will resume a downward trend
- Tuesday: Fed's Fisher speaks
- Thursday: Philly Fed index expected to rise to -11.4 from -16.3 in July
- Friday: Bernanke to speak on financial stability in Jackson Hole
Asia: Japan weakening but rate cut unlikely
GDP numbers for Q2 confirmed that the Japanese economy has seriously deteriorated (see Flash Comment - Japan: Q2 GDP plunge on weak exports and private consumption). The bulk of the blame lies with private consumption and exports, although the negative contribution from net exports was less than we had estimated due to a greater than expected decline in imports. Also weighing negatively on growth was a surprising fall in housing investments of -3.4% q/q - we had counted on a small rise. While there are clear signs that the pressure on the Japanese consumer has spread to the housing market, we reckoned that this would not hit housing investments until Q3.
The Bank of Japan (BoJ) will be holding a monetary policy meeting in the coming week, and like the market we expect that it will keep rates unchanged at 0.5% - anything else would be a major surprise. We are still of the opinion that the BoJ will keep its leading rate unchanged for the coming year, which is also the market view (see graph below). Very weak data in recent months has meant the market pricing in a lower probability of a rate hike and increasingly seeing the risks as more symmetrical - ie, the next move in rates could be in either direction. We still believe the next move will be up, but that it will not happen until at least late 2009. The BoJ will, however, presumably soften its tone in the coming months as it adjusts its forecast to reflect the current weakness in growth. This means the market may very well start to price in a greater probability of a rate cut in the coming months, whereas it is less likely that the market will begin to aggressively price in a rate hike in 2009. One reason we do not buy into a rate cut is that we doubt a reduction in rates of 25bp or 50bp would have much effect on the economy. Indeed the discussion in Japan is now increasingly about whether there is a need for fiscal easing.
Chinese economic data have recently has been something of a mixed bag, though mainly positive. Most important was that inflation fell again in July (see Flash Comment - China: Inflation drops more than expected), which provides more elbow-room to stimulate growth. Exports, however, are gearing down (see Flash Comment China: Export growth still slowing despite robust July figure) and this is presumably contributing to slightly weaker growth in industrial production at the moment (see. Flash Comment - China: Industrial production slows).
Key events of the week ahead
- On Tuesday, the BoJ will announce its rate decision in connection with its monetary policy meeting. We expect an unchanged key rate of 0.5%
- Japanese trade figures for July due Thursday. Focus will be on exports, which fell sharply in Q2.
- Nothing of importance due in China.
Foreign exchange: EUR/USD turnaround could be slow and bumpy
When we presented our latest FX forecast at the start of July (see FX Forecast Update: To catch a rising tide), we were quite sure that EUR/USD was set to go higher. This prompted us to revise up our short-term forecast for EUR/USD to 1.60. However, we were not prepared to abandon our expectation of the inevitable halt in the enduring ascent of the euro, and so we kept our 1-year forecast of 1.50 intact. Events have moved fast since then, with EUR/USD already hitting a new high of 1.6038 on 15 July and then tumbling below 1.50 in early August.
To be sure, it is not only the euro that has lost ground to the dollar, which underlines that the main explanation behind the movements of recent weeks is heightened fears of an economic downturn outside the USA. While the economic woes of the USA should definitely not be underestimated, there now appears to be an increasing risk of a global recession, or at least a G7 recession. A rising dollar at this point underlines both the defensive characteristics of the USD and that the USA's problems have been plastered across the front page for rather a long time.
There are three sound reasons why EUR/USD could continue to decline in the coming year. First, the euro is decidedly overvalued relative to historical benchmarks. This can continue as long as the economy is expanding, but in a downturn, with several countries on the brink of recession, it can be difficult to maintain. Second, Euroland has experienced a significant outflow of capital over the past several months (see EUR: Where's my 75bn?). From a historical perspective, it is rather unusual that the euro has been able to rise at the same time as net capital flows have been outbound. One likely explanation is that while there has been an outflow overall, there has been a significant inflow from the USA. This is a relatively new phenomenon that arose because European investors have been aggressively selling US securities since last summer. However, we do not believe this will continue. Third, one should not underestimate that the USD typically strengthens between 6 and 12 months into a US slowdown.
There are, of course, risks in the other direction, including the significant cyclical and structural problems that lie ahead for the USA just as economic policy targets after the November election are unclear. Overall, though, we believe that EUR/USD could fall further - and USD/DKK rise - in the coming year, but just as was the case in 2000/2001, the turnaround could be slow in coming.
Fixed Income: Weak data and falling commodity prices drive European yields lower
Euroland yields slid further in the past week, continuing the trend of the late summer. 2-year German government yields have now fallen a little more than 60bp from their peak in July to around 4%, while 10-year yields are down by 47bp to 4.19%. The pronounced fall in yields in Europe has occurred as market focus has shifted from inflation fears to growth concerns. This development has basically been driven by three factors: A sharp turnaround in commodity markets, where prices are now back at spring 2008 levels, further losses and problems in the financial sector, and surprisingly weak European growth data. Falling commodity prices have allowed the ECB a little more room to manoeuvre, and at its latest meeting the central bank shifted from purely inflation worries to a more balanced concern for both inflation and growth. This has had an increasing impact on the markets over the past week, and they are now pricing in almost two rate cuts of 25bp for next year.
We very much expect that the trend of falling market yields will continue in the coming months. First because there is the prospect of further deterioration in the growth data for Euroland, where the risk of a recession is rising. Second, the US economy remains on the cusp of a recession, and the economy will face renewed weakness in H2 as the effects of the tax rebates fade. At the same time, we expect that commodities will stabilise around current prices, meaning that inflation will begin to fall - slowly but surely - a few months from now. Furthermore, financial market uncertainty remains high, with an elevated risk of more bad news from the financial sector. We estimate that this cocktail will allow market rates to fall further and curves to steepen as a result - both in the USA and in Euroland. With renewed weakness in US data on the cards, we expect that the fixed income markets in Europe and the USA will track each other relatively closely in the coming months (see New yield forecast - growth concerns are back , 15 August 2008).
After a couple of weeks packed full of inflation data, growth data will top the agenda in the week ahead - among them the first US housing market data for July and the first confidence indicators for August. Greatest attention will presumably be focused on data from Euroland, where PMIs and the ZEW indicator are expected to deliver more bad news. All in all, we expect that this will help cement the trend of falling yields in the markets.
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Danske Bank
http://www.danskebank.com/danskeresearch
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- U.S. retail sales lower and inflation higher
- Canadian housing and trade data weak
Global economic sentiment continued to sour this week. The Japanese economy contracted by a 2.4% annualized pace in the second quarter, while the Eurozone economy contracted by 0.8%. The expectation for both economies over the next twelve months is fairly weak. As a result, the pace of real Canadian export growth slowed in June, with better results to the U.S. than other destinations, while housing data for July came in very poor. Meanwhile, the U.S. fiscal stimulus appears to have fizzled, with retail spending in July recording its first monthly contraction since February, and on a year-ago basis, real spending has fallen 2.9%. The Federal Reserve reported credit conditions tightened further in the second quarter. And, adding insult to injury, consumer prices continued to move skyward, with headline inflation unexpectedly jumping from 5.0% to 5.6% and core prices nudging up from 2.4% to 2.5%. The ongoing decline in oil prices should ease some of these pressures, and inflation expectations have recently been trending lower, but it is still worrying that every U.S. inflation sub-index, except for medical expenses, accelerated in July.
Passing the buck
US import prices have shot up to a 22% annual pace, driven by the weak dollar and elevated food and energy costs. Producer price increases have been sizeable, as well, increasing the pressures on business's margins. This pipeline inflation need not translate into higher consumer prices though. In fact, firms can adjust three ways. In addition to raising their sales prices – directly increasing consumer inflation – they can also lower wages or reduce employment. All options will improve the bottom line. And firms have been selectively using all three. Real wages have fallen 3.1% over the last year while 412 thousand jobs have been cut. As the chart here shows, the two do tend to change in tandem. If the U.S. experiences higher job losses, as the 525 thousand losses we expect in the second half of this year, this implies firms will need to pass along less increases in prices.
This is our base case U.S. forecast and the most likely scenario given the tightening in credit and weakening consumer spending power is likely to help moderate inflation. But, if the modest pace of job losses that we've seen in the U.S. were to continue, averaging just 65k per month, then the U.S. would likely see inflation higher than we currently forecast, as businesses try to make ends meet, and the Fed would be hard pressed not to raise interest rates before the middle of 2009 as we currently forecast. On the other hand, given the ongoing twin financial/commodity shocks, we could see even greater job losses, even larger wage declines, and even further retrenchment in spending and growth – resulting in lower inflation but unlikely an easing in monetary policy. The base case scenario balances both of these risks, but the risks are real.
Death of the dollar has been greatly exaggerated
Putting aside the forecast risks, the latest news of higher inflation in the US has markets pricing in a higher risk interest rates could march higher. This has three effects, all negative for oil prices. Higher interest rates mean even less U.S. consumer demand. Strike one for oil. Higher expectations for interest rate increases from the Fed tend to mean a stronger U.S. dollar, which markets have used as shorthand for shorting oil. Strike two. Lastly, the fact that the U.S. dollar has appreciated by about 5-10% against most emerging market and major currencies in the last month means oil prices elsewhere have either fallen less or not at all – especially after you account for falling subsidies in many emerging markets. Strike three. As a result, oil prices – with many other commodities – haven't just come off the boil, they've spilled all over the floor.
There were a couple quotes this week that the oil markets' story this year has been the weaker than expected demand in OECD countries. Really? The economy was going to chug right along with the price of oil doubling in 2007 and then increasing by another 50% in the first six months of 2008? It doesn't take an economist to find the flaw in that logic, but we did, given our forecast throughout this oil spike for prices to near $100 per barrel by the end of 2008. The real oil market story this year has been the market's willingness to throw common sense to the wind. Of course OECD demand would wane. What did support oil for so long was the fact oil price declines were associated with ongoing U.S. dollar declines, which moderated the impact for every other nation and allowed emerging markets to continue their solid expansions. It should be no surprise - especially given our perfect hindsight – that oil markets finally peaked just as the US fiscal stimulus was waning, emerging market subsidies were receding, and economic growth across the advanced world was flailing. The concern now is that the largest destruction of economic demand from high oil prices tends to only be felt 3-4 quarters later, which means the lingering effects will still be sizeable into the first half of next year and will only be partially offset through the relief from lower prices. The shadow of oil still lingers large.
Hazy, crazy days of summer
For Canada, on the other hand, lower oil prices tend to be good for consumers due to slower inflation and increasing purchasing power, but are still a net negative for economic growth as a whole. With the rapid drop in oil prices – that we expect is not over – driving the prospects for Canadian economic growth and inflation lower, there is a nascent risk that the Bank of Canada may shift back into a dovish stance. We don't think we are there yet, but the economic data this week did very little to dispel this notion. Housing starts in June unexpectedly fell 14%. We expect some upward correction in July given the volatility of this series and the fact that the economic fundamentals suggest the pace of starts should be closer to 200k, not the current 186k, to be more representative of the underlying demand and supply in the major markets. Existing home prices in Canada are now showing declines over last year, but they too seem to have overshot the fundamentals. The national 3.6% decline in existing home prices is also being driven by the sizeable 8% decline in Calgary and 5% decline in Edmonton. Excluding these two markets, the year-to-date prices have grown by 2%, much closer to what we think is consistent with the current state of the economy. Canadian manufacturing shipments provided a ray of hope for Canadian GDP in June, but the trend there is still lower as export demand weakens. Looking through the volatility, it seems clear the Canadian economy is struggling to expand through the summer months.
UPCOMING KEY ECONOMIC RELEASES
U.S. Housing Starts - July
Release Date: August 19/08
June Result: 1066K
TD Forecast: 980K
Consensus: 960K
The unexpected surge in U.S. residential building activity in June (driven by the changes to the New York building codes, and affecting permits issued after July 1) should begin to unwind this month, though we highlight the risk that starts could remain unnaturally high as previously approved permits are implemented. More generally, with the malaise in the overall U.S. housing market continuing unabated, deteriorating labour market conditions and a sluggish economy, there is little signs of an imminent turnaround for the sector. We expect housing starts to fall back to 980K in July. Moreover, with the inventory of unsold new and existing homes remaining at elevated levels, home builders are likely to continue retrenching their building activity in the coming months, further depressing starts in the second half of the year.
Canadian Wholesale Sales - June
Release Date: August 19/08
May Result: total +1.6% M/M
TD Forecast: total +1.5% M/M
Consensus: total +0.5% M/M
After a disappointing first quarter, Canadian wholesale sales rebounded with a vengeance in the first two months of the second quarter, with even real sales posting sizeable gains. We expect the momentum to be sustained for at least one more month, with sales posting a further 1.5% M/M increase in June, following the robust 1.6% advance in May, on account of the revival in Canadian manufacturing sector activity – which has been driven in large part by the astonishing surge in auto-related sector activity during the month. Looking further ahead, however, we expect activity in the sector to moderate as the impact of the slowing U.S. and Canadian economies takes hold.
Canadian Retail Sales - June
Release Date: August 20/08
May Result: total +0.4%% M/M; ex-autos +0.4% M/M
TD Forecast: total +0.7% M/M; ex-autos +1.0% M/M
Consensus: total +0.4% M/M; ex-autos +0.4% M/M
Canadian retail sales are expected to post their biggest gain since January with a strong +0.7% M/M advance in June, on the heels of the 0.4% M/M rise in May. Much of the strength in sales will likely come from gasoline sales, given that gas prices rose by a very strong 5.8% M/M during the month. The dramatic turnaround in weather conditions in June, following the unseasonably cold May, is also likely to be an important factor. Notwithstanding the jump in the headline number, with consumers continuing to shy away from automobile purchases, sales excluding autos are expected to advance at a more robust 1.0% M/M clip. In real terms, sales are likely to be less strong and most of the gains will likely come from price effects.
Canadian Consumer Price Index - July
Release Date: August 21/08
June Result: core 0.1% M/M, 1.5% Y/Y; all-items 0.7% M/M, 3.1% Y/Y
TD Forecast: core 0.1% M/M, 1.5% Y/Y; all-items 0.2% M/M, 3.2% Y/Y
Consensus: core 0.2% M/M, 1.6% Y/Y; all-items 0.4% M/M, 3.4% Y/Y
As global commodity prices moved skywards in the first half of the year, Canadian headline consumer price inflation when along for the ride, accelerating from a modest 1.4% Y/Y in March to a rather toasty 3.1% Y/Y in June. However, with the ascent in crude oil prices (and other commodities) appearing to have come to an end, we expect consumer inflation to begin moderating, before falling later in the year. Indeed, with gasoline prices rising by their smallest margin in many months (increasing by less than 1% M/M following four consecutive monthly gains of 4% M/M plus increases), we expect to see consumer prices rise by a more modest 0.2% M/M. The seasonally adjusted index is also expected to increase by 0.2% M/M. Annual headline inflation should rise to 3.2% Y/Y. Core inflation is expected to remain unchanged at a tepid 1.5% Y/Y for the fourth straight month. On a monthly basis, we expect core consumer prices to rise by 0.1% M/M, with the seasonally adjusted index posting a 0.2% M/M gain.
TD Bank Financial Group
The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.
Weekly Economic and Financial Commentary
Four for the Future
This week we saw four economic indicators that helped define our economic future. First, the nation's trade deficit narrowed more than expected during June, falling to $56.8 billion. Broad-based strength in exports contributed to the gain with particular strength in capital goods ex-autos, industrial supplies and aircraft. The improvement was even greater after adjusting for inflation. In real terms, the trade gap fell $43.2 billion compared to $60 billion during 2006. On the import side, non-petroleum imports fell reflecting weakness in domestic demand.
Improvement in the trade deficit means second quarter real GDP will come in much stronger than earlier estimated. Our current forecast, which calls for a 3.0 percent rise in second quarter GDP, assumes a contribution of 3.2 percent from trade.
Retail Sales: Fading Stimulus
Second, over the last three months retail sales, ex-auto and gasoline, have slowed to a 3.5 percent pace compared to over eight percent in 2006. Consumers continue to pull back on big ticket discretionary items such as furniture and autos.
On net, retail sales suggests that the spike in food and energy costs means that much of the economic stimulus was either siphoned away at the gas pump or eaten up at the grocery store. Moreover, there appears to be little forward momentum for consumer spending for the second half of this year (this view is reinforced by the other two indicators released this week and covered below). Our outlook is for consumer spending to decline for the second half of this year. Real household income growth remains weak. Confidence is low. Credit is limited. The consumer remains under pressure. See our related special commentary: Consumers Are Feeling Blue.
Jobless Claims: Weak Labor Market Persists
Weekly jobless claims declined just 10,000 in the latest week and the four week moving average came in at 440,000 which is much higher than is consistent with any forecast of job gains. Certainly the claims are biased upward due to the new federal extension of benefits but the extent of the rise in claims still appears excessive relative to what would be consistent with any turnaround in the job market.
We retain our outlook for continued job losses in the second half of this year. Job losses are a blow to household income growth as well as consumer sentiment. As a result, we retain our outlook for a drop in consumer spending for the second half of this year.
Consumer Prices: Temporary Peak? How Much Decline Ahead?
Recent oil price declines were seen as helping the consumer, reducing the downside risks to the overall economy and helping financial asset prices. Not so with the latest consumer price data. Inflation is clearly at problematic levels. The Consumer Price Index rose 0.8 percent in July, while headline CPI is now up 5.6 percent year-to-year. Meanwhile, core CPI, excluding food and energy items, rose 0.3 percent and is up 2.5 percent year over year. Persistent inflation is a hit to real household incomes.
Slower economic growth has not led to lower inflation as many analysts had expected. Moreover, the extent of any decline in inflation may still leave the pace of inflation above that consistent with current financial asset prices. One odd observation in the data is that food at home is now more expensive than food away from home. The price of chicken on the grill is going up faster than chicken at our favorite fast-food place. If this keeps up, it could become cheaper to go out to eat than to fix dinner at home.
U.S. Outlook
Producer Price Index • Tuesday
As much as producers would like to pass along the recent higher wholesale prices to consumers, that definitely happening remains in question. Domestic demand is weak and the outlook is even weaker. That's not your typical recipe for higher consumer prices. While upward price pressure will persist, the outlook for consumer prices will be determined greatly by the direction commodity prices head from here.
Specifically looking at July, we believe headline PPI will rise a modest 0.2 percent as seasonal factors should limit any increase with gasoline prices. Food prices, however, should continue to its upward climb. Lower motor vehicle prices, especially from SUVs, should help limit the increase in core PPI to 0.2 percent, in line with the past two months.
Previous: 1.8% Wachovia: 0.2%
Consensus: 0.5%
Housing Starts • Wednesday
Recent changes to the building codes in New York City caused developers to jumpstart multi-family projects before the tougher building requirements took effect. As such, total housing starts jumped 9.1 percent to an annualized pace of 1.066 million units in June from 977K in May. Single-family starts fell 5.3 percent to an annualized rate of 647K, marking its lowest level since January 1991.
Even though it appears the decent of housing starts has slowed and may even prove to be the cycle bottom, tough underwriting standards (as evidenced by the July Senior Officer Loan Survey) and higher mortgage rates will continue to pressure the housing market for some time. We still believe it will take another year before we see a positive contribution to overall economic growth from the residential construction sector.
Previous: 1066K Wachovia: 930K
Consensus: 960K
Leading Economic Indicators • Thursday
With component data reported so far, it appears the Leading Economic Indicators Index will decline for the third consecutive month in July. Negative contributions from initial unemployment claims and the S&P 500 stock index should more than offset positive contributions from the yield curve and consumer expectations as measured by the University of Michigan's consumer sentiment index.
The coincident index, which measures current economic activity, continues to remain in a tight range around levels that suggest the overall economy is just barely staying out of recession territory.
Previous: -0.1% Wachovia: -0.3%
Consensus: -0.2%
Global Review
British Pound Takes A Plunge
As shown in the graph at the left, the British pound has plunged to a 2-year low. Not only has sterling weakened versus the U.S. dollar over the past two weeks, but it has lost ground against most other major currencies as well. What has taken the luster off of sterling?
In short, it is the realization that the British economy is weakening at a marked clip, which has altered expectations for Bank of England monetary policy going forward. As shown in the top chart on page 4, respective PMIs for the manufacturing, service and construction sectors have declined to multi-year lows. The first two PMIs currently stand near levels that were reached in late 2001. Although the British economy continued to expand in 2001 and 2002, the year-over-year growth rate got as low as 1.6 percent in the first quarter of 2002. Note that the U.K. economy grew 1.6 percent in the second quarter of this year relative to the same period in 2007. In our view, real GDP growth will slow even further, and perhaps turn negative, in the quarters ahead.
The construction PMI in the United Kingdom has essentially collapsed, which is consistent with the apparent weakness in the housing market. Indeed, orders for new housing are currently down about 20 percent relative to the same period last year. In addition, U.K. home prices are now declining on a year-over-year basis (see middle chart). A widely followed index of house prices remains more than three times higher than it was in the mid-1990s, but further declines in house prices, at least in the near term, seem likely. Should house prices continue to fall, U.K. consumers, some of which are highly geared, may pare back spending further. In that regard, the year-over-year growth rate in real retail sales slipped to 2.2 percent in June, the slowest rate in more than two years.
With highly geared consumers and declining house prices, the U.K. economy "looks and smells" very much like its counterpart in the United States. And, like the Federal Reserve, the Bank of England finds itself in an unenviable position. Clearly, recession is a very real possibility in Britain, which would argue for monetary easing as soon as possible. However, the Bank of England appears unwilling to cut rates, at least in the near term, because CPI inflation is well above the 2 percent rate that the Bank is mandated to achieve in "the medium term" (see bottom chart).
That said, the Bank hinted in its Quarterly Inflation report this week that rates could eventually be cut. Not only did the Bank acknowledge the balance of risks to its growth outlook are skewed to the downside, but it also projected that inflation will fall below the Bank's target in "the medium term." However, the Bank likely will refrain from cutting rates until inflation starts to unambiguously decline. In our view, the earliest the Bank could cut rates would be the end of this year.
Long-term interest rates in the United Kingdom have declined in anticipation of eventual easing. For example, the yield on the 2-year government bond has dropped about 100 basis points since mid-June, which has undermined support for the British pound. We look for sterling to depreciate further in the quarters ahead.
Global Outlook
Canadian Retail Sales • Wednesday
Consumer spending has been a primary driver of Canadian real GDP growth over the past few years. Although growth in retail spending remains positive, it has been slowing over the past few months due in part to the sharp rise in energy prices earlier this year. Solid labor market conditions have helped to support consumer spending, but the unexpected large decline in non-farm payrolls in July poses downside risks to consumer spending later this year.
Data on CPI inflation will be released on Thursday. The overall rate of inflation recently breached the top end of the Bank of Canada's 1 percent to 3 percent target range, and it is expected to rise even higher in July. However, the core CPI inflation rate, which stood at 1.5 percent in June, is expected to remain well within the target range, allowing the Bank to keep its policy rate unchanged at 3.00 percent for the foreseeable future.
Previous: 0.4% (month-over-month change)
Consensus: 0.4%
Euro-zone PMIs • Thursday
Both the manufacturing and service sector PMIs in the Euro-zone slipped below "50" in the second quarter. Data released this week showed that real GDP in the Euro-zone fell at an annualized rate of 0.8 percent in the second quarter, the first quarter of contraction since area-wide GDP statistics began to be compiled in 1995. Although it probably is premature to claim that the Euro-zone has slipped into recession, growth clearly is quite weak at present. The "flash" PMI data for August will shed some light on how the Euro-zone economy is faring at present. "Hard" data on new orders in June are slated for release on Friday. Although the pace of growth is very weak at present, the ECB probably won't ease policy anytime soon due to concerns about inflation.
Previous (Man): 47.4 Consensus (Man): 47.0
Previous (Ser): 48.3 Consensus (Ser): 48.0
U.K. Retail Sales • Thursday
Consumer spending in Great Britain was quite strong earlier this year, but spending seems to have decelerated recently. Indeed, the volume of real retail sales has been broadly flat over the past few months. With unemployment starting to rise and consumer confidence plunging to the lowest level in decades, the outlook for consumer spending in the months ahead is not especially bright.
The second estimate of real GDP growth in the second quarter, which originally printed at 0.2 percent (not annualized), is slated for release on Friday. The release will be interesting because it will provide the first breakdown of second quarter GDP into its underlying demand components, which should give us some insights into the likely trajectory of U.K. GDP in the third quarter.
Previous: -3.9% (month-over-month change)
Consensus: -0.2%
Point of View
Interest Rate Watch
Credit Spreads: Still Waiting for Godot
Over the last two months we have witnessed a narrowing of market expectations on the Federal funds rate through the rest of this year. In May, there were estimates for both a Fed increase and decrease in the funds rate over the second half of this year. Yet expectations for the benchmark funds rate have now settled in on no change.
But credit spreads have widened over the last two months. Whereas spreads had narrowed in the first four months of the year, the latest observations suggest that there is no direct path to a new equilibrium. Spreads on home equity, CMBS, high grade and high yield spreads have widened. Our sense is that the same below-trend economic growth that keeps the Fed on hold also suggests that downside risk remains for housing, commercial real estate and corporates. Moreover, investors appear very nervous on individual credit announcements. For example, in recent weeks we have heard about large write-downs on CDO portfolios. While issues with these portfolios were known, the reality of seeing the actual market pricing of these assets has increased investor sensitivity to risk. The Fed's Senior Loan Officer Survey suggests credit remains tight.
Our sense is that the worst of the credit crisis has passed and the peak in credit spreads occurred in March. But the workout will continue for quite some time—at least through the rest of this year. Overall economic growth remains below par. Employment declines will underline consumer weakness and thereby pressures on credit card, auto and housing. Home prices in the speculative markets continue to decline. Credit markets continue to search for the new equilibrium.
Topic of the Week
Tight Lending Conditions Will Linger
Earlier this week, the Federal Reserve released its July Senior Officer Loan Survey which showed elevated tightening continued in lending standards for all major loan components. As standards tightened, the net percentage of respondents indicating they were increasing their spreads of loan rates over the banks' cost of funds reached record levels.
Unfortunately it appears the difficult lending environment will stick around for a while, limiting potential economic growth. One of the special questions in this quarter's survey asked respondents how they expected credit standards on loans to households and businesses will change in the second half of 2008 and the first half of 2009. Senior loan officers' expectations across all loan products were clearly for continued tighter lending standards. About 55 percent of domestic banks said they expect tightening credit standards on Commercial & Industrial loans in the second half of 2008 with 45 percent expecting tightening standards in the first half of 2009. The outlook for commercial real estate loans looked worse with 72 percent and 52 percent expecting tightening lending conditions in the second half of 2008 and first half of 2009, respectively. Loans to households did not fare better with expectations for tightening lending conditions persistent in prime & nonprime mortgages, home equity lines and credit cards.
Not surprisingly, banks have become increasingly risk-adverse as they protect their precious capital positions. Given the expectations of sub-par growth in the coming quarters, it appears it is going to take another year or so before bank credit begins to become a significant factor towards overall economic growth.
Wachovia Corporation
http://www.wachovia.com
Disclaimer: The information and opinions herein are for general information use only. Wachovia Corporation and its affiliates, including Wachovia Bank, N.A., do not guarantee their accuracy or completeness, nor does Wachovia Corporation or any of its affiliates, including Wachovia Bank, N.A., assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or any foreign exchange transaction, or as personalized investment advice. Securities and foreign exchange transactions are not FDIC-insured, are not bank-guaranteed, and may lose value.
U.S. Weekly Wrap-Up
For the week, the DJIA fell 0.6%, the Nasdaq gained 1.6%, and the S&P500 edged up 0.1%. In addition to weakening the Euro, the Russian bear growling has sparked some flight from European equity markets this week: the German DAX fell 1.7%, the French CAC fell 0.9%, and the UK's FTSE index dropped 0.6%.
The ARS probe by New York AG Andrew Cuomo continued to wring settlement agreements out of major banks this week. Wachovia said it would buy back up $8.5B in ARS and pay a $50M fine. JPM and MS have agreed to buy back more than $7B in ARS and pay fines, as well. Merrill Lynch is holding out, prompting Cuomo to "preparing to commence legal action" against the firm, giving it five days to explain why he should not sue.
The auction-rate securities situation was only part of the trouble for financials, as various commentators insisted that the credit crisis is far from over. S&P noted that banks are at best half way through the credit crisis and the WSJ's Heard on the Street said that JP Morgan's warning about a $1.5B mortgage-related loss shows that credit markets are as unsettled as ever. Merrill downgraded most of its peers to an underperform rating citing a seasonal slowdown and Ladenburg Thalmann's Dick Bove cut his estimates for Lehman, Goldman, and JP Morgan. Meanwhile, the monoline bond insurers MBI and ABK provided a bright spot among all the gloom; S&P affirmed the monolines' AA ratings on Thursday and the names are up 30% on the week.
Things have been relatively quiet on the data front. The June US trade deficit came in at $56.8B, better than the expected reading of $62.0B. Currency dealers said that growing exports and imports should help boost the GDP reading for Q2. Manufacturing data on Friday was less bad than expected: the Fed reported that US industrial production edged up 0.2% in July, below the 0.4% gain in June but above expectations a 0.0% reading. The preliminary University of Michigan confidence data showed the biggest decline in one-year inflation expectations since September 2006, reflecting the easing in commodity prices, but the headline July CPI reading showed prices climbing at twice the rate expected, while the annual inflation rate hit 5.6%, its highest level since 1991.
Major retail names reported positive quarterly earnings that were tempered by cautious comments for the coming quarter, another indication of a slowing economy. Wal-Mart came in just above EPS estimates and just below revenue expectations, and boosted its FY08 outlook over its prior view. The CEO called the forecast "appropriately conservative.” Kohl's also came in above estimates and guided higher for the year, although its outlook for the coming quarter is more tepid. JC Penney beat earnings and revenue estimates while guiding lower for the next quarter, warning that the firm sees a "challenging" consumer environment. Clothier Abercrombie & Fitch guided under analysts estimates for the year, while Nordstrom cautioned that its outlook is shaped by "continuous pressure" on margins.
In currencies, the week began with dealers continuing to assess the recent technical damage in various European and emerging market pairs against the USD. The EUR/USD cross-tested below the 1.4970 level, which was a key pivot point last November, with dealers noting that a sustained break below the level opens up a potential test towards 1.44. Throughout the week the USD managed to fend off renewed hawkish ECB sentiment regarding inflation and comments from various European officials discounting the prospects of a Euro Zone recession. The recent gains in the dollar have prompted chatter that the Fed has initiated "stealth intervention,” evidenced by the fall in the US Treasury's international currency reserves.
Dealers have shrugged off the higher UK and Norwegian inflation data, focusing instead on the emerging consensus that growth outside the US will continue to slow. Thursday's release of the German Q2 GDP reading was supposed to be the economic highlight of the week, and while the actual reading still showed contraction in Europe's powerhouse economy, it came in at a better-than-expected -0.5% (vs. -0.8% estimate). The number was not, however, strong enough to offset other negative European economic data, chief among them a report showing Q2 Euro Zone GDP shrinking 0.2%, with France contracting more than expected. Inflationary data was seen in the UK and Norway, topped off by the US CPI report.
The GBP/USD cross endured a lot of selling, falling the most in a single week since May 2000, and hitting its lowest level since mid-2006. This was prompted by the Bank of England's (BoE) quarterly inflation report, which lowered its 2009 GDP outlook and noted that a protracted slowdown would be necessary to bring CPI back under the 2% target. The BoE's King emphasized that the UK economy is facing an unavoidable and painful period of adjustment. The bank's GDP outlook fired rate-cut speculation among FX dealers, taking the probability of a BoE rate cut to over 60% by year-end from the 25% chance before the report. Markets are pricing in another 25bp interest rate cut by May 2009.
By Friday the USD had extended its gains thanks to further declines in metals and energy. Analysts noted that the USD's recovery is reducing the appeal of commodities and suggest that the six-year commodities bull market was at an end, supported by a reshuffling of assets away from commodities during the European session. Spot gold tested $773 before rebounding while spot silver hit $12.40/oz. The break of EUR/USD level of 1.4850 (where sovereign bids were said to be lurking) seems to have unleashed a self-reinforcing cycle of lower commodity prices and a stronger greenback. Goldman emphasized that the changing USD outlook comes from weakening global growth, declining oil prices and an improved US trade balance. By mid-day Friday, the EUR/USD cross was testing below the 1.47 level and the GBP/USD was approaching the 1.86 handle.
In treasuries, yields were headed for their lowest levels in nearly a month on Friday as inflation concerns move to the back burner amidst the slide it commodity prices. The ten-year yield is back in the low 3.8% range while the two-year is below 2.4%. With growth clearly slowing around the world and the US housing market still struggling to find traction, the likelihood of a Fed rate hike this year continues to diminish. The January fed fun future is pricing little more than a 30% chance the Fed hikes in 2008. With nothing penciled in on the Treasury's calendar in terms of new supply next week, technicals will take center stage. Traders will look to see if the ten-year yield can close below its 200-day SMA for the second week in row.
Trade The News Staff
Trade The News, Inc.
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- The USD surge is for real
- The great global growth slowdown is just getting started
- Don't bet against the US consumer
- Key data and events to watch next week
The USD surge is for real
Last week's USD break higher has been confirmed by further gains this past week, while pullbacks have been exceptionally minimal. The speed and size of the move caught many in the market off guard, and while many analysts have already started with the 'too far, too fast' routine, I would argue further direct USD gains are in store. Precisely because the USD rebound was so fast and large, many asset managers missed the move and have been anxiously waiting for some pullback on which to buy USD. That the pullbacks of the last two weeks have been so minimal and so short-lived (rarely more than 4 hours) is evidence that institutional investors and asset managers are being forced to go to market and buy USD on strength/sell EUR on weakness. Normally, that dynamic tends to create more instability-- new positions are opened at disadvantageous price levels and are ripe to get whipsawed.
But the price action this week has remained especially persistent. For example, EUR/USD went into a consolidation between Tuesday's NY open and it lasted only until Thursday NY morning (and barely amounted to 150 pips retracement, and that after a 700 pip decline in the prior 72 hours), when the move down resumed. Traders have come to expect greater consolidations/corrections after such large price shifts, and when they don't materialize, those traders miss the move again. So from a market dynamic perspective, I look for further direct USD gains as more investors are forced to reach higher to buy USD. And those who buy the 'too far, too fast' and short the buck are likely to provide additional buying interest as they capitulate and stop themselves out.
The primary level I'm watching in EUR/USD is the measured move objective from the double-top at 1.6020/40 which comes in between 1.4500/50. That level is round-number psychological support and also roughly corresponds to the start of the USD plunge earlier this year. Beyond there, I'm looking at 1.4300/20 lows from Dec. 2007 as the next likely point of stabilization. I think the sell zone in EUR/USD is now between 1.4900-1.5000. Everyone and their brother were looking to sell on a bounce back to 1.52/53, and that's another reason I think we'll see 1.43/45 before we ever see back above 1.50.
The great global growth slowdown is just getting started
The US economy dragged down global growth prospects starting in late 2007 and the ripples have spread out now to hit the rest of the G7. European growth contracted in the 2Q, as did Japan's. UK data continues to deteriorate and 3Q GDP there will likely be negative. Recent Canadian data also points to a recent erosion in the outlook north of the border. The G7 accounts for a bit more than half of global GDP, so when G7 growth turns down, the rest of the global economy will surely be impacted. Markets seem to have only just recently grasped the idea that global growth is slowing and many are still discounting the risks to the global growth outlook. The main rationale is that growth in emerging economies, with the BRIC nations (Brazil, Russia, India and China) typically cited, will sustain global demand. Were that it was likely.
The BRICs account for around 13% of global GDP, so even if they manage to maintain growth rates, they're unlikely to prevent further slowing globally. Not to mention, much of the strength in emerging economies is due to exports. But if the economies that they export to are contracting, what does that imply for the outlook to their exports and growth in general? Just two quick examples to illustrate: 1) Taiwan total exports dropped from +21.3% YoY in June to +8.0% YoY in July; 2) South Korean retail sales fell from +10.1% YoY in May to +6.8% in June. I realize both those numbers are positive and strongly so from a G7 economy point of view, but it's the relative shift that I find alarming. Emerging economies are still bearing the brunt of higher food and energy prices, and one could argue that recent declines in commodities may offset slowing global growth. But the recent commodity price declines are minimal in relation to the amount of price increases over the last two years, and need to correct much more to stop being a drag.
Falling commodity prices have also contributed greatly to the resurgence in the USD, but that means other currencies have weakened. Since most commodities are priced in USD, lower commodity prices are partially offset by a stronger USD/weaker domestic currency. For example, WTI oil priced in USD is down about 24% from its peak, while the same oil priced in EUR is only down about 18%.
To tie this all together, the most developed economies are slowing due to oppressive increases in raw materials prices and a host of individual domestic issues (e.g. housing downturns and restrictive credit conditions). The slowdown in the G7 is increasingly reverberating in emerging economies, the ones that were supposed to stave off a global recession, and this is likely to be felt even more so in the months ahead. Finally, slowing global growth is undermining demand for commodities which is helping to boost the USD. While USD strength adds to the pressure on commodities, it also gives less relief to non-US economies, which will keep the USD in the limelight. In short, the global slowdown is only just getting started.
Don't bet against the US consumer
Despite massive headwinds from declining home prices, a stagnant credit market, and an absolute surge in gasoline prices at the pump the US consumer has managed to hang in there. This resilience is behind the amazing winning streak for the US consumer, with the last quarterly decline in real personal consumption expenditures occurring all the way back in 4Q 1991. What is also stunning is how the consumer has managed to sock away roughly $70 billion of the stimulus checks while keeping consumption above water over the May and June months (July data due up August 29). This cannot all be attributed to more rampant use of the credit card either, as the annual rate of revolving credit outstanding slowed to 4.9% in 2Q08 from 6.8% in 1Q08 and 8.2% in 4Q07. So it seems that the consumer balance sheet in a state of very serious and very speedy repair.
The recent decline in oil prices and the deceleration of home price declines bode well for a resilient consumer spending environment as well. Oil has come crashing down towards the $112-110/bbl area in a matter of weeks. And while gasoline prices at the pump take a bit longer to react, if the historical relationship holds, this suggests average regular gasoline prices will be sitting near the $3.60 mark in about one week. This is roughly a $0.50 decline from the nearby highs in mid-July. If we apply a well recognized formula that every penny decline at the pump creates an influx of $1.3 billion into US consumers' wallets, this is an additional $65 billion in consumer stimulus just as the tax rebates come to an end. While it is uncertain whether consumers will continue to hunker down and save or merely spend this new found wealth unabashedly, we would be cautious about forecasts predicting the demise of this 70% chunk of the US economy. In our view, this potential for a fundamental improvement in the US economy coupled with the continued deterioration in economies across the pond augurs for a sustained USD rally into year-end and the first half of 2009.
Key data and events to watch next week
The US data calendar is modestly busy in the week ahead and the action kicks off with the National Association of Home Builders (NAHB) index on Monday. Tuesday is a busy one with producer prices, housing starts/permits, and Dallas Fed President Fisher speaking on the US economy. Thursday has the usual weekly jobless claims, the Philly Fed manufacturing index, and the index of leading economic indicators. Friday rounds out the week with Fed Chairman Bernanke's speech at Jackson Hole. This has been a very important event in the past and will be closely watched by the markets.
The Euro-zone has a few bits of top-tier data on tap. Monday starts it off with the Euro-zone trade balance and the Bank of France business sentiment indicator. On Tuesday we'll see the all important Euro-zone and German ZEW surveys along with German producer prices. Wednesday is PMI day with the release of Euro-zone, French, and German services and manufacturing PMIs all on deck. These should provide further evidence that the deterioration in Eurozone economies is continuing in earnest. Eurozone industrial new orders and current account will round out the week on Friday.
The data calendar in the UK is pretty light and starts with the Rightmove home price indicator on Sunday evening. The Bank of England minutes are set to be released on Wednesday and will be closely watched as the BOE did not release a press statement upon their latest decision to leave rates unchanged. That same day, the Confederation of British Industry releases their industrial trends survey of UK manufacturing as well. Retail sales are on tap for Thursday along with business investment data. Friday rounds out the week with 2Q preliminary GDP.
Japan's calendar is similarly light but important, with the Bank of Japan rate decision the highlight on Tuesday. The market expects no change to rates from the current 0.50% target. Before that, we'll se the leading index and department store sales data on Monday. Wednesday has trade data and Thursday rounds out the week with machine tool orders.
It is very light in Canada and it starts off with wholesale sales data on Tuesday. Wednesday has the important retail sales report along with leading indicators. Consumer prices close out the week of data on Thursday.
Data is also light down under. New Zealand producer prices kick off the week on Monday. Tuesday has Australian imports data and the RBA minutes on tap. Thursday ends the week for data with New Zealand credit card spending and Australian motor vehicle sales.
Brian Dolan, Chief Currency Strategist
Jacob Oubina, Currency Strategist
Forex.com
http://www.forex.com
DISCLAIMER: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase of sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
The Economic Week Ahead - Inflation, Growth, Confidence and Retail Numbers
This week starts with a dollar in unique shape, something that the greenback has been searching for quite a while. The dollar has strengthened for 5 weeks against a wide range of currencies; the dollar index cannot find any resistance tough enough to stop the gains at the moment, and Chicago based Commitment of Traders reports now show net long dollar positions.
Euro-Zone: The currency market will have another hard test of valuations as a number of releases gauging the investor and consumer sentiment from the euro-zone hit the wires. Lately, the analysts have failed to gauge the release numbers and sentiment. One of the most important this week, the Zew economic sentiment for the Euro-zone, is expected to come at -65.0, dropping 90 points from a year earlier. The Purchase Managers Index (PMI) releases, showing the latest developments in the manufacturing and service sectors, will be out this week as well, with activity levels in the Euro-area expected to show continued contraction.
The U.S. PMI reads however show activity is starting to pick up on the other side of the Eur/Usd pair, after its dip into the contraction zone. The strength the euro had for some time, together with high interest rates had a negative effect on the Euro-zone business climate and this is starting to be reflected now in the Zew and PMI releases.
Central Banks: The Reserve Bank of Australia and the Bank of England will release the meeting minutes. The RBA releases are expected to show the board expects a prologue slowdown at the same time that inflation will be less of a worry, the markets will have to question how much is already baked into to current valuations. The Bank of England meeting minutes are expected to show that the MPC had 7-2 (hold-cut) vote for a hold. At the last release the vote was 7-1-1 (hold, cut, raise). The financial and economic data coming out of UK has weakened at a steep pace since the last meeting. An additional vote for a cut may trigger another wave of selling, sending the pound even lower from the current 22-months low and probably extending the longest decline in the last 37 years. That is unless the ‘sell the rumor’ part of the ‘sell the rumor buy the news’ has already been put in place. Retail sales on Thursday may bounce the pound around as the markets look for the recent economic effects on the U.K. consumer.
In Japan the GDP releases recently showed the economy contracted at a strong pace in the second quarter. The finance ministry, the movers behind the Bank of Japan said in recent statements that the economy may have a hard lending in the following quarters, as exports decline. It is a possibility the bank will consider to loosen the monetary policy at the next meetings, the first of which is on Monday, and if so the Jpy may further depreciate.
America: The U.S. calendar is somewhat lighter in the coming week. There are just two releases expected that might create a lot of volatility and are both scheduled in the same day: building permits and Producer Price Index on Tuesday. The recent release data shows the new building permits may have found a (temporary) bottom, but adjusting from the raw numbers, the housing market is in a very bad shape. The expected number, of almost 1M, is just half of what the releases would have shown from the expansion phase of 2003-2006. At the same time, the Producer Price Index shows a large degree of inflation coming from the food and energy products and eventually those numbers will hit the CPI, especially if oil cannot breach and hold under $110 a barrel. If the U.S. releases are not up to scratch the market can look forward to Fed Chairman Mr Bernanke’s speech at 10:00 EDT on Friday to put things into perspective.
Written by TheLFB Trade Team, © 2007-2008 LFB Services, LLC. All rights reserved. http://www.TheLFB-Forex.com
TheLFB Risk Disclaimer can be found at http://www.thelfb-forex.com/content.aspx?id=174.
US Currency Outlook -- Forex Currency Pairs
Forex Forecast of Major Currency Pairs
The Global-View.com Month Ahead Currency Outlook is prepared weekly by the trading professionals at GVI Forex. For information on the GVI Forex Service Click Here
As noted last week, all kinds of bubbles have been bursting in August. The big ones have been in oil, gold, the commodity currencies and the EUR/USD. The most important development has been the EUR/USD penetration of its 200-day moving average at 1.5235. Once that happened, the EUR/USD reached a critical point of no return. There have been massive short USD positions accumulated over the past few years that cannot be unwound in a week. A need to reduce short USD positions over time will put a lid on EUR/USD rallies.
As indicated last week, the fortunes of the USD and oil have been closely intertwined, but the strength of that correlation could be weakening. One characteristic of a bull USD move is when the markets start to single out individual vulnerable currences and run at them one at a time. Recently, the Aussie dollsr, the kiwi and sterling have been individually singled out for attacks.
As for the market dynamics, dealers are no longer on the fence for EUR/USD, and decidedly lean in the direction of a higher USD in a longer term time perspective. Where this liquidation phase leads is anybody�s guess.
Click on chart for two year history
Click on chart for two year history
The U.S. and Eurozone economies have been slowing. The U.S. is much further along in the process. Note below in the U.S. Monetary Policy outlook insert that official U.S. rates have reached a floor, but are not headed higher for a while.
| UNITED STATES |
GVI U.S. Feberal Reserve Bank Policy Meeting Preview
FEDERAL RESERVE Policy Objective: The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.    |
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Major Currency Pairs - Currency Forecasts- Monthly Perspective
The ECB seems to be indicating that monetary policy is no longer in a tightening phase due to inflationary pressures (see policy insert below). The E-Z economy has been showing signs recently of rapid deterioration. Some wonder if M. Trichet will last much longer in his job.
| EUROZONE |
GVI European Central Bank Policy Meeting Preview
ECB Policy Objective: The primary objective of the ECB's monetary policy is to maintain price stability. The ECB aims at inflation rates of below, but close to, 2% over the medium term.  |
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The Japanese economy is in a weakening state and now inflation has started to show up in key price indices. Tokyo is not unhappy with a weakening JPY.
| JAPAN |
GVI BOJ Policy Meeting Preview
BANK OF JAPAN Policy Objective: The Bank of Japan Law states that the Bank's monetary policy should be "aimed at, through the pursuit of price stability, contributing to the sound development of the national economy."    |
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The markets now expect Bank of England rate reductions by the end of this year as the economy swiftly weakens. The GBP has been under severe pressure due to worries about the deteriorating economy.
| UNITED KINGDOM |
GVI Bank of England Policy Meeting Preview
BANK OF ENGLAND Policy Objective: The Bank's monetary policy objective is to deliver price stability, low inflation, and, subject to that, to support the Government's economic objectives including those for growth and employment. Price stability is defined by the Government's inflation target of 2%.   |
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The Swiss National Bank tries to maintain a stable relationship of the CHF vs. the EUR. It is never pleased with weakness of the CHF against the EUR.
| SWITZERLAND |
GVI Swiss National Bank Policy Meeting Preview
SWISS NATIONAL BANK Policy Objective: The National Bank equates price stability with a rise in the national consumer price index (CPI) of less than 2% per annum. In so doing, it takes account of the fact that not every price movement is necessarily inflationary. Furthermore, it believes that inflation cannot be measured accurately. Measurement problems arise, for example, when the quality of goods and services improves. Such changes are not properly accounted for in the CPI; as a result, inflation, as measured by the CPI, will be slightly overstated.   |
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The Australian economy is clearly slowing. The key foci for the Reserve Bank of Australia remain inflation and slowing external demand. The Reserve Bank of Australia has signaled a 25 bp rate cut in September.
| AUSTRALIA |
GVI Reserve Bank of Australia Policy Meeting Preview
RESERVE BANK OF AUSTRALIA Policy Objective: The policy objective is a target for consumer price inflation, of 2-3 per cent per annum. Monetary policy aims to achieve this over the medium term and, subject to that, to encourage the strong and sustainable growth in the economy. Controlling inflation preserves the value of money. In the long run, this is the principal way in which monetary policy can help to form a sound basis for long-term growth in the economy.   |
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Trading in the CAD had been volatile as the Bank of Canada was making aggressive rate cuts to keep pace with the Fed and to get ahead of a possible economic slowdown. No more rate reductions are in the pipeline.
| CANADA |
GVI Bank of Canada Policy Meeting Preview
BANK OF CANADA Policy Objective: The Bank of Canada aims to keep inflation at the 2 per cent target, the midpoint of the 1 to 3 per cent inflation-control target range. This target is expressed in terms of total CPI inflation, but the Bank uses a measure of core inflation as an operational guide. Core inflation provides a better measure of the underlying trend of inflation and tends to be a better predictor of future changes in the total CPI.   |
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John M. Bland is a co-founder and partner of Global-View.com. Prior to Global-View.com, he was a Vice-President and senior dealer in a forex inter-bank and futures trading arm of a subsidiary (ContiCurrency) of the Continental Grain Company in NYC. Previous to that, he was one of the early members of the Chemical Bank corporate advisory service in NYC, and also worked in international liability management for that bank. John holds an MBA from the Hass School at the University of California at Berkeley and a bachelor�s degree in International Economics from Berkeley.
Tuesday, August 12, 2008
Beige Book
By Ryan Barnes
| Release Date: | Two Wednesdays before every Federal Open Market Committee (FOMC) meeting, 8 times per year |
| Release Time: | |
| Coverage: | Anecdotal and discussion-based summaries of regional economic activity |
| Released By: | Federal Reserve Board; National summary authored by rotating Fed district |
| Latest Release: | http://www.federalreserve.gov/FOMC/BeigeBook/2007/ |
Background
Made public in 1983, the Summary of Commentary on Current Economic Conditions by Federal Reserve District, or Beige Book, as it is known, has a different style and tone than many other indicators. Rather than being filled with raw data, the Beige Book takes a more conversational approach. The book has 13 sections in total; 12 regional reports from each of the member Fed district banks, preceded by one national summary drawn from the individual reports that follow it. This is the first chance investors have to see how the Fed draws logical and intuitive conclusions from the raw data presented in other indicator releases.
The Beige Book is published eight times per year, just before each of the Federal Open Market Committee (FOMC) meetings. While it is used by committee members during the meeting itself, it does not carry more clout than other data values and indicators. There is a lot of real-time data that the Fed has at its disposal and, unfortunately, notes from the FOMC meetings themselves are currently not public information.
The Beige Book aims to give to give a broad overview of the economy, bringing many variables and indicators into the mix. Discussion will be about things such as labor markets, wage and price pressures, retail and ecommerce activity and manufacturing output. Investors can see comments that are forward-looking; the Beige Book will contain comments that look to predict trends and anticipate changes over the next few months or quarters.
What it Means for Investors
The Beige Book by itself is not likely to have a big effect on the markets in the short term, mainly because no new data series is presented here.
Investors and Fed watchers look to the Beige Book to gain insight into the next FOMC meeting. Is there language that shows fear about inflation? Do the reports suggest that the economy needs a financial boost to continue growing? This is the critical information that will be analyzed in the Beige Book.
To read the Beige Book effectively, one must become accustomed to "Fed speak", a special verbiage of measured remarks intentionally designed to say a little without ever saying a lot. The last thing the Fed wants to do with its words is corner itself into a pre-supposed policy decision prior to the next FOMC meeting. Investors won't ever see a definitive statement about the Fed going one way or the other with monetary policy, but there may be valuable clues in the Beige Book - at least for the trained eye.
The Fed directors and their staffs will use their very long proverbial arms to obtain an economic pulse that can't be found in any other indicator's report. They will interview business leaders, bank presidents, members of other Fed boards and hundreds of other informal networks before writing the reports that will be compiled in the Beige Book.
Investors who hold investments that conduct business in specific regions of the country may find valuable information about how those areas are performing as a whole. For instance, a stockholder in a regional bank operating in the
Occasionally, the Beige Book will give evidence that may contradict what a previous indicator has presented; the Employment Report may suggest that there is slack in the labor market, while Beige Book reports may give anecdotal evidence that wage pressures are forming, or that certain specific labor markets are tight.
On rare occasions, the Beige Book will be released at a time when information is badly needed in the markets; shock events like the September 11, 2001, terrorist attacks or a stock market crash can effectively wipe the data slate clean, and investors will count on the Fed to help describe the relative state of affairs during these tumultuous times.
Strengths:
- Contains forward-looking comments - the Fed districts aim to draw relative conclusions in the Beige Book, not just regurgitate facts already presented
- Gives investors a "man on the street" perspective of economic health by taking first-hand accounts from business owners, economist, and the like
- Aims to put pieces from different reports together into an explanatory whole, giving qualitative measurements instead of quantitative figures
- It's the only indicator that gives reports by geographic region, rather than just by industry group or sector.
- Most regions will report on the state of the service industries, an area not well covered in other indicator reports, although it is a large component of real gross domestic product.
Weaknesses:
- Rarely is any new statistical data presented, only anecdotal reports
- Filled with measured "Fed-speak"
- Specific industry conclusions are hard to draw from the report.
- Each Fed district can use its discretion on what to include in its report; one region may discuss manufacturing activity while others don't report on the topic.
- Private forecasts compiled by economists and analysts tend to closely match what is reported in the Beige Book, so estimates rarely change following the release.
The Closing Line
The Beige Book is not likely to send shock waves through the market on its release, but it provides an original point of view about economic activity and is a marked departure from the dry raw data releases of the other indicators. It also gives investors insight into how the Fed approaches its monetary policy decisions and responsibilities.
investopedia.com
Monday, August 11, 2008
Week Ahead In US Financial Markets (August 11-15 2008)
Financial Markets Summary For The Week of August 11-15
The publication of the advance retail sales report for the month of July on Wednesday and the consumer price index for the same month the following day should be the primary market moving macro events of the week. Outside of the US macro data, corporate earnings reports on Thursday for Wal-Mart, Nordstrom's and Berkshire-Hathaway all will be closely observed by the market. For the week earnings at Flour on Monday, Indy-Mac on Tuesday and Macy's on Wednesday will also impact the week in trading. The week will kick off with the release of the June trade balance and US budget statement for July on Tuesday. Wednesday will see the July import price report and June business inventories statement. Thursday will see the release of the weekly jobless claims data and the week will conclude the publication of the industrial production/ capacity utilization report for July, the TICS data for June and the preliminary estimate of consumer confidence by the University of Michigan for August.
Fed Talk
The week ahead will see a light schedule of Fed speakers. On Wednesday FRB Minneapolis President Stern will speak on “Repercussions from the Financial Shock” at 2:30 EDT. The following day Chicago Fed President Evans will speak on the US economic outlook at 12:30 EDT.
Trade Balance (June) Tuesday 08:30 AM
The trade balance should see a bit of deterioration in June due to the run-up in oil prices during the sampling period. The price of West Texas Intermediate moved from $128.00 per barrel to a high of 140.58 to close the month. This should partially offset the continued strong demand for US goods and services on the back of a diminished US dollar and relatively strong external demand. We expect that the deficit will increase to $-61.5bln for the month.
US Budget Statement (July) Tuesday 2:00 PM
We expect that going forward that the US budget deficit will grow materially worse. Our forecast of a -$83.7bln deficit is a sign of things to come. Our expectation of a growing problem in the deficit is a function of increased outlays and shortfalls in tax receipts. Revenues from individual taxes paid have begun to deteriorate along with corporate tax payments. Overall total receipts are down -6.0% year over year. We expect that the 2008 deficit will arrive in line with administration forecasts, but the fiscal year 2009 could approach -$600.0 billion should the Congress attempt to pass a second stimulus package and take other measures to shore up the finances at the FDIC.
Import Prices (July) Wednesday 08:30 AM
Import prices in July should advance 1.8% month over month and 21.1% on an annual basis. However, the fall in the cost of imported petroleum should provide a bit of drag on the overall increase in the cost of imports, which is the first positive news that market has observed in some time. Ex-petroleum costs for industrial supplies, foods and beverages and consumer goods will all continue to see solid increases. While the easing of the cost of imported oil will provide some measure of relief to the market in coming months, the inflation imported via the trade channel from China will remain on ongoing concern going forward as the focus inside the Middle Kingdom shifts from combating inflation to supporting growth.
Advance Retail Sales (July) Tuesday 08:30 AM
The month of July should capture the final surge in spending related to the well-timed stimulus package. The data based on the Redbook weekly and chain store sales both support this assessment and looked to receive further support due to back to school sales activity. While outstanding problems in demand for autos continues to weigh heavily on the headline, ex-autos sales are holding up relatively well all things considered. The outstanding question hovering over the retail sales picture going forward is how will consumers respond to the modest relief seen at the pump during the sampling period. We think that the cost of gasoline will have to move back towards $3.50 per gallon in the short term and below $3.00 per gallon later this year for the retail sales environment to see a solid response by the consumer. We expect that the headline will see a 0.20% increase m/m and a 0.6% advance ex-autos.
Consumer Price Index (July) Thursday 08:30 AM
The move in the headline to 5.0% in June provided a material measure of discomfort to the market. The publication of the July CPI should facilitate a sense of déjà-vu if our forecast of a 5.2% y/y and 0.5% m/m arrives on target. While, some will dismiss the headline and focus on the core, we do not take much comfort in our expectation of a 0.2% m/m and 2.4% y/y increase in core inflation. Our one-year ahead forecasts suggest further deterioration in the core. While, the market of late has taken solace in the Fed forecast that inflation should moderate in the coming months, we are careful to note that they have been making this claim since August 2006. Moreover, it is our assertion that once the liquidity that the Fed has pumped into the system over the past year begins to provide support to the economy that firms who have seen their profit margins shrink will look to regain more than a share of pricing power. Should this occur, core pricing will continue to bedevil a Fed that is counting on headline pressures easing somewhat over the next several months.
Initial Jobless Claims (Week ending Aug 9) Thursday 08:30 AM
Initial claims over the past two weeks has surged well above the critical threshold of 400K and the less volatile four week moving average has increase to 419K. The strong move to the upside may partially be a function of legislative changes that have enabled continuing files to be identified and initial filers. This implies that the market should see the headline moderate over the coming weeks towards the four-week moving average. Thus we expect a 442K print for the upcoming week.
Empire Manufacturing (August) Friday 08:30 AM
The modest decline in pricing pressures should provide a measure of relief to purchasing managers in August. We expect that with production picking back up in the manufacturing sector and new orders moving back into positive territory the contraction in the manufacturing sector should ease somewhat in August. Moreover, the midyear inventory correction, as illustrated by the -14.74 reading in the July inventory component inside the release, should have run its course and provide a bit of positive support for the month. We anticipate that the general business conditions headline will arrive at -1.0 for the month, with a risk to the upside.
Industrial Production (July) Friday 09:15 AM
Industrial production should continue to limp along on the back of demand for utilities. Our forecast of a 0.10% increase for the month is a function of the traditional summer increase in demand for energy than a solid and sustainable increase in the overall manufacturing sector. We remain quite bearish on the manufacturing sector outside of demand from the external sector and with the dollar firming, over the coming months that support should begin to weaken somewhat.
University of Michigan Consumer Sentiment (August-Preliminary) Friday 10:00 AM
After a long period of steady increases in the cost of gasoline, consumers have begun to see the most modest amount of relief at the pump. Over the past four weeks the cost of gasoline fell .23 cents to $3.88 per gallon nationally. While not enough to provide support for an observable increase in personal consumption, it should be sufficient to drive overall consumer sentiment upward to 62 during the preliminary estimate of consumer confidence. While, this is a positive development, consumer sentiment still remains at decade long lows and for lack of a better term still stinks.
Joseph Brusuelas
Chief Economist
Merk Investments
http://www.merkfund.com/
The views in this article were those of Axel Merk as of the newsletter's publication date and may not reflect his views at any time thereafter. These views and opinions should not be construed as investment advice nor considered as an offer to sell or a solicitation of an offer to buy shares of any securities mentioned herein. Mr. Merk is the founder and president of Merk Investments LLC and is the portfolio manager for the Merk Hard Currency Fund. Foreside Fund Services, LLC, distributor.
Sunday, August 10, 2008
Euro Crushed But Is A Bounce Due?
* Dollar: Suddenly Supreme
* Euro: Hawk No More
* Yen: 110???
* Pound: Just A Matter of Time
* Commdollars: Complete Collapse of CRB
Top 5 Stories in FX This Week
* A Tale of Two Monetary Policies
* The Knife's-Edge Economy
* Has the Dollar Fallen Far Enough?
* Spotlight on Euro
* Baby Boomers We Have A Problem
FX Market Outlook
Last week we went on Squawk and said that if 1.5500 gives way 1.5200 could soon follow. Frankly, however, even we were surprised by the ferocity and the magnitude of the decline. Once again currencies demonstrated that speculative markets will always move far more that you expect once the cascade of stops kicks in.
The rally in the dollar was of course not due to any improvement in US economic prospects but rather the result of bursting of the euro bubble. After Trichet's press conference on Thursday not only did the markets stop thinking about any additional rate hikes, but they started to price in rate cuts by early 2009 as all evidence pointed to the start of a recession in the 15 member union.
The key question next week - will 1.50 hold? There is little on the economic calendar to suggest direction either way as both US and EZ data is likely to disappoint. At this point trading is all a matter of flow. If 1.5000 does not find bargain hunters the fall in the EURUSD could continue all the way to 1.4800. Still, with the pair having fallen so far so fast, and with US data unlikely to offer any upside surprises, a short covering rally could be due, so sell at your own risk.
Cable followed euro to the downside albeit at a slower pace as 1.9500 gave way all the way down to 1.9200 and traders became convinced that it is only a matter of time before BoE caves and starts to cut rates. Last week the BoE left rates unchanged, but this week the labor data may hold the key to future policy decisions. If traders see another month of poor unemployment numbers, the pressure on Mr. King and company to cut will become immense.
USDJPY meantime came within a whisker of the 110 handle and really appears to be grossly overbought at this level. The dollar rally has been predicated on the assumption of US rate hikes by early 2009, but we are highly skeptical of Fed doing any tightening for all of next year. As matter of fact US monetary policy is very likely to follow the Japanese model as the economy sinks deeper into deflation and authorities continue to socialize losses on financial assets. When markets finally realize that no rate hike is coming USDJPY rally will stop dead in its tracks.
Finally the collapse of the CRB index has really hurt the commdollars and instead of parity the Aussie now trades below 90 cents. A bet on comm dollars is a bet on global growth and global growth is clearly slowing. The Chinese market is already discounting the post Olympic hangover and if the equity investors are right the commdollar may have more pain to go but kiwi may see a dead cat bounce if retail sales print better than forecast.
Trading Thoughts-Running Money
K and I often receive offers to manage money and so far we've refused everyone of them because we are simply too busy with research and our advisory services to devote the proper energy to the task. However the idea of running money has made me think about the criteria I would use to evaluate a money manager. Following are simply my thoughts and are by no means the final word on the subject, but I thought they may be useful points of reference for everyone to consider.
1. Be Sceptical
I never believe triple digit returns. Even if the trader can show me an audited trail of his results (and most never can), I know that 100%+ gains can only be achieved in two ways - through massive leverage or unbelievable luck. In either case, disaster is just around the corner. Leverage will turn on you like a rabid dog and luck will always run out. Have I seen traders take $100 to $10,000? $10,000 to $1,000,000? Yes and yes. But inevitably I've seen those same accounts give the money back as $10,000 suddenly shriveled to $2,000 and $1,000,000 dropped to $100,000.
The problem with investing with a hot hand is that you never jump on board during the initial $10,000 to $1,000,000 run because the trader has no “record”. Once the trader has a “record” and you climb fro the ride the losses inevitably start. In fact the longer I am in finance the more I believe that allocating your capital based upon the best return “record” is a near guarantee of losing money.
2. Acceptable Drawdown
Paul Tudor Jones, one the greatest traders of all time, has a very simple and I believe very effective formula for properly analyzing trading success. No sharp ratio, no risk-adjusted returns, no complicated math at all. Instead the Tudor Jones rule is quite straight forward. Your drawdown should not be greater than 1/3rd of your gains. That means that for every $1 run up in profits you should not give back more than 33 cents to the market. That is a very difficult task to achieve. Even, if the trader only gives back 50 cents of every dollar won consider him a good prospect for your money.
3. Evaluate By Months, Not Trades
Consistency is the last refuge of the unimaginative according to Oscar Wilde, but when it comes to financial returns it is the true measure of success, because money compounds and grows much faster in the long run with small but predictable returns rather than with huge hits or misses. At the same time worrying about every trade is a sure path to an early grave. Most professionals evaluate trading records on a monthly basis which seems to be a period long enough to smooth out the day to day bumps but short enough to warn the investor of any possible problems. Steve Cohen and Paul Tudor Jones have only had two or three losing months out of more than 200 and in the losing months they never gave back more than 2% of the equity. That's the gold standard to beat.
4. The 1% Solution
What's a reasonable rate of return? 1% per month. Achieve that and you are making 12% a year - almost double the long term average of the equity markets. Make 2% per month and you are on the way to hedge fund immortality as less than 1% of all investors worldwide produce such returns on a consistent basis. These expectations may seem remarkably modest but they are realistic. You make millions one slow dollar at a time.
Let me know if you have any other thoughts on the subject and I will be happy to publish them in future columns.
Boris Schlossberg
BKTraderFX
The Weekly Bottom Line
- Fed, ECB, BoE remain on hold
- Canada loses 55,000 jobs in July
This week, there was a common feeling among central banks around the world: downside risks to economic growth are increasing. It was only a few weeks ago when inflation was the major concern for most central banks. But, while inflation risks still exist, there is mounting evidence that the global economy is slowing - perhaps much more than anticipated. As such, the central banks in the U.S., Europe and the U.K. all left interest rates unchanged this week, as they wait to assess the risks on each side of the equation.
Fed holds interest rates steady at 2.00%
The Fed's decision to leave interest rates unchanged at 2.00% was largely expected by financial markets. However, the communiqué that accompanied the decision hinted that the concerns over economic growth have intensified since the last meeting. Indeed, the Fed downgraded its view, stating that "downside risks to growth remain", whereas the previous statement stated that these risks had "diminished". The Fed once again highlighted softening labour markets, tight credit conditions, stress in financial markets, the ongoing housing contraction and elevated energy prices as the main sources of downward pressure on economic growth.
On the inflation front, while the Fed acknowledged the recent pullback in commodity prices and expects inflation to moderate later this year and next, it still believes upside risks to inflation exist. Personal consumption expenditure (PCE) figures released on Monday highlighted these risks, as headline PCE inflation jumped 0.8% in June - the fastest growth rate since 1981. Meanwhile, core PCE inflation accelerated to 2.3% Y/Y, up from the 2.2% Y/Y increase in May.
Nonetheless, the Fed's assessment is now balanced, with both the downside risks to growth and upside risks to inflation of "significant concern". Therefore, a rate hike in the near-term is highly unlikely. We expect the Fed to remain on the sidelines for the rest of the year, as it waits to see how the risks on each side of the scale play out.
Economic growth conditions deteriorate worldwide
After inflation concerns dominated the last European Central Bank (ECB) interest rate decision meeting, leading to a 25 basis point rate hike, economic growth in the Eurozone has since moved into the spotlight. ECB President Trichet stated that the current economic weakness was only "in part" expected and that downside risks are materializing - which is why the Bank decided to leave interest rates unchanged yesterday. Despite the likelihood that the Eurozone economy contracted in the second quarter and that, in our opinion, economic growth may bottom out later than the ECB currently expects, strong lending activity and high inflation levels will prevent the ECB from cutting rates until March of 2009.
The UK economy seems to be in an even worse position, as it is decelerating rapidly and is on the brink of slipping into a recession in the coming quarters. Still, inflationary pressures have kept the Bank of England (BoE) from cutting rates at the past two meetings. But, if oil prices continue to fall as we expect, a string of rate cuts by the BoE is a likely scenario - and could begin as soon as October.
In Japan, where a growing number of analysts have said the economy is in a recession, the Cabinet Office hinted that there may be some truth to this statement. In its August report, the office used the word 'weakening' - as opposed July's statement that the 'recovery is pausing' - to signal the end of a 6.5 year expansion period. While official judgment on whether or not the economy is in fact in a recession is done retroactively, a Cabinet official admitted that "there is a possibility that the economy has entered a recession".
Commodity prices lose steam
Mounting evidence of slowing or deteriorating growth in major economies has led to a significant pullback in commodity prices. This week, oil prices made headlines as they slipped below the psychological US$120 per barrel level on increased concerns over demand destruction. But it wasn't just oil - this week saw a slide in the commodity complex as a whole. Natural gas prices slid to a 5-month low, gold prices dropped to US$850, and most base metals prices also lost ground.
The drop in commodity prices certainly did not bode well for the Canadian dollar. After reaching parity with the greenback in September 2007 for the first time in over 30 years, and peaking in November, the Canadian dollar has stayed within a tight range of 97 US cents and US$1.03 - until this week. Indeed, the loonie broke through the 97 cent floor on Monday, hovering in the 95 US cent range throughout the week. And after this morning's employment report, the loonie fell even further, hitting 93 US cents. Given the fact that the Canadian dollar has cracked the floor that has been in place for the past nine months, and that we expect commodity prices to fall by 20% over the next 12 months, there is considerable risk that lower Canadian dollar levels could be in store.
Canada loses 55,000 jobs in July
Recent economic indicators in Canada certainly aren't providing any support for the loonie either. Indeed, after this morning's jobs report, it's safe to say that the boom in the Canadian labour market is over. Canada lost 55,000 jobs in July, following a loss of 5,000 jobs in June. The drop was widespread, with 8 of 16 sectors and 6 of 10 provinces posting declines. While Central Canada felt the brunt of the losses, western Canada was hit as well, with significant declines seen in Alberta and Saskatchewan. Perhaps the most shocking detail of the report - aside from the massive number of job losses - was the mass exodus of labour force participants (-74,000) which managed to drive the unemployment rate down to 6.1%.July's employment data undoubtedly shows underlying weakness in the Canadian economy. However, it is important to keep in mind that July is just one data point. Looking back, the employment sector in Canada has been quite astonishing this year. During the first quarter of the year when the economy actually contracted slightly, an average of 35,000 jobs were created. Hence, it was only a matter of time before some payback occurred. July's plunge brings the average monthly growth rate throughout 2008 down to 10,200 jobs - which is much more consistent with an economy expected to grow by 1.0%, and is a pace that is likely to continue for the remainder of the year.
Today's report, coupled with other data released over the past few weeks, shows that Canada is not immune from the global economic slowdown. Indeed, the Bank of Canada left interest rates unchanged at its last meeting as well, and given the current weakness in the economy, we expect it to refrain from hiking rates until the second half of 2009.
UPCOMING KEY ECONOMIC RELEASES
Canadian Housing Starts - July
Release Date: August 11/08
June Result: 216K
TD Forecast: 210K
Consensus: 210K
It is now becoming increasingly clear that the pace of Canadian housing market is slowing, as the pace of activity moderates to levels consistent with the longer-term trend, and more aligned with the current stage of the Canadian business cycle. And with tighter lending standards and a sluggish domestic economy, we expect this orderly moderation to continue into the coming months. With that in mind, Canadian housing starts should fall slightly in July to 210K, following the big drop the month before. Looking ahead, we expect Canadian housing starts to remain within the 200K to 220K range.
Canadian International Trade - June
Release Date: August 12/08
May Result: $5.5B
TD Forecast: $6.0B
Consensus: $5.8B
A weaker Canadian dollar and robust energy price gains in June are expected to provide the fuel for a modest boost in Canadian merchandise trade balance. Indeed, with energy prices posting a rather healthy 8.1% M/M gain and the Canadian dollar depreciating by 2% M/M during the month, we expect Canadian merchandise exports to rise a further 1.0% M/M in June, following the strong 5.4% M/ M in May. On the other hand, imports are likely to remain flat, following the 4.0% M/M gain a month earlier. However, with this improvement in the merchandise trade balance coming from price effects, the volume of exports will likely fall, due mostly to the weakness in the Canadian manufacturing sector.
U.S. Retail Sales - July
Release Date: August 13/08
June Result: total +0.1% M/M; ex-autos +0.8% M/M
TD Forecast: total -0.1% M/M; ex-autos +0.4% M/M
Consensus: total +0.2% M/M; ex-autos +0.6% M/M
As the impact of the tax rebate cheques wear off, we expect U.S. retail sales to come back down to earth in July. In particular, with the fiscal stimulus package having run its course, U.S. retailing activity is expected to moderate in the coming months as consumers pare back their spending as they buckle under the weight of the deteriorating labour market, declining home equity and tighter lending conditions. Moreover, the continued downward trajectory in motor vehicle sales (given the elevated level of fuel prices) will continue to weigh heavily on the overall retail sales number, though sales excluding automobiles are expected to post some modest gains. For July, our call is for total retail trade to fall by 0.1% M/M, while sales ex-autos are expected to rise by a modest 0.4% M/M.
U.S. Consumer Price Index - July
Release Date: August 14/08
June Result: core 0.3% M/M, 2.4% Y/Y; all-items 1.1% M/M, 5.0% Y/Y
TD Forecast: core 0.2% M/M, 2.4% Y/Y; all-items 0.2% M/M, 4.9% Y/Y
Consensus: core 0.2% M/M, 2.4% Y/Y; all-items 0.4% M/M, 5.2% Y/Y
The recent retreat in natural gas and gasoline prices in July will go some way in moderating U.S. consumer price inflation. During the month, we expect headline inflation to rise by a more modest 0.2% M/M, bringing the annual level of price increase to 4.9% Y/Y, following the multiyear high of 5.0% Y/Y reached in June. Core consumer prices are also expected to rise by 0.2% M/M, leaving the annual core inflation rate unchanged at 2.4% Y/Y. Moreover, with energy prices receding in the coming months and U.S. economic activity tapering off, we expect to see both inflation measures come back down from their current elevated levels.
Canadian Manufacturing Shipments - June
Release Date: August 15/08
May Result: +2.7% M/M
TD Forecast: -0.2 % M/M
Consensus: +1.0% M/M
Canadian manufacturing activity has shown some surprising resiliency in the past few months, with the sector posting fair-sized gains in four of the last five months. However, with a slowing Canadian economy and sluggish U.S. economic activity, we do not expect the fight-back to last much longer. Indeed, we expect a correction of sorts in the month of June, with monthly manufacturing shipments posting its second monthly drop this year with a modest 0.2% M/M drop. We believe that despite the favourable support coming from the weakened domestic currency, the medium to long-term profile for the Canadian manufacturing sector remains fairly weak.
TD Bank Financial Group
The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.
This Week's Market Outlook
- Is the USD rally for real?
- Fundamental and technical arguments for a move back into the range
- Strategy outlook
- Key data and events to watch next week
Is the USD rally for real?
The very sudden and very explosive USD rally has many believing that this is finally it for the buck, the move higher we've all been waiting for. That said, the speed at which this happened still has us cautious about a short-term reversal. EURUSD fell out of bed in last 24 hours, plunging to a recent low of 1.5005 after touching a high near 1.5505 moments after Trichet's hawkish inflation comments hit the tapes. The selling that followed was fast and furious as the market took Trichet's subsequent remarks on the weakening Euro-zone economy as confirmation that the central bank will be hard-pressed to raise rates further -- despite the fact that their only mandate is to keep inflation in check. Indeed, the futures market is now pricing in odds of ECB rate CUTS into 1Q 2009. The sharp move leaves EURUSD in "no man's land", below the recent range of 1.5290/1.5930 but above the previous November-March range of 1.4310/1.4980. While the fundamentals of deteriorating European growth and a stabilizing US economy augur for further weakness in EURUSD, we would be cautious about further acceleration in USD gains until we break back below 1.4980/70.
Fundamental and technical arguments for a move back into the range
What exactly am I looking at in terms of why we might see a move back into the recent range? Tremendous uncertainty remains on the US outlook, both in financial markets and the broader economy. The financial sector remains in traction after a nasty collision with reality. Home prices are still declining and jobs are still being shed. The main sources of current US growth (exports and manufacturing) are heavily reliant on USD weakness and are increasingly threatened by slowdowns in the global economy. Fears abound about the US economic trajectory after the effect of the stimulus package fades into 4Q, and the list goes on. In recent weekly reports, I have discounted most of these concerns, and I still believe rightly so, but I never denied their existence.
Because the fundamental factors are as fluid and uncertain as they are, I'm going to rely on the technicals to provide the guidance. Statistics frequently lie, and sometimes prices do, but far less often and usually not for very long. Technically, the bottom of the range in EUR/USD was a series of intra-day lows at 1.5280/90 and everyone in the market was keenly watching this level. That made it a much more treacherous level to trade, with potential false breaks taking out reasoned long positions and pulling in break-out sellers who go with the break, only to take it between the eyes on a reversal. Instead, for final confirmation, I will be looking for a few daily closes below the 200-day simple moving average (currently at 1.5224), just far enough below the range lows to lure in unsuspecting break-out traders but then spark a reversal. I will also look for confirmation from gold, with a daily close below $850/oz the key, and oil, with a daily close under the $110/bbl level as the spark.
Strategy outlook
I am still convinced that we are looking at the best set-up in many months for a break lower in EUR/USD and a further extension of USD gains across the board. A few weeks back I noted the 'persistence' of the USD's advance/EUR's decline and interpreted it as an indication that a larger move was likely also unfolding. That persistence has remained in evidence, with EUR/USD bounces staying extremely shallow and any attempts to rally being sharply rejected (note the many long tails/wicks on the upside of daily candlesticks). Such persistent price movements might also be symptomatic of summertime inertia -- less market interest taking the other side -- but indications from the institutional side suggest asset managers have been mainly exiting EUR/USD longs and have only begun to get short below 1.5500. This suggests a rather badly positioned market (short at relatively low levels) and provides a basis for a correction higher. Rather than getting caught in the cross-fire around range lows, I prefer to take partial profits on USD longs/EUR shorts and look to re-sell on any subsequent corrections.
Key data and events to watch next week
The calendar is jam-packed with top-tier data in the US next week and it kicks off with the trade balance on Tuesday. Wednesday we will see import prices, retail sales, and business inventories. Thursday has the all important consumer price index and the usual weekly jobless claims data. The NY Empire manufacturing index, industrial production, and the University of Michigan consumer sentiment index round out the week on Friday. In Fed speakers we have Minneapolis Fed President Stern on tap Thursday and Chicago Fed President Evans on Friday.
Growth and inflation data dominate the landscape in Europe next week. Monday starts the week off with German wholesale prices and French industrial production. Tuesday has French consumer prices on deck and Euro-zone industrial production is due up on Wednesday. Thursday closes out the week with a ton of data, starting with German consumer prices. This will be followed by German GDP, French nonfarm payrolls, French GDP, and Euro-zone GDP and consumer prices. We will be looking for signs of improving inflation and deteriorating growth to validate the recent EURUSD selloff.
Data in the UK is crammed into the early part of the week. Monday is busy with producer prices, trade balance, BRC retail sales monitor, and RICS home prices. Tuesday has consumer and retail prices on tap while Wednesday sees the employment report and the BOE's quarterly inflation report.
Japan also has top-tier data due up next week. It starts with machine tool orders and goods prices on Monday. Tuesday is the busiest by far with industrial production, consumer confidence, GDP, current account, and the trade balance data all on deck. Wednesday closes out the week of noteworthy data with the Tertiary industry index.
It is a slow one in Canada with housing starts and prices kicking off the week on Monday. Tuesday sees trade data and Friday closes out the week with motor vehicle sales and manufacturing shipments.
The week is relatively light in the land down under and starts off with Australian business confidence and New Zealand producer prices on Tuesday. Wednesday has the Australian Westpac consumer confidence numbers along with the 2Q wage index. Thursday rounds out the week with New Zealand business PMI, New Zealand retail sales and Australian consumer inflation expectations.
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Forex.com
http://www.forex.com
DISCLAIMER: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase of sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
Weekly Economic and Financial Commentary
Economic data released this week corroborated our view of sub-par economic growth in the second half of this year. Overall GDP growth should slow during the second half of 2008 as growth in both consumer spending and business investment should be flat to negative. For the consumer, June income and spending data were impacted by the tax rebate checks that have been distributed to the majority of Americans. Over the last three months wage & salary growth has slowed to 3.3 percent compared to 5 percent plus in the prior two years. Meanwhile, real consumer spending has slowed to just 1.5 percent compared to roughly 3 percent in the first half of last year.
For the third quarter much of the benefit from the economic stimulus checks will be siphoned away by higher energy prices. Moreover, low levels of consumer sentiment and tighter credit standards are slowing spending for big-ticket discretionary items. Motor vehicle sales declined even further in July, hitting their lowest level in 15 years. The net result should be an outright decline in consumer spending during the third quarter, marking the first drop in 18 years. We expect another drop in the fourth quarter.
Years ago we developed a concept called core GDP, which measures private final domestic demand. Core GDP includes three items: consumer spending, business fixed investment and residential construction. The concept excludes swings in inventories, net exports and government spending. The net result is a measure much closer to how Main Street views the economy. Core GDP is expected to decline at a 1.2 percent pace in the third quarter and fall further at a 1.1 percent pace in the fourth quarter. The weakness in core GDP helps explain why three-quarters of Americans believe the economy is in recession even though the GDP data remain solidly positive.
Capital Spending: Modest Growth in June
Non-defense capital goods orders ex-aircraft, a key leading indicator for capital spending, rose 1.2 percent in June and is up 2.9 percent year-over-year. However, this is much weaker than the ten percent plus pace we experienced during the 2004-2006 period. Shipments for non-defense capital goods ex-aircraft were unchanged at 0.7 percent in June and up 2.7 percent over the last three months.
This suggests a business spending environment that remained positive in the second quarter but does not hold out much promise for the second half of this year. Weaker corporate profits, tighter credit lines and reduced expectations for growth all suggest that business investment in the second half of this year will be in-line with our outlook for smaller gain.
Service Sector Outlook Slowing
For the broad service sector, this week's ISM non-manufacturing index came in at 49.5, just a touch below neutral. This suggests the service sector, particularly retail, remains in a no-man's land of neither expansion nor contraction - just treading water. The most forward-looking components of this survey, new orders and employment, still remain below the key "50" level. This suggests to us that the economy, while not technically in recession, remains uncomfortably sluggish. The near-term outlook should remain challenging for service providers as prospects for growth in coming months are limited.
Two elements of the service survey highlight the conflict in the economic outlook. First, the employment index at 47.1 is below par and suggests that hiring remains weak and thereby is a negative signal on the consumer. Meanwhile the price index is over 80 suggesting that input prices could lead to upswing for inflation.
U.S. Outlook
Trade Balance • Tuesday
While imported petroleum products should rebound significantly in June, we should see growth in non-petroleum imports begin to wane as domestic demand has turned sluggish. Exports should continue to post another monthly increase with notable gains in capital goods and industrial materials. On balance, we expect the trade deficit to rise to -$61.9B.
The real trade deficit, which is important in the calculation of real GDP, continues to narrow. This is a positive for economic growth as a narrowing of the trade deficit is counted as a contribution to overall growth. It appears net exports are on track to provide further positive contributions in the third and fourth quarters, albeit less contribution than in previous quarters. For an economy that is currently struggling, this continued contribution is key to keeping overall growth in positive territory.
Previous: -$59.8B Wachovia: -$61.9B
Consensus: -$61.5B
Retail Sales • Wednesday
While weak motor vehicle spending will weigh heavily again on total retail sales in July, we expect to also see modest declines about everywhere else as the majority of the economic stimulus package has likely played out. Retail gasoline prices declined about four percent on the month which should result in lower gasoline station sales. One bright spot, however, should be online store sales. Online shopping should post another significant gain as consumers continue to look for ways to offset elevated gasoline costs.
Consumer spending held up admirably in the second quarter rising at a 1.5 percent annual pace - thanks largely to the economic stimulus package. However, that momentum will fade in the second half of the year. We now expect consumer spending to decline at a 0.7 percent annual rate during the third and fourth quarters. The Grinch may play an important role this holiday shopping season.
Previous: 0.1% Wachovia: -0.3%
Consensus: 0.1
Consumer Price Index • Thursday
Primarily due to rising gasoline and food prices, headline inflation has been accelerating in 2008. In June, headline CPI was up 5.0 percent over the past year. Despite rapid increases in energy and food prices, the core CPI, while uncomfortably elevated, has remained fairly stable - up at a 2.4 percent pace over the past year.
Fortunately oil prices have back off record highs over the past few weeks and that has resulted in lower prices at the pump. If this trend continues we should see year-over-year headline inflation begin to move lower in the coming months. In addition, there have also been a few signs of easing in food inflation. Core CPI is expected to remain better behaved as softer motor vehicle prices, apparel and shelter costs help offset increases in medical care and airline tickets.
Previous: 1.1% Wachovia: 0.4%
Consensus: 0.4%
Global Review
Aussie Dollar Takes a Hit
After reaching a 25-year high last month, the Australian dollar has declined almost 10 percent versus the U.S. dollar (see graph at left). The slide in the value of the Aussie dollar accelerated this week in the wake of the policy meeting at the Reserve Bank of Australia (RBA). The RBA kept its policy rate unchanged at 7.25 percent, which was universally expected. However, the RBA surprised investors by stating in its policy statement that the "scope to move towards a less restrictive stance of monetary policy in the period ahead is increasing." In other words, rate cuts appear to be on the horizon down-under.
A few months ago, the RBA had an implicit "bias" to tighten policy further. What happened? The short answer is that the economy is slowing quickly. This point was underscored last week when retail sales data for June printed much weaker than expected. As shown in the top chart, growth in retail sales has been weakening most of the year. Moreover, real retail sales dropped 0.6 percent in the second quarter relative to the previous quarter. Although services probably continued to expand, it looks like growth in real consumer spending may have been relatively weak in the second quarter. Recent data on business and consumer confidence are also consistent with slower growth. Australian real GDP, which expanded at a year-over-year rate of 3.6 percent in the first quarter probably slowed further in the second quarter.
But with the CPI inflation rate well above the Bank's target range of 2 to 3 percent (see middle chart), would the RBA really entertain a rate cut in the near term? Yes. As shown in the bottom chart, monetary policy in Australia is rather restrictive at present and it will take a number of cuts to bring policy back to a more accommodative stance. Given the long and uncertain lags involved in monetary policy changes, it could take some time before rate cuts are actually felt in the economy. In the meantime, growth could weaken even further. If recent drops in food and oil prices are sustained, then the overall CPI inflation rate should decline going forward. Moreover, slower growth should put downward pressure on inflation.
Another factor that may be weighing on the Aussie dollar at present is the recent decline in commodity prices. Australia is more dependent on the production and export of commodities than are most other economies, and an increase in commodity prices raises the country's terms of trade. That is, Australia can buy more imports from a given quantity of exports, which effectively raises national income. The decline in commodity prices, especially if it continues, would contribute to slower growth in the Australian economy. Moreover, slower economic growth in the rest of the world would also weigh on economic activity down-under via weaker growth in export volumes.
Looking forward, we project further losses, at least on a trend basis, for the Aussie dollar vis-à-vis its U.S. counterpart. (For details, see our Monthly Economic Outlook, which is posted at www.wachovia.com/economics.) We think the slide in the Aussie dollar will become more pronounced later this year and early next year as the RBA actually begins to cut rates.
Global Outlook
Japanese GDP Growth • Tuesday
The Japanese economy grew at a brisk pace in the first quarter, paced by strong growth in domestic demand as well as in net exports. However, monthly indicators suggest growth was quite weak in the second quarter. Indeed, the consensus forecast looks for a sizeable contraction in the recently completed quarter.
Japanese GDP growth has a tendency to bounce around from quarter to quarter, so the second quarter's expected outturn may overstate the weakness of the Japanese economy. That said, Japan has probably slipped into a mild recession. The outlook for the Japanese economy depends in large part on the pace of global growth going forward. If global growth weakens significantly then Japanese exports will turn down, which would weigh further on Japanese GDP growth.
Previous: 4.0% (quarterly annualized rate)
Consensus: -2.3%
U.K. CPI Inflation • Tuesday
CPI inflation has shot well above the 2 percent rate the Bank of England is mandated to maintain in the "medium term." And it appears the bad news is not over yet for policymakers at the Bank as the consensus forecast anticipates that the year-over-year rate of CPI inflation breached 4 percent in July.
Most of the increase in inflation reflects the sharp rise in energy prices earlier this year. Core CPI inflation is more benign. However, the Monetary Policy Committee (MPC) will have its hands tied cutting rates, although the U.K. economy is weakening at an alarming rate, until CPI inflation starts to recede. If oil prices stay at current levels, then inflation should come down going forward. However, it may be a number of months before the MPC can ease policy. The labor market for June, which will print on Wednesday, should shed some additional light on the current state of the U.K. economy.
Previous: 3.8% (year-over-year)
Consensus: 4.2%
Euro-zone GDP Growth • Thursday
Real GDP in the Euro-zone grew at a decent clip in the first quarter. However, warm weather, which helped construction, may have flattered the results. Most analysts had looked for slower growth anyway in the second quarter, but recent economic data from the Euro-zone has been weaker than expected. Indeed, the consensus forecast looks for a mild contraction in real GDP in the second quarter.
Data on Euro-zone industrial production in June will print on Wednesday. Although the data won't really increase our knowledge of the second quarter, it will tell us how much momentum the economy had entering the current quarter. Weaker than expected data could cause the euro to break into a new (lower) trading range.
Previous: 0.7% (not annualized)
Consensus: -0.2%
Point of View
Interest Rate Watch
Range Bound Rate Outlook Offers No Easy Out for Credit Adjustment
There is no easy out for creditors or debtors in our outlook. A difficult workout remains ahead. Short-term rates are likely to remain steady as the Federal Reserve faces the dual imbalance of below-trend economic growth and above-target inflation. For the second half of this year we expect average real growth around 1.5 percent with weakness centered in the domestic economy - consumer and business investment. Meanwhile, inflation, as measured by the core PCE deflator remains at or above the top end of the Federal Reserve's target range.
As for long rates we expect inflation stability will keep the ten-year rate in a tight 3.8 - 4.0 percent range. Yet there is significant uncertainty on both the dollar and federal deficit outlook that suggests that rates could rise above our outlook. On the opposite tack, our concerns about the dollar and further Treasury financing issues are likely to limit any Treasury rallies towards lower rates.
Credit Spreads: Wide and Volatile
Unfortunately, credit spreads are not expected to tighten in the near term. They have not only tightened over the last month, they have widened anew as negative financial news reminds creditors of the event risk in company announcements. Capital markets continue to search for a new risk/reward tradeoff. At present, the trend in the TED spread (three month futures contract for U.S. Treasuries less the three month Eurodollar futures contract) suggests the new equilibrium spread will be higher than what it was during the 2004-2006 period. Risk is being more fairly priced - we just haven't seen what the new equilibrium price is quite yet.
Topic of the Week
Get Ready for Lower Inflation
There was a stretch in early spring where it seemed like all we heard about was the rising price of food and energy. In late April the news media was full of reports of the run-up in rice prices which had doubled in a matter of weeks. At the time, warehouse stores began to impose limits on rice purchases, as consumers and small business owners rushed in to buy 20 lb. bags of the staple grain.
Rice had become the prime example of over-heated food prices. Higher costs for food passed through to the consumer and were ultimately manifested in sharp increases in components of the Consumer Price Index (CPI). In June, the "food" component of CPI was increasing at a 3-month-annualized rate of 8.5 percent.
In recent weeks however, there has been considerable cooling in the red-hot commodities market. Since April when rice peaked, prices have come down more than 34 percent. Other food staples are also down from their peak in the spring. Corn is down 33 percent, while wheat is off 36 percent.
Energy prices have also shed value. Crude oil has come down more than 20 percent from its peak in early July. And while prices at the pump are still far from cheap, retail gasoline prices have eased as well.
We are beginning to see anecdotal signs of food costs coming down. This week King Arthur Flour announced a price reduction for its line of premium flours. If recent price declines stick, we would not be surprised to see month-over-month declines in CPI.
Some market-watchers thought the Fed should have hiked rates to address rising inflation. Maybe the FOMC members are looking at those 20 lb. bags of rice in their pantries.
Wachovia Corporation
http://www.wachovia.com
Disclaimer: The information and opinions herein are for general information use only. Wachovia Corporation and its affiliates, including Wachovia Bank, N.A., do not guarantee their accuracy or completeness, nor does Wachovia Corporation or any of its affiliates, including Wachovia Bank, N.A., assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or any foreign exchange transaction, or as personalized investment advice. Securities and foreign exchange transactions are not FDIC-insured, are not bank-guaranteed, and may lose value.
Weekly Focus: Focus Shifting Back to Growth
European bond markets have been remarkable this year as focus has shifted back and forth between financial crisis/weak growth and inflation. In the first quarter, focus was entirely on the acceleration in the financial crisis. The Fed was cutting rates aggressively and by the end of the first quarter the European market was pricing in 100bp of rate cuts from the ECB within a year.
In the second quarter, things swung dramatically the other way. Financial markets calmed while oil prices rose substantially. This shifted focus 180 degrees onto inflation, which suddenly became the main worry and prompted the ECB to announce a July hike. Within three months, the market went from pricing 100bp of cuts to 100bp of hikes within the next year.
Now we are in the third quarter, and the pendulum is shifting back toward a focus on growth. Oil and other commodity prices have retreated, dampening inflation worries. At the same time, the data in Euroland have weakened substantially - most notably in Germany, where indicators now suggest the economy could be on the brink of recession. This is what sparked the sudden shift in ECB rhetoric at the meeting on Thursday, when it softened its assessment of the growth outlook. The market, meanwhile, is now again pricing in a rate cut next year, and going forward we expect market focus to remain on the weak growth situation. In our view, rising unemployment and more soft surveys will result in the market pricing in more rate cuts - and hence bond yields should fall further and the yield curve should steepen again. This will be reflected in our revised yield forecast next week.
Euroland: "Profit warning" from ECB
After the recent weakening of data it was a matter of when and not if the ECB would soften its assessment of the growth outlook. The ECB has until recently hung on to a quite rosy view of the Euroland economy - despite the massive headwinds piling up this year. But reality has finally caught up with ECB, and it decided to change its assessment of the economy at the rate meeting on Thursday. The ECB said that "downside risks to growth have materialised", which clearly points to a downward revision to the growth projection when it is published in connection with the September meeting.
So what tilted the bank? We believe the sudden shift in the German economy over recent months has been decisive. During the spring the German ifo survey held on to quite decent levels, and this underpinned the ECB's more positive view despite the weakening seen in many other countries, particularly Italy and Spain. Over the past few months the German ifo index has dropped significantly, and Germany has shifted from "last man standing" to "last man falling". The weakness in the ifo has been confirmed by hard data such as factory orders and industrial production. These developments show once again just how important an indicator the German ifo is for general sentiment on the Euroland economy - not least at the ECB.
The ECB will likely come under increasing pressure in the coming quarters, as growth appears set to continue to look soft and a new phase of the slowdown with rising unemployment will likely unfold. If commodity prices stay down, inflation should peak soon, and focus will return to growth. We continue to believe the ECB will stay sidelined, as it still sees medium-term price pressures from money expansion and globalisation. Nevertheless, the probability of rate cuts has increased. We expect the markets to price in 2-3 rate cuts (currently one cut is priced) over the coming months, and hence see scope for a further decline in bond yields. Next week, focus will be on Q2 GDP numbers, which will likely be weak. It has already been leaked that German GDP will fall around 1% q/q, and Italy (first to report) reported a decline of 0.3% q/q for Q2 on Friday.
Key events of the week ahead
- Thursday: German and Euroland GDP. Germany is expected at -1.0%, as indicated by leaks recently. After weak Italian GDP we see downside risks to Euroland as a whole.
- Thursday: Euroland inflation released. Final data which include core inflation. Headline expected in line with Flash at 4.1%. Core seen unchanged at 1.8%
Switzerland: Swiss economy treading water
Monday brought us the PMI for July. The overall index confirmed our view of the Swiss economy, namely that a downturn is on its way. The index fell from 54.9 in June to 54.1 in July, its lowest level for three years, although the drop was not as steep as the market had anticipated. Looking ahead, there is reason to expect the index to approach the watershed level of 50. Switzerland is a small, open economy highly dependent on developments in the global - and in particular the European - economy. The European economy's current woes will inevitably impact negatively on Swiss growth. However, that being said, a PMI reading of 54.1 is a high reading in global terms and still points to economic expansion.
Friday saw the release of the Swiss employment report for July. There was little here of note - the labour market is still treading water. Unemployment is still relatively low at 2.5%, and the ratio of vacancies to unemployed - a forward-looking indicator - is still at its highest since 2003, which could indicate that there is still relatively robust demand for labour. However, a global - and domestic - slowdown will naturally exert upward pressure on Swiss unemployment.
There is little in the economic calendar in the coming week. Thursday brings consumer confidence data for July, and it will be interesting to see if these confirm the trend suggested by the latest figures for the KOF leading indicator, where the private consumption sector, in particular, pulled down the overall index.
Key events of the week ahead
- SECO's consumer confidence survey for July will be released on Thursday.
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