Week Ahead In US Financial Markets (July 28-August 1)
Financial Markets Summary For The Week of July 28-August 1
The week of July 28-August 1 will see a fairly significant amount of US macro data. The major releases will be clustered near the end of the week on Thursday and Friday. Thursday will see the publication of the preliminary GDP for Q2, jobless claims, Chicago PMI and the employment cost index for Q2. The week will be capped by the release of the July non-farm payrolls report and the estimate of the ISM of national manufacturing conditions for that same month. Tuesday will see the release of July consumer confidence survey by the Conference Board and Wednesday will see the ADP estimate of payrolls for July. The week will see another heavy five days of earnings statements with heavyweights such as Disney, Starbucks, Chevron and Berkshire-Hathaway reporting near the end of the week.
Fed Talk
The only Fed speaker scheduled for the week is FOMC Gov. Mishkin who will give an address titled "Whither Federal Reserve Communication," on Monday. As is custom one week ahead of an FOMC meeting beginning Tuesday, there will be a blackout on Fed speak.
Chart of the Week
Consumer Confidence (July) Tuesday 10:00 AM
Consumer confidence for the month of July should see another 30 days of sagging sentiment among individuals subject to an increasingly difficult job environment. We expect that headline will decline to 49.2 on the back of continued stress among consumers. With the rebate checks spent, there is precious little to offset the real reduction in purchasing power among consumers due to a weak dollar and rising inflation. The aforementioned factors should combine to press the headline estimate of consumer confidence to decade long lows.
GDP Q1 Preliminary Thursday 08:30 AM
The combination of a 1.0% increase in personal consumption and a 1.9% increase in net exports should provide a decent rate of economic expansion during the initial estimate of output for Q2'08. However, the data elsewhere is still relatively weak. Firms carefully managed the purchase of stock and it does appear that inventories contracted at a rate of 0.5% for the quarter. More importantly, due to data suggesting that expenditures on fixed business investment remain absolutely flat and the ongoing contraction in residential investment, we do expect that overall investment should again provide a net drag on overall growth. Thus we expect to see an increase of 2.1% in the preliminary estimate of GDP for the second quarter of 2008.
Employment Cost Index (Q2) Thursday 08:30 AM
Although inflation has continued to work its way through economy, there has been scant evidence that it has yet to put upward pressure on wages. We expect that to be the case again in Q2 when our forecast implies that employment costs will increase 0.8%. Due to a relative lack of bargaining power, labor is in no position to demand higher wages among a weak job market and uncertain economic prospects going forward.
Initial Jobless Claims (Week ending July 26) Thursday 08:30 AM
Initial claims for the week ending 26 July should see a slow and steady uptick back towards 380K. With the four week moving average trending in that direction after a bout of holiday induced data, the weak labor market does not at this time have the capacity to stimulate a move lower for the foreseeable future.
Chicago PMI (July) Thursday 09:45 AM
We expect that a month of weak orders and economic weakness in the upper Midwest should combine to drag down the headline estimate of the July Chicago PMI to 48.6. Our forecast implies that new orders should decline to 49.1 and prices paid should increase to 86.3 for the month. Although, the cost of imported oil eased during the month, the greater concern on a regional basis is the latest round of planned cutbacks in auto assembly schedules in Detroit that should further depress manufacturing activity in the area.
Total Vehicle Sales (July) Thursday-Throughout Day
Hope in the auto sector that rebate checks would provide a modicum of support for domestic sales did not materialize in June and sales took a sharp turn south. On the back of some very pessimistic forecasts out of Detroit we do not anticipate a recovery in demand for new cars anytime soon. Our forecast implies a modest bounce back in July with the sale of domestic autos arriving at 10.1mln units and demand for foreign fuel efficient autos modestly advancing to 13.9mln.
Non-Farm Payrolls (July) Friday 08:30 AM
The labor sector continues to see a steady downward drift and our forecast implies that the market will observe a net loss of -93k jobs in July. We expect that the service sector will see the second negative print in the past three months and further losses in the goods production and manufacturing sector should by the primary catalyst driving employment losses throughout the economy. Given some of the interesting adjustments at the Bureau of Labor Statistics regarding assumptions of job creation in the leisure and hospitality industries in June, we think that the report is ripe for downward revisions over the past two months and this should set the stage for what is shaping up to be another month of negative data from the labor sector.
ISM (July) Friday 10:00 AM
We have grown quite bearish on manufacturing conditions domestically, regardless of the still relatively strong demand from the external sector. Lackluster domestic demand has dragged down the headline reading below 50.0 four times during the first six months of the year. Our forecast indicates that this will be the case again in July when the headline falls to 49.3. We expect new orders to decline to 49.0 and prices paid to increase to 89.5.
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.
This Week's Market Outlook
Highlights
- USD strengthens across the board; looking for more to come
- EUR/USD & USD/JPY price levels to watch
- Outlook continues to stabilize in US while deteriorating elsewhere
- Key data and events to watch next week
USD strengthens across the board; looking for more to come
The USD recovered broadly against other major currencies this week as the GSE panic subsided further and oil and other commodity prices continued their sharp retreat. US 2Q bank earnings reports also came in generally better than expected, though many firms still reported significant losses and write downs, but left the impression that financial sector hemorrhaging is nearing an end. Non-financial firms' 2Q earnings reports were also generally better than expected, reinforcing the notion that US firms are well-positioned to weather the current economic storm, with attendant positive implications for the US economic outlook.
In short, the US outlook continues to stabilize while fresh signs of deterioration are appearing in other major economies' outlooks, particularly in Europe and the UK. (We look at some key recent data points to support this view in the next section.) Hawkish Fed rhetoric (FOMC minutes, Stern and Plosser) has increased expectations of a Fed rate hike in the fall-Fed Fund futures now reflect a nearly 50% likelihood of at least a 1/4% increase in US rates at the September 16 or October 29 meetings. Increased US rate hike expectations, coupled with the sharp declines in commodity prices (stemming from overall slower global growth and demand, e.g. China's 1st half 2008 steel exports fell sharply), are dovetailing to support the USD. I am now more optimistic than in many months that the US will avoid a recession and that in a few months time we'll look back at July 2008 as the significant low point for the USD.
While I am significantly more optimistic that the worst-case scenario in the US and for the USD will be avoided, I would remind traders of the highly uncertain outlook both here in the US and globally, as well as recent range-bound trading conditions that have dominated FX markets this summer. Take it one step at a time. At the same time, I am very encouraged by the persistence of the USD's recovery this week-pullbacks were minimal and the USD is closing nearer to its highs for the week. I view such persistent price moves as an indication that markets were are not positioned for a USD rebound, and consequently had to chase the buck higher, limiting any pullbacks. That also suggests additional flows are likely to come into the USD in the weeks ahead, as shorts continue to unwind and long positions are established. The inverse relationship between commodities (oil still the key) and the USD (commodities down/USD up) continues to be the most visible trading correlation at the moment and will remain a key driver of USD. A WTI oil price drop below the $119-122/bbl support zone is the trigger for further steep losses, likely to the $100/105 area.
EUR/USD & USD/JPY price levels to watch
EUR/USD: Trendline support for the recent upmove since June 13 was broken on the drop below 1.5830, and is now resistance at 1.5900/10. A 'double top' looms above at 1.6020/40. More immediate resistance is at the 1.5750/55 level, which is marked by the Kijun line and the 38.2% retracement of the decline from 1.6038 to 1.5625. Only a daily close above the Tenkan line at 1.5833 signals further upside potential. The Tenkan Line is falling and looks set to cross down below the Kijun line next week, generating a sell signal should it occur. To the downside, the Ichimoku cloud is below between 1.5652 and 1.5572, and a drop through there will confirm fresh weakness ahead. The 100 and 55-day moving averages are also at the 1.5655 level. Also, there was talk this week of institutional buying orders between 1.5570/1.5620, highlighting that area as the key to further weakness. I look for 1.5450 next on a daily close below 1.5570.
USD/JPY: Broke and closed above the 200-day moving average, now at 106.93, and trend line resistance from recent highs, now support at 106.60/70, highlighting the potential for further gains. 108.00 is immediate resistance from a trend line drawn off the 6/16 and 6/25 intra-day highs, and above there is the recent high at 108.65/70 as the next target. Overall, the shift above the 200-day moving average suggests potential to 109.50/110.00 area. USD/JPY is currently above the Tenkan and Kijun lines at 105.88 and 106.10, respectively.
Outlook continues to stabilize in US while deteriorating elsewhere
The relative strength of the US economy versus its counterparts across the pond seems to be shifting in earnest. While no one can say that US growth has rebounded and is now on the verge of turning higher, it can be said that the data of late suggest signs of stabilization and that the worst of the declines are very likely behind us. Consumer confidence is improving, business activity looks resilient, and housing seems pretty darn close to putting in a bottom. In contrast, the European economies are witnessing renewed deterioration in these areas. We believe that the market has not yet priced in these developments and that the potential for a firming in the USD is very real, from a fundamental standpoint. We highlight some of the key economic developments here.
Consumer Confidence
Falling oil prices are translating into a more upbeat US consumer as evidenced by the latest University of Michigan sentiment numbers. The headline index jumped to 61.2 in July from 56.6 in June, and the first time above 60 since April. More importantly, the economic outlook component rose to 53.5, which is the highest result since March. This highlights US consumers' obvious sensitivity to gasoline prices and suggests that if oil continues to crumble, consumer spending looks to hold up even after the tax stimulus dissipates. On the flipside, the data in the UK this week showed a consumer on the brink. Retail sales for June plummeted -3.9% on the month and the annual growth rate sank to just 2.2%, the weakest since early 2006. This is why despite the hawkish inflation talk recently from the BOE we are still sellers of GBP/USD on rallies and especially into the 2.00 area.
Business Activity
Business confidence took a turn for the worse in the Eurozone this week as pretty well every indicator measuring sentiment fell. French business confidence slipped to 98 from 101, German IFO business climate plunged to 97.5 from 101.2, and the Eurozone PMI composite fell to 47.8 from 49.3 just to illustrate a few. Meanwhile, business spending in the US was running on nearly all cylinders in June. The latest report on capital spending showed that non-defense capital goods ex-aircraft orders -- which feed directly into GDP -- rose a strong 1.4%, while core shipments were up a healthy 0.7%. This suggests an increase in US 2Q GDP of more than 2.0% (the current consensus) and the robust orders provide a good handoff to 3Q to boot.
Housing
Housing has been a thorn in the side of the US economy for some time now and it looks from the last few months of data that stabilization is finally in the works. Existing US home sales seem to have found a bottom near 4.9 million units, as the pickup in foreclosures continues to create bargains for market entrants that were once hesitant about falling home prices. The new home sales data also showed signs of improvement, especially on the very worrisome inventory front as the latest release showed months' supply falling to 10.0 on higher sales, even as median prices rose. The same cannot be said about Western Europe where the UK saw mortgage approvals plunge to the lowest level since 1997 just this week and an inventory glut of new homes in Spain threatens to plunge that economy into recession.
Key data and events to watch next week
Next week marks month end and traders should be aware of reduced liquidity and heightened volatility, especially around key economic data releases. We believe the ramped up volatility bodes well for a USD break higher as lower volumes will see more explosive trading. Also keep in mind that the Senate is expected to sign the GSE legislation this Saturday (July 26), a measure already passed by the House. President Bush has announced his intention to sign the bill into law and this will remove another cloud hanging over the US markets.
The US economic calendar is bustling with top-tier events next week. It kicks off with the Case Shiller home price index and the Conference Board consumer confidence measure on Tuesday. Wednesday sees the ADP employment report, which has been pretty unreliable as a gauge for the government's measure of employment change. Thursday we have the advance release of 2Q GDP and the Chicago PMI index. Friday is the big day with the July NFP employment report release, ISM manufacturing, and construction spending all on tap.
The Euro-zone will also be pretty hectic, and it starts the week off with German GfK consumer confidence on Monday. Tuesday is jam-packed with French producer prices, French housing starts, German consumer prices, and the German Trade Chambers' company export survey -- this should give us some color on how the high priced euro is impacting European trade sentiment. (Our hunch is negatively.) On Wednesday we'll see Euro-zone business climate indicator, Euro-zone consumer confidence, and German retail sales. Thursday rounds out the key data with Euro-zone CPI estimate and German unemployment data.
The data week in Japan is pretty light and starts the off with the employment numbers and retail trade on Monday. Tuesday we have industrial production on tap and Thursday closes out the week with housing starts.
The UK is also relatively on the modest side. Tuesday starts it all off with consumer credit, mortgage approvals, and CBI distributive trades report (a private retail sales report) all on deck. Wednesday sees the all important GfK consumer confidence report while Thursday has nationwide home price numbers out. Friday rounds out the week with the release of the PMI manufacturing report.
Canada is very light but important nonetheless. Wednesday has the industrial and raw materials price indices while Thursday sees the important May GDP numbers. The reports will be key to assessing the Canadian inflation-to-growth balance and should provide guidance as to the BOC's next move on rates.
It is modestly busy down under and the week kicks off with New Zealand trade data on Sunday evening. Monday sees Australian leading indicators along with New Zealand building permits. Tuesday we'll see the Australian NAB business confidence while Wednesday brings Australian building approvals. Thursday has the all important Australian trade balance and Australian retail sales data on deck. Last but not least, the AiG manufacturing index is on tap for Friday.
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 Weekly Bottom Line
HIGHLIGHTS
- U.S. home construction shows signs of life
- Global inflation and growth woes remain
In the 1980s, economist and Nobel laureate Amartya Sen found that famines tend to happen not because of a lack of food, but because of obstacles preventing those in need from acquiring the existing stores of food. This juxtaposition is center stage across the globe right now - an ongoing famine for liquidity in many financial and housing sectors versus the flood of petro-liquidity driving consumer and producer inflation higher worldwide. We have liquidity in spades, just not in the sectors that welcome it or need it most.
Why so serious?
Remember April and May? The leaves were returning. The flowers were blooming. The credit crunch was over. Well, the spring fling is over and markets have come to the realization - which incidentally has been TD Economics base case scenario all along - that the credit crunch will continue to slowly bleed for some time. While the market roller coaster saw increasing optimism early this week, apparently markets forgot that the U.S. housing market remains in shambles. There is some light. For the first time since the spring of 2007, the 3-month trend in new home sales and starts is positive. New home construction is what is captured in GDP measures of residential investment, and this same signal preceded rebounds in U.S. residential investment in each of the last three downturns. Existing home sales, on the other hand, make up the majority of the U.S. housing stock and mortgage market, and sales there dropped another 2.6% M/M in June and are down over 15% over last year. Critically, at this current pace of sales, it would take over 11 months to sell the inventory of unsold homes already on the market. And this doesn't include other homes dumped on the market in coming months through foreclosure or voluntary sales. In the second quarter, one in every 171 U.S. households was foreclosed on - with Nevada showing a staggering one in 43 households and California one in every 65.
This is the heart of the liquidity famine. As more homes are dumped on the market, home prices fall further, driving further mortgages underwater, leading to further foreclosures, further homes dumped on the market, and further home price declines. Lather. Rinse. Repeat. At some point, lower prices will entice buyers into the market, but not until the expectation for further declines recedes. Why buy today when you can buy next year for 10% less? In the meantime, liquidity in the housing market is nonexistent. This feeds directly into the current dilemma for the financial sector. The smaller and more regional the bank, the more exposed to the mortgage market. Real estate loans account for 1/3 of all assets of U.S. commercial banks - over ½ of all assets for banks with total assets less than $1 billion - and nearly 2/3 of assets of savings and loans. This puts these institutions in a vise, and those like Fannie and Freddie that have bought or underwritten about half of all these mortgages in a bind. As a result, commercial banks' average daily borrowing of $16 billion from the Fed's emergency lending programs last week was the highest ever.
So the issue becomes what can be done to get that liquidity flowing again? In a perfect world, we'd let the market work itself out. Prices would fall to the point that buyers would move in, and larger banks would recapitalize by attracting investors. But current regulations limit the ability of buyout firms to move into the banking sector - an issue the Federal Reserve is reportedly trying to address - while large foreign investors that bought into large banks earlier have since lost money on their investments and may be once bitten, twice shy. The bill moving through the U.S. Congress right now hopes to help stop the self-fulfilling prophesies of doom, gloom, and liquidity vacuum. The government would increase its debt ceiling by about $800bn - about half of which could cover the expected 2008 federal deficit and the other half would be there just in case. This "just in case" would help cover, among other things, the federal government insuring approximately $300bn in mortgage debt belonging to 400,000 American households who will refinance their subprime loans into 30-year fixed-rate mortgages, $4bn in federal transfers to the states, and the ability of the U.S. Treasury to buy stock in Fannie and Freddie up to the federal debt ceiling. As banks continue to struggle, these two institutions are key to helping the U.S. mortgage market grind on. While not ideal, a government backstop may be just what is needed to avoid their failure and the vicious cycle in the mortgage market. Earlier this week, the Congressional Budget Office estimated the cost of the Fannie and Freddie rescue plan at $25bn. As with most of the estimates placed on the cost of credit crunch, this seems likely to creep higher, but is still much lower than the cost of doing nothing. In the worst case scenario - or even just the next incremental step because let's be honest, there isn't much of a difference between the first step off the cliff and the second - the costs to the Federal government could be ten times higher.
A horse with no name
The current U.S. predicament is core inflation and GDP growth both running at about a 2.5% pace over last year. For those unlucky few who need to buy gas and food on a regular basis, total inflation is running at twice that pace. Still, this is well short of the near 15% pace of core inflation and 1% Y/Y contraction in U.S. GDP in 1980 that saw the invention of the moniker "stagflation." Nor are there signs inflation will come unhinged in the U.S. to that extent so the "stag" part is much more likely than the "flation." Similarly in Canada, headline inflation is now running at twice the pace of core inflation (3.1% vs. 1.5%). In fact, on a global scale, the most likely scenario is further stagnation in advanced economies and further inflation for emerging markets, with very few of either seeing both on a sustained basis. The U.S. consumer is quickly running out of stimulus checks to spend. In Canada, retail sales for May showed an ongoing sharp deceleration in everything not being bought at a gas station. In Europe, surveys of the manufacturing and service sectors showed sharper than expected decelerations in Q2. The U.K. economy posted its weakest quarterly GDP growth rate in three years in 2008Q2 and is likely to contract before the year is out. And, the pace of exports from Japan and Hong Kong saw precipitous declines in June. So growth is likely to slow in these regions and exert a downward pressure on domestic inflation.
On the other hand, broad-based emerging market resilience and inflation worries remain. The pace of inflation-adjusted retail sales in China is the highest in 12 years. Korea's economic expansion stayed constant in Q2 while inflation remains at a 10-year high. And across the EM universe (or at least averaging 57 EMs), inflation has accelerated from a 5% pace in June 2007 to 12% in June 2008. So while Malaysia this week hiked interest rates for the first time since 2006, and Brazil surprised markets with a larger than expected rate hike, the average pace of inflation across EMs is rising faster than the average interest rate. This is pushing down real interest rates and helping to fuel both faster growth and inflation in these markets. The same is not occurring in advanced economies, with average real rates still above zero in the G-7.
So in the immortal words of the modern philosopher Axl Rose, "Where do we go now?" Sluggish economic growth in advanced economies is likely to keep a lid on growth prospects in EMs, but not unbearably so. Inflation in EMs is likely to place upward pressure on advanced economy inflation, but not uncontrollably so. And we are likely to see more mirages in the desert before we finally find paradise and bring balanced liquidity back to the global economy.
UPCOMING KEY ECONOMIC RELEASES
Canadian Real GDP - May
Release Date: July 31/08
April Result: +0.4% M/M
TD Forecast: +0.2% M/M
Consensus: +0.2% M/M
The Canadian economy appears to have snapped back to life in Q2, following the disappointing 0.3% Q/Q ann. drop in domestic output in Q1. And we expect the economy to grow for a second consecutive month in May with a modest 0.2% M/M increase in output, coming on the heels of the fairly robust rise in GDP in April. The increase in overall economic activity should be on account of the strong performance in real exports and the fairly strong advance in real wholesale sales during the month. The manufacturing sector will also add favourably to economic activity during the month, given the modest increase in real manufacturing shipments. However, despite this cautious revival in economic activity, we expect Canadian GDP growth to remain soft in the coming months as the economy navigates against the challenges of a weakening U.S. economy, a slowing domestic housing sector and a sluggish labour market.
U.S. Real GDP - Q2/08
Release Date: July 31/08
Q1 Result: +1.0% Q/Q ann.
TD Forecast: +2.2% Q/Q
Consensus: +2.0%
The story behind second quarter U.S. GDP was supposed to be the impact of the fiscal stimulus on consumer spending. However, the bump in spending has been somewhat anaemic, resulting in a quarterly number that is likely to disappoint expectations. Durable goods consumption is expected to contract for the second straight quarter, led by a sharp drop in motor-vehicle purchases. Instead, it will be the tremendous strength of exports that will steal the headlines when the advanced estimate for U.S. growth is released. Exports likely contributed close to half of the total growth in the quarter and combined with falling imports will be more than enough to offset weakness in domestic spending. Residential construction will continue to subtract from growth, offset partially by non-residential structures investment that continues to show resilience.
U.S. Nonfarm Payrolls - July
Release Date: August 1/08
June Result: -62K; unemployment rate 5.5%
TD Forecast: -60K; unemployment rate 5.5%
Consensus: -75K; unemployment rate 5.6%
The U.S. economy has lost jobs for six straight months since January with a total of 438K positions being eliminated from the nonfarm payrolls, and the monthly revisions have been consistently downwards. We expect the deterioration in the U.S. labour market to continue at roughly the same pace in July, with a further 60K drop in the employment ranks (following the 62K fall in June). The unemployment rate should hold steady at 5.5%. Indeed, with the sluggishness in the domestic economy and higher input costs, employers are likely to continue economizing on their use of labour services as they contend with the challenge of reduced demand for their products. Needless to say, the weakness in the U.S. labour market continues to be highlighted by the elevated level of jobless claims, though it is important to bear in mind that predicting employment data in July has always been challenging, given the variability of seasonal factory layoffs. Our bias is for nonfarm payrolls to continue deteriorating in the coming months.
U.S. ISM Manufacturing Report - July
Release Date: August 1/08
June Result: 50.2
TD Forecast: 49.0
Consensus: 49.2
We expect the recent surprising upswing in the ISM (in May and June) to be short-lived, with the diffusion index falling back marginally below the 50 threshold in July. Indeed, it is no secret that the U.S. manufacturing sector continues to struggle as it tackles the headwinds coming from the slowing domestic economy and high input costs. Moreover, notwithstanding the natural ebb and flow in this indicator, and the important offsets that have been coming from strong export demand, we expect the long-run general stagnation in the U.S. manufacturing sector to continue in the coming months. If there is a risk to this call it is to the upside, given the strong durable goods orders in June.
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.
Economic Outlook: Unemployment Up in the US
This week's highlights
For the financial markets, the most important economic indicator this week is employment in the US. Employment is one of the indicators used to assess whether the US is in recession, and looking only at the labour market the US is in recession. The following indicators point to this:
- Unemployment has increased by 0.5 percentage point over the past six months which usually only happens in connection with a recession (apart from 1992)
- Private-sector employment has fallen by 0.4% over the past twelve months, and this has not been seen since WWII except when the economy has been in recession
- Notably cyclical sectors such as the manufacturing industry, construction, retail, transportation and business services have cut jobs.
The labour market indicates that there are signs of a mild recession, just like the two previous in 1990/91 and 2001. So far, the unemployment rate has increased by almost 0.1 percentage point a month over the past six months. In comparison, the unemployment rate rose by 0.15 percentage point a month during the recessions in 1990/91 and 2001 and during the more severe recessions in the early 1980s it rose by 0.25 percentage point a month.
Using the moderate rise of 0.1 percentage point as guideline for the future development, the unemployment rate ends the year at 6.1%. A sharper rise of 0.15 percentage point will send the unemployment rate to 6.4%, and a repetition of the development in the early 1980s will result in an unemployment rate close to 7%.
We expect the moderate development to continue, and this means that unemployment for 2008 will end at 6%. This is due to the fact that businesses are in somewhat better shape than usual at the beginning of a recession and that the access to the labour market has slowed down due to the demographic development since the labour force grows at a lower rate. In our view, it will be very unusual if the Fed raises interest rates in this situation.
This week's other highlights
- USA: GDP for Q2, ISM, consumer confidence and house prices
- The euro zone: consumer prices, preliminary
- The UK: PMI Manufacturing
- Japan: industrial production and unemployment
In the course of the week
Germany: consumer prices - July
The German consumer prices rose again in June to 3.3%. The German consumer prices are the first indication of the flash estimate of inflation in the euro zone and will be announced on 31 July. Therefore, the data will attract much attention - considering the ECB's interest-rate announcement on 7 August.
Monday
Japan: unemployment - June
The tight labour market appears to be softening. The unemployment rate was unchanged at 4% in May and confirmed the picture that the fall in unemployment is coming to an end. Moreover, new jobs and vacant jobs per application are on the decline. Economic growth is slowing and profit in the corporate sector is under pressure from the high oil and commodity prices, for instance, which influence the labour market. We expect the unemployment rate to remain around 4% in June since initially businesses will react by reducing bonus payments rather than cutting jobs.
Tuesday
USA: house prices from Case/Shiller - May
There are various measurements of house prices in the US. Case/Shiller measures the price development of homes in the large cities. That is why Case/Shiller often increases/falls more than the entire housing market. In April house prices had fallen by 15.3% over the past twelve months, which is the sharpest fall since the start of the data collection (1988). It is cause for concern that the fall in house prices has accelerated lately. If it is measured in terms of a three-month period and compared with the preceding three months and in y/y terms, the fall is 22%.
We expect a further fall in house prices in May.
USA: consumer confidence - July
Consumer confidence as reported by the Conference Board is usually the most important consumer confidence indicator. Consumer confidence has declined by almost 55 points over the past 12 months, which is the largest fall ever (1968). This reflects the fact that consumers are very much under pressure from falling employment, rising unemployment, high petrol and food rises, falling house prices and equity prices as well as lower wage increases.
Consumer confidence is expected to be affected by the following factors:
- the crisis involving Fannie Mae and Freddie Mac has not added to the optimism
- employment fell again in June and in the previous months
- the Department of the Treasury is almost done sending out cheques with tax cuts
- the turmoil in the financial markets has picked up again and equity prices have fallen
- mortgage rates have increased significantly since mid-March
- petrol prices have increased further
- the other consumer confidence indicators, ABC and Uni. of Michigan, have in fact risen a little after what can be characterised as a sharp fall.
We expect a small fall in consumer confidence in July since consumer confidence has already fallen considerably, i.e. the majority of the bad news has already been discounted.
There will also be focus on consumers' assessment of the labour-market situation through their assessment of 'how difficult it is to get a new job' and 'plenty of new jobs'. These assessments are expected to show that consumers have grown even more pessimistic due to the rise in unemployment.
Japan: industrial production - June
Industrial production grows at a slower pace. In May it grew by 1.2% y/y and the year on year rise for the past three months is 0.8%. We expect the slower global and Japanese activity to be increasingly reflected in the forwardlooking economic indicators such as PMI which shows that new orders are on the decline and stocks are accumulated.
Thursday
USA: GDP - Q2
GDP is also one of the important economic indictors this week. GDP is the total production of goods and services in the US and the best indicator of the development in the economy. GDP is often used as a measurement of whether the economy is in recession. In Q1, GDP rose by 1% after a rise of 0.6% in Q4. Although there are prospects of stronger growth in Q2, it is not a sign that the risk of recession has disappeared.
Growth was driven up by consumer spending and notably the tax cuts. They lifted consumer spending by 0.5% in the first two months of Q2 compared with Q1. In terms of retail sales, consumer spending was weak in June, but services which are not included in retail sales are expected to pull up consumer spending. We therefore expect consumer spending to grow by somewhat more than the 1.1% in Q1.
Net exports (exports minus imports) contributed strongly to growth over the past four quarters and the prospects are also good for Q2. Exports have significantly outperformed imports in the two first months of the quarter, and this may cause growth to rise by up to 1 percentage point.
The indicators of corporate investment point to a rise as the sale of investment goods increased in the first two months. On the other hand, businesses have cut jobs, which is often seen together with a fall in investment.
Housing investment which has driven down growth by an average of 1 percentage point since Q2 2006 will also drive down growth in the second quarter. The drag on GDP growth by housing investment is expected to fall during the rest of the year, which is reflected in a more moderate fall in residential construction.
The largest element of uncertainty is inventory investment. The businesses have not increased the production although the demand from consumers has been boosted by the tax cuts. This indicates that businesses have met a large part of the demand by drawing on inventories. A fall in inventories pulls down GDP growth, and this factor increases the uncertainty about growth considerably.
All in all, we expect growth to be slightly above 2% in Q2. On the other hand, there are prospects that growth will fall in Q3.
The GDP data comprise the Fed's preferred inflation indicator, the personal consumption expenditure deflator ex. food and energy. It rose by 2.3% in the first quarter.
USA: labour costs - Q2
The employment cost index is the Fed's preferred indicator of the inflationary pressure from the labour market. It will be a significant signal if the rate of increase of labour costs falls. When labour costs are so significant it is because they account for two thirds of companies' total costs and thus extensively determine the development in companies' total costs. Wages account for 70% of labour costs while the rest pays for social security, pension, sickness, leave, etc.
The increase in labour costs in the private sector slowed a little from Q4 to Q1. This was mainly due to a fall in other staff costs whereas the proportion of wages actually rose. Since the wage rises in, e.g., the labour market report have slowed solidly, we expect labour costs to rise at a more modest pace. In Q1 they rose at 0.7% (Q4: 0.8%).
The euro zone: consumer prices - July
Consumer prices are high and much too high for the liking of the ECB. Moreover, the high rate of inflation is deadly to growth in consumer spending since it erodes households' purchasing power. In June, inflation rose to 4.0 % y/y. We expect inflation for July to be a tad higher or at the same level.
The UK: house prices - July
According to Nationwide, house prices have been falling for the past eight months. The fall in June was 0.9% m/m. That reduced the rate of increase to -6.3% y/y, the biggest fall since 1992.
We expect the housing market to be soft for some months yet, with house prices falling further. The ratio between house sales and the stock of unsold houses in the RICS survey - which is a good indicator of future house prices - is still falling, and the number of mortgage loans has fallen to an all-time low since the start of the series in 1993. The number of deals is very low, and this indicates that the tight credit conditions are inducing many potential house buyers to stay out of the market.
Friday
The US: employment - July
Employment is usually the most important indicator for the financial markets. The employment data give a good indication of the state of the economy, although there has been some discrepancy between the picture painted by the employment data and GDP lately.
As evident from this week's highlight, the economy is in recession judging by the labour market, although the recession looks fairly moderate. Employment has fallen by 73,000 a month over the past six months, and a look at private employment in particular shows that private employment has done worse than that, recording a fall of 93,000 a month.
We expect the employment situation to deteriorate over coming months. This is corroborated by the fact that most indicators signal a sharper fall in employment. We expect a fall in employment of about 80,000 in June, but we still await a number of indicators which are not released until next week.
Jobless claims fell by 16,000 between the two collection weeks (when employment data are collected). The level points to a small fall in employment. ISM's index of employment in the manufacturing industry fell sharply, to 43.7, and this signals that the number of workers laid off in the manufacturing industry is rising (by about -100,000 a month). ISM's index of employment in the service sector also fell sharply in June, to 43.8. That indicates a massive fall in employment in the service sector, but indicators are somewhat volatile, so you should not overinterpret this signal. The weighted employment index of the ISMs points to a fall of 125,000 in employment. The indices of vacancy ads in newspapers and on the internet have fallen further. In the construction sector, employment has fallen, but construction has fallen more sharply still. In our view, there is a surplus of 300,000 skilled workers in the residential construction sector.
Overall, we expect a total fall in employment of 90,000. You should also remember the reviews of employment made for the two preceding months. The latest revisions have all been downward, as was the case during the recession in 2001.
Because of the interest in inflation, there is also focus on developments in wages. Wages rose by 0.3% from May to June and by 3.4% y/y. The general rise in unemployment is expected to lead to a lower rate of wage increase and hence to weakening inflationary pressure from the labour market.
The US: ISM Manufacturing - July
ISM is the nationwide sentiment indicator for the manufacturing industry and gives a reasonable indication of the development in industrial production and GDP. What the financial markets will be looking at this time is whether the ISM falls like the European sentiment indicators. In June, ISM rose from 49.6 to 50.2, which indicates unchanged activity in the manufacturing industry.
We expect a fall in ISM in July due to the following:
- Our ISM indicator signals that ISM may fall by a few points, to 47, in July.
- The turmoil in the financial markets may pull ISM down.
- The sentiment index of small businesses has fallen considerably more than has ISM. They are notably bearish about sales.
- New orders in the manufacturing industry have risen robustly since February. However, the rise is to some extent due to price rises.
The fall in oil prices may calm down the corporate sector.
In addition to the index, focus will be on new orders, employment and the price index. The price index in particular, which rose in June to 92, the highest level since 1980, will attract a good deal of attention. Given the fall in oil prices, the price index may fall.
The US: car sales - July
Factory car sales are interesting, because the number has fallen drastically. Sales in June were as low as 13.6m, the lowest they have been since August 1993). Q2 sales 2007 were 16m. There are no prospects of improvement for the short term, and we expect another fall in July.
The fall in car sales was due to the high petrol prices (above USD 4 a gallon) which have already prompted Americans to reduce their driving. Another factor that pulls down car sales is the fact that consumers under pressure from, e.g., lower employment, higher unemployment, slowing wage rises and lower house prices, will postpone buying durable consumer goods including cars.
According to a manager at Ford, there are prospects of a further fall in sales n July. Notably the American car producers are hit hard by the rising petrol prices and the tighter credit standards.
The UK: PMI Manufacturing - July
The sentiment indicator of the manufacturing industry fell sharply in June and has been below 50 for the past two months, which indicates a setback in the sector. The PMI index is now the lowest it has been since the beginning of 2002. The sub-indices of production, new orders and employment have all fallen significantly, whereas the price indices are rising and are now the highest they have been since the series started. This means that there are prospects of a setback for the manufacturing industry at the same time as mounting inflationary pressure. We expect PMI to remain week over the coming months.
Sweden: GDP - Q2
The Swedish economy is slowing down. GDP rose in Q1 2008 by 0.4% q/q, the lowest rate of growth since mid-2003. In addition to slower growth in consumer spending, also inventories pulled down growth, and there was a fall in public investments. We expect the growth rate to remain moderate in Q2 (at around 0.3%-0.5% q/q) due to the global economic slowdown and the fall in domestic demand.
Households are under pressure because the rising inflation rate erodes the purchasing power, and the weaker data for retail sales and consumer confidence in May and June indicate a slowdown in private consumption. In conjunction with lower expectations of exports, this means that there are prospects of companies toning down their investment plans from the existing robust level. This is also reflected in the business confidence indicators, and the rate of increase of new orders - for the domestic market as well as the export market - has fallen significantly. On the other hand, we expect public investments to swing back into positive territory after the fall in Q1.Jyske Markets - FX Research
http://www.jyskebank.dk/finansnyt
Weekly Market Commentary
Overview
Equity indices' 'relief rally' fizzled out mid-week as they continue to grapple with pivotal chart levels. Most are now slightly lower than where they started and Brazil's Bovespa has lost over 20% since June's record high. The US dollar strengthened marginally, and especially against the Czech koruna because Vice-governor Hampl said, 'the crown recently has become unhinged…(and) is one of the things influencing the behaviour of the central bank'. The Mexican peso strengthened to 10.00 per greenback, the strongest since November 2002, as the overnight lending rate was raised by another 25 basis points to 8.00% (to fight inflation running at 5.26%). Likewise Brazil +75 basis points to 13.00% and inflation 6.3%. Most commodities are lower, dragged downed by Crude Oil and Natural Gas. Interest rates are very mixed and moving to different dynamics. Most Treasury yields are lower and the Reserve Bank of New Zealand trimmed the Official Cash Rate by 25 basis points to 8.00%.
Political and Economic Developments
Tough times for Britain, we know, and now it's official. Retail Sales collapsed -3.9% in June, the biggest slump since records began in 1986, reversing sunny May's +3.6% leap. Clothing and footwear, the usual victims, suffered badly but interestingly food sales crashed a record -3.6% although the value of retail sales at £5.1B is +3.4% higher than a year ago: spend more get less, great! The Grocer magazine reported that sliced white break and white potato sales are markedly higher, suggesting chip butties all round is the Brits' idea of belt-tightening. Q2 GDP was just +0.2% Q/Q and +1.6% Y/Y, a sharp reduction from Q1's +2.3%. The National Institute of Economic and Social Research predicts it will be +1.5% in 2008 and +1.4% for 2009, well under the 3.1% rate in 2007 and the lowest since Q4 1992. And they suggest a rate hike to tame inflation (potentially killing off the economy too). The number of mortgage approvals are the lowest since January 1996.
Germany is not immune with August's IFO Business Sentiment Index seeing its biggest drop since 9/11/2001. Danish Consumer Confidence is at a 16-year low and the Eurozone's Composite PMI is at a record low at 47.8. Japanese exports unexpectedly shrank for the first time in five years and the Bank of Japan accepts that the country might slip in to a shallow recession because consumer spending would not make up for this decline.
Underlying Themes
The average US home costs $215,000, down 6.1% from this time last year. Foreclosures are +14% in Q2 from Q1, amounting to 739,714 properties, and 121% higher than Q2 2007. These properties, with prices dramatically slashed, account for between 30% and 40% of all June Existing Home Sales. California and Florida were the highest by volume but Nevada, where on in every 43 households received a foreclosure filing in Q2, holds the dubious distinction of the record ratio. Government owned Ginnie Mae, whose share of the mortgage markets has increased from 8% to 20% in 12 months, has lent and securitised $3 billion worth of 'jumbo mortgages' (between $363K and 730K a piece) since the program began in April. To who? On what? Where? Why buy now?
What to watch for next week
A general election in Cambodia on Sunday and July CPI for the different German states due from this day. Monday just UK June Nationwide House Prices and German August GfK Consumer Confidence. Tuesday Japan June Jobless, Household Spending and Retail Sales, UK Consumer Credit and US July Consumer Confidence. Wednesday Japan June Industrial Production, July Small Business Confidence, German June Retail Sales and Eurozone July Business Climate. Thursday Japan June Labour Cash Earnings and Housing Starts, UK July GfK Consumer Confidence and German Unemployment. Then EZ15 June Unemployment and July CPI, US Q2 GDP, Core PCE, June Help Wanted Index and July Chicago Purchasing Managers. Friday the 1st August July Manufacturing PMI's for various European countries, US June Construction Spending, July Manufacturing ISM, Non-farm Payrolls and Unemployment. Saturday a referendum in Latvia on proposed changes to the constitution.
Positioning and Technical Analysis
Thinning markets as we approach August summer holidays and Beijing's Olympics. Allow for another week or two where equity indices trade nervously around these key chart levels. Here, and in a whole range of financial markets, intra-day and weekly prices moves are likely to get bigger and implied volatility higher. Vacations are only part of the story though. Scarce cash means less money for trading; fear of losses encourages super tight stops; a raid on savings to smaller investment pots. When some shares are priced at just one tenth of their peak value, they behave like 'penny stocks'. The media as always terribly quick to point out that A was up 12% that day, or B down 20% the next, and so on. We question whether this sort of instrument should be included at all in a sensible, defensive, investment strategy. The next dilemma is where exactly interest rates should be in the fight between opposing forces: inflation and recession. Getting this right is key, and doing nothing is not necessarily an option. The fragility of the current situation means the slightest miscalculation could topple everything, with dramatic consequences. We doubt the authorities have the necessary skills and tools to walk this tightrope. They also do not have deep pockets.
Have a nice weekend!
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