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Monday December 17, 2007 - 03:33:20 GMT
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Market Directions Sunday, December 16, 2007

The euro climb against the dollar, intact since the beginning of August, broke down conclusively on Friday with the united currency closing below 1.4450 for the first time since early November. Surprisingly it was the American consumer that shoved the euro lower. All the recent doomsday scenarios for the dollar run have through the spending habits of the US consumer. Battered by falling house prices and frightened by the credit crisis, US consumers were supposed to begin a retreat from their free spending ways. Consumer spending is 70 percent of the US GDP, as it fell, production and jobs would ebb away, inhibiting consumer spending even more, and the whole cycle was due to end in a severe slowdown or outright recession. Notwithstanding that it was these same terrified consumers who powered 3rd quarter GDP to a 4.9% expansion, the currency markets have been waiting confidently for the collapse in consumer spending, the US economy and the dollar.

Thus far the US consumer has not cooperated. Retails sales in November, released on Thursday, were much stronger than anticipated. The euro began to move lower with the sales figures but it was the CPI inflation numbers on Friday that delivered the heaviest push. With core CPI 2.3% higher than last year, consumer spending strong and industrial production buoyant the prospects for another Fed rate cut at the end of January diminished appreciably and euro selling began in earnest.

The financial markets have been traumatized by the credit crisis. The seizing of the medium term credit markets and the inverted yield curve are troubling signs for the US economy. An inverted curve, with long term rates lower than short term rates, is a traditional precursor of recession. This is true despite the fact that all inversions have not been followed by recessions and all recessions have not been preceded by an inverted yield curve. The logic of inversion is simple. Falling economic growth elicits rate reductions from the Fed, the farther end of curve drops as expectation for a reduction cycle takes hold. Since the end of the cycle is not in sight when the rate cuts begin anticipation keeps future rates low until signs of economic recovery are apparent. The current problem, though it is not really a problem, is that the economy has not yet faltered. The Fed has begun to reduce rates to ameliorate the unusual economic circumstances, a prolonged housing decline coupled with a credit crunch that could, if extended, deny credit to business, and to head off the anticipated economic slowdown. Mr. Bernanke is taking out insurance, as he has said, but as in any insurance purchase the insured circumstance has not yet occurred.

In all of these considerations the simple fact remains that the economy has not slowed yet. The housing slump has been an economic reality for more than 18 months, the credit crisis for four, two of which were in the third quarter but the economy grew at a blistering 4.9% in that quarter. Job creation remains moderate and real wages, taking into account health care and other services, are expanding at more than 3.0% annually.

Housing wealth does contribute to the consumers’ overall asset picture but it may not be as important to daily spending habits as many economists and commentators have surmised. Jobs, rising wages, low interest rates and available consumer credit may be far more important and may yet keep the seven year US expansion in moderate forward gear. An American economy at 2.0% or 2.5% GDP growth in the next two quarters is not a scenario for a falling dollar. Traders have begun to entertain the possibility of a far more resilient US economy and a far less crippled US dollar.

The rapid decline of the dollar against the euro since August has been predicated on two linked assumptions: first that the American economy will bend if not break under the accumulated weight of the housing collapse and the credit crisis and second that in order to alleviate the worst of these potential developments the Federal Reserve will push rates lower for the first half of 2008. Both assumptions were called into question by the economic data this week and the dollar had its best two days in over three months. There is a good chance that the direction of the dollar for the remainder of the year has been set and it will see further gains into the New Year holiday.

Central Banks

The American Federal Reserve dropped the Fed Funds target rate for the third time since September to 4.25%. The 0.25% cut made the total reduction 1.0% in less than three months. The discount rate, the cost for banks to borrow directly from the Fed, was cut 0.25% to 4.50%. The rate reductions were the minimum expected by the market. The FOMC statement cited "intensification of the housing crisis and some softening in business and consumer spending" as reasons for the cut. It also mentions inflation, but the FOMC made its decision about inflation vs. growth back in September so the notice that price risks are still evident is neither here nor there.

Directly addressing the severe shortage of medium term liquidity in the money markets, the Federal Reserve and four other central banks have arranged an auction funding facility. It is hoped that the greater access to funding that this facility will provide will enable many banks which do not have direct access to the Fed’s money market cash injections to secure direct financing from the central banks if they are unable to fund through normal commercial channels. The bankers are clearly still struggling with how to provide liquidity to a market whose private lenders have become extremely risk averse, so much so that normal money market funding between commercial entities has been drastically curtailed.

The Week in Review December 3 - 7

United States

There has been as yet no appreciable spillover into consumer spending from either the eighteen month decline in housing or the much more recent ‘credit crisis’. Retails sales were twice as strong as predicted, and the ex auto was number three times the median forecast. The robust sales numbers in the month before the holiday spending season support higher estimates for GDP growth in the fourth quarter. Inflation concerns reignited with producer prices rising at a 7.2% pace and consumer prices surging 4.3% in November. The prices rises were spread across all categories of goods, led by energy costs. The combination of strong consumption and burgeoning inflation may be enough to keep the FOMC on hold at their next meeting January 30th.


The inflation concerns of the European Central Bank (ECB) proved well grounded as the November harmonized inflation index reached the highest level since monetary union began in 1999. ECB rhetoric over the past several months has not countenanced even a hint at rate reduction but financial market worries will prevent a rate increase any time soon. The bank is likely to be on hold well into the spring of next year.


Faster yuan appreciation and higher interest rates will be part of a new “tight” money policy in China according to a spokesman for a Chinese government think tank. The Ministry of Commerce estimated that a 1% drop in US GDP growth would slow Chinese export growth by 6.0% . “ The Chinese government’s biggest concern is continued dollar depreciation, it has put too much pressure on the yuan to appreciate”, said Zhu Baoliang from the State Information Center, the government affiliated think tank.

Economic Releases December 10 - 14

United States

Monday: National Association of Realtors (NAR) Pending Home Sales Index for October rose 0.6% to 87.2, the second small monthly gain in a row. This series tracks housing contract activity, a signed contract is not counted as completed until the transaction closes. The index is down 18.4% since last year.

Wednesday: the International Trade Balance deficit for October increased to -$57.8 billion. The deficit with China reached a record -$25.9 billion, with Japan it was -$8.0 billion and with the OPEC countries -$11.0 billion. Exports rose $1.3 billion and imports gained $2.0 billion. The September deficit was revised higher as well to -$57.1 billion from -$56.5 billion. All of the increase was due to the rise in crude oil prices. The volume of oil imports in October rose slightly but the average price in October was $73.49 per barrel, in September it had been $68.51. Excluding energy products the deficit actually shrank in October. With the average price for a barrel of oil even higher in November further increases in the trade deficit are expected. Import Prices jumped 2.7% in November, the largest single boost since October 1990, led by the 9.8% rise in petroleum products.

Thursday: Retails Sales in November proved surprisingly strong gaining 1.2% over October, twice the median forecast and six times the October figure. The ‘ex food and auto’ result was even more pronounced adding 1.8% on expectations of +0.6% and October’s +0.2%. It was the largest rise since January of 2006. There was strength in all categories even building materials posted a gain pf 1.2%. Figures for the prior two months were adjusted higher, the headline ‘sales’ added 0.1% in total and ‘ex auto’ 0.5%. The Producer Price Index shot up 3.2% in November, a +7.2% yearly rate. It was the biggest monthly jump in more than a generation, +1.4% had been predicted. The core rate (without food and energy) added 0.4%, a +2.0% yearly rise, against a prediction of +0.2%. Gasoline prices rose 34.8% in the month and were the biggest driver. But have since fallen somewhat relieving some of the future pressure on prices.

Friday: CPI gained 0.8% in November, far stronger than the expected +0.6% and almost triple the October 0.3% result. The headline CPI is now running at +4.3%. Core CPI added 0.3% for the month, more than the 0.2% forecast and October figure. Core CPI was at 2.3% yearly in November. Industrial Production jumped 0.3% in November, ahead of the 0.2% estimate, but the October number was revised down to -0.7% from -0.5%. Capacity Utilization was 81.5% in November, 81.8% had been forecast, October was 81.7%.


Tuesday: ZEW Survey of economic experts for December fell, 5.7 to -35.7 in the ‘economic expectations’ category and 0.6 in the ‘current conditions’ summary to 59.6. The November readings were -30.0 and 60.2 respectively.

Wednesday: Industrial Production outstripped expectations in October rising 0.4%, 3.8% y/y, on predictions of +0.1% and +3.7%; the September figure was adjusted to -0.8% from -0.7%, the year on year number was unchanged at +3.5%. .

Friday: final HICP inflation for November advanced 0.5% over October and added 0.1% in the year on year reading to 3.1%. The yearly number matches the highest reading since monetary union began in 1999 and matches the May 2001 number.


Tuesday: ZEW Survey of economic experts for December came in well below forecasts and is at the lowest level since January 1993; ‘economic expectations’ -37.2, expected -35.0, November -32.5; ‘current conditions’ 63.5, expected 66.0, November 70.0. ‘Economic expectations’ are now below the long term average of -31.4.

Friday: final HICP rose 0.5% in November as expected, 3.3% on the year. CPI was slightly higher in the final number +0.5%, +3.1% y/y over the preliminary readings of +0.4% and +3.0%. The HICP figure is at an all time high for this harmonized inflation rate; CPI is at a 13 year peak.

United Kingdom

Monday: output producer prices gained 0.5% in November, the biggest jump in 16 years, and a +4.5% rise since last November. A rate of +0.4% monthly and +4.2% had been forecast. Food and fuel were the main culprits. The Monetary Policy Committee (MPC) of the Bank of England (BOE) did not have these figures when it decided to lower rates by 0.25% on December 6th.

Wednesday: the three month average for average earnings growth dropped to +4.0% in October from +4.1% for September; +4.2% had been forecast. The ILO unemployment rate eased to 5.3% in October, down 0.1% from September.


Monday: machinery orders rose 12.7% in October more than double the anticipated 6.2% gain. This was this first positive month since June.

Tuesday: consumer confidence scored 39.8 in November, the lowest reading in almost four years, 43.0 had been expected, October was 42.8.

Friday: the Tankan report for the 4th quarter showed a decline in business sentiment. Large manufacturing firms registered 19, less than the forecast of 21 and off the 3rd quarter result of 23. It is the lowest since the 3rd quarter of 2005. Large non manufacturing firms voted at 16, slightly better than the forecast, 15 but substantially less than the 3rd quarter reading of 20. Economy Minister Hiroki Ota blamed the sagging Tankan on high oil and commodity prices and a strong yen. Small firms exhibited the same weaker prospects as their larger brothers.


Monday: November PPI was 4.6% ahead of the same month last year.

Tuesday: the November trade surplus measured $26.28 billion, a slight decline from October’s $27.05 billion. The January though November surplus was $238.13 billion an astonishing 52% more than the same period last year, $156.52 billion. November CPI was 6.9% higher than a year prior. Once again food prices were the main driver. A gain of 6.4% had been the median prediction; October prices rose 6.5%.

Wednesday: Retails sales were 18.8% stronger in November than a year previously; in October the growth was +18.1%.

The Week Ahead December 17 – 21

United States

Monday: Treasury International Capital System (TICS) net long term securities transactions for October at 9:00 ET; September +$26.4 billion. TICS total flows for October at 9:00 ET; September -$14.7 billion. NAHB Housing Market Index for December at 10:30 ET; November 19.

Tuesday: Housing Starts for November at 8:30 ET; October 1.229 million. Building Permits for November at 8:30 ET; October 1.170 million.

Thursday: third quarter GDP (final); preliminary 4.9%, advanced +3.9%.

Friday: Personal Income for November at 8:30 ET; October +0.2%. Personal Expenditures for November at 8:30 ET; October +0.2%. PCE Core Price Index for November at 8:30 ET; October +0.2%. University of Michigan Consumer Sentiment for December at 10:00 ET; November 76.1


Wednesday: construction production for October at 10:00 GMT; September 0.0% m/m, +1.5% y/y.

Friday: industrial new orders for October at 10:00 GMT; September -1.6% m/m, +2.0% y/y. ‘Flash’ (1st issue) PMI for December at 10:00 GMT; November manufacturing 52.6, services 53.7.


Wednesday: PPI for November at 7:00 GMT; October +0.4% m/m, +1.7% y/y. IFO Survey for December at 9:00 GMT; November ‘business sentiment’ 104.2, ‘current assessment’ 110.4, ‘business expectations’ 98.3.

Thursday: GfK Consumer Confidence for January at 7:00 GMT; December 4.3.

United Kingdom

Monday: Rightmove House Prices for December at 00:01 GMT; November +0.7% m/m, +7.9% y/y.

Tuesday: CPI for November at 9:30 GMT; October +0.5% m/m, +2.1% y/y. Core CPI for November at 9:30 GMT; October +1.5% y/y.

Wednesday: minutes of December 6th MPC meeting where the committee voted 7-2 to cut rates 0.25%. CBI Distributive Trades Survey (reported volume of sales) for December at 11:00 GMT; November 13.

Thursday: third quarter GDP (3rd issue) at 9:30 GMT; prior issue +0.7% q/q, + 3.2% y/y.

Friday: Hometrack House Price Survey for December at 00:01 GMT; November +0.2% m/m, +3.6% y/y. Retail Sales for November at 9:30 GMT; October -0.1% m/m, +4.4% y/y. GfK Consumer Confidence for December at 10:30 GMT; November -10.

Joseph Trevisani
FX Solutions
Chief Market Analyst

[email protected]

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