The recovery in the dollar since late November and its partial submergence this week were end of the year technical plays, nothing more. From August to November the dollar lost over 11% against the euro, profit taking on such an exceptional trend was inevitable, especially in December. The dollar fall since last Friday was a reversal triggered by the weak durable goods number on Wednesday. Neither move is predictive of market opinion going into the New Year.
In January the constants will return with the state of the American economy and its reflection in Federal Reserve policy paramount, and developments in Europe and the ECB a close second. The primary focus on the US is simply because Fed policy and its next rate decision is undetermined. Ben Bernanke, the Chairman of the Fed would probably like to leave rates at 4.25% at the January 31st meeting. The financial and business communities would passionately like another rate reduction. The run up to the meeting will provide plenty of room for speculation.
The ECB meeting on January 10th will not generate nearly as much interest because the governors have so much less operational room. Inflation has been well over the 2.0% since September and is not likely to subside in the near term. But the ECBâs corporate desire to fulfill its inflation mandate is constrained both by the unresolved financial and credit market debacle and the faltering European economies. Both banks will probably have to rein in their better instincts when they make their January decisions; the Fed will likely cut 25 basis points, the ECB will remain on hold.
For a market primed for better news after last weekâs strong retail sales figures, the US durable goods figures were a major disappointment. The dollar slid more than 100 points against the euro in the aftermath. The numbers hit the market at almost exactly the same time as the news of the assassination of Pakistani politician and presidential candidate Benazir Bhutto. An increase in tension in Pakistan and by proxy the oil producing regions of the Middle East should damage the United States economy less than the EMU, the States are far less dependant on Middle Eastern oil than Europe, but with the market already moving against the dollar there was no change in attitude. What transpires in the next few weeks in Pakistan will determine the overall market reaction but the mechanism will be the price of oil. Pakistan has a nuclear arsenal and the government is under great pressure from Islamic radicals, the presumed assassins of Ms Butto. The more radicals can destabilize the Islamabad government the higher the oil price will rise. If there is ever a change of power in Pakistan the sky may be the limit for oil. The ramifications for the world economy of a forced change in government in Pakistan could be devastating.
The Week in Review December 24 - 28
The US economy seems to have a split personality. Consumer spending is strong, employment, wage growth and manufacturing are moderate, witness Fridayâs Chicago Purchasers Index and the recent retail sales figures, but the housing sector continues to plummet. There is no lack of consumption but one question has been unavoidable for the past 18 months, 'when will the housing sector drag down the rest of the economy'? Perhaps we are asking the wrong question? If jobs are available and wages are steady or rising must the 72% of the economy made up by consumer spending suffer? Aren't consumers being eminently rational when they delay the purchase of a new house but not the purchase of a new flat screen or dress?
A home is the largest purchase most consumers will ever make, one with a very long mortgage trail and it entails a much longer view of the economy than normal consumer spending. Retail purchases are not usually delayed in the hope of a lower price in the future, in most cases the cost saving doesnât stand against the immediate desire to own, and our culture encourages instantaneous consumption. But housing isnât a normal retail purchase. With a house a wait of six months or a year may very well produce a substantially lower cost. That is especially true now. Isn't patience a logical reaction to the current housing market? And isnât it sensible that moderate consumer spending is a product of the moderate job market? Home prices in many areas of the country have not fallen all that much from their peak, clearly prices must drop to market clearing level before customers will return. If consumers are holding off on the purchase of a new home that doesnât necessarily mean other spending will diminish. Maybe the correct question is not when will the consumer economy be pulled to recession by the housing market but if?
The ECB continued its war of words against inflation. Jurgen Stark, executive board member promised that âthe ECB will not hesitate to act before second round effects emergeâ. âActâ can only mean raising interest rates but the possibility for an ECB hike in the near future is severely undercut by two factors: the still unfolding credit market situation which subsides for a time only to reappear and rekindle fears of a financial system meltdown and the declining GDP growth in the EMU which would be devastated by an unexpected ECB rate hike. Whatever the rhetoric out of Frankfurt, the ECB will wait until the economic picture clears before it puts its words into action.
The yuan appreciated 6.4% against the dollar in 2007, that is nearly twice its 3.3% improvement in 2006, and it rose 3.5% against a trade weighted basket of currencies. But the yuan fell 3.7% against the euro in the same period This appreciation of the yuan against the currency of its most vocal critic, the United States, has led to predictions for a further 7 to 10 percent appreciation against the dollar in 2008. Chinese inflation was 6.9% annually in November and the government views yuan appreciation along with domestic interest rates and bank reserve requirements as its prime tools in controlling inflation. Beijingâs economic planners do not issue inflation targets nor do they comment on the specifics of the yuan exchange rate but with the Chinese economy expanding at more than 10% annually and commodity prices at historic highs, it is unlikely the yuan will appreciate any less in 2008 than it did in 2007.
Economic Releases December 24 - 28
Wednesday: Case Shiller Home Price Index sank 1.4% in October to 192.89, the largest one month fall on record. From August to September the index had dropped 0.79%. Prices are down 6.5% year on year in October, in September they were 4.9% lower. In the past three years this series has weakened in the period from July to October.
Thursday: Durable Goods Orders added 0.1% in November far less than the +1.5% predicted, though better than the October 0.4% fall. It was the first positive month since July. Durable Goods ex transport fell 0.7%, the same as last month, the third drop in four months. Durable Goods ex defense rose 1.2%, the second gain in the past four months. Boeing added 177 new orders in November; in October the commercial airplane manufacturer received 56 orders. Conference Board Consumer Confidence for December was revised slightly higher to 88.6 from the preliminary figure of 87.8, âexpectationsâ gained while the âpresent situationâ fell.
Friday: the Chicago Purchasers Index for December was unexpectedly vibrant at 56.6 against predictions of 52.0 and Novemberâs 52.9. âNew Ordersâ was the strongest component at 58.4, November had been 53.9. New Home Sales fell 9.0% in November to a 12 year record low at 647,000. The October sales figures was revised lower to 711,000 from 728,000. Market supply rose to 9.3 month, resuming the trend higher after the September to October drop from 9.2 months to 8.8 months. Despite the gloomy sales numbers the median sale price is down only 0.4% from a year ago. Whatever price declines have occurred, and there is wide local variation, they have not been enough to tempt people to purchase.
No economic statistics released
Friday: flash (preliminary) CPI for December was +0.5% m/m and +2.8% y/y, +3.1% had been predicted for the yearly number; November was +0.4% m/m, +3.0% y/y. Flash (preliminary) HICP for December was up 0.7% m/m and 3.1% y/y, a rise of +3.2% had been anticipated; Novemberâs readings were +0.5% m/m, +3.3% y/y.
Monday: Hometrack Hose Prices fell 0.3% in December, the greatest monthly drop in almost two years, cutting the annual rise to its smallest since June of last year. In November prices fell 0.2% for a yearly gain of 3.6%.
Friday: Nationwide House Prices fell 0.5% in December but are still 4.8% higher on the year. Results of -0.4% m/m, +5.3% y/y had been predicted. November was -0.8% m/m, +6.9% y/y.
Friday: Retail sales were 1.6% higher in November over a year ago, in October the gain had been 0.8%. Core CPI rose 0.4% year on year in November, the October result had been +0.1%. The Japanese unemployment rate fell to 3.8% in November from 4.0% in October.
The Week Ahead December 31 â January 4
Monday: Existing Home Sales for November at 10:00 ET; October 4.97 million.
Wednesday: ISM Index for December at 10:00 ET; expected 50.0, November 50.8. Construction spending for November at 10:00 ET; October -0.8%. FOMC minutes of the December 11th meeting.
Thursday: ADP National Employment Report for December at 8:15 ET; November +189,000. Factory orders for November at 10:00 ET; October +0.5%.
Friday: Non-farm Payrolls for December at 8:30 ET; expected +75,000, November +94,000. Unemployment rate for December at 8:30 ET; expected 4.8%, November 4.7%. ISM non-manufacturing Index for December at 10:00 ET; November 54.1. Average Hourly Earnings for December at 8:30 ET; November +0.5% m/m, +0.1% y/y.
Wednesday: Manufacturing PMI for December at 9:00 GMT; November 52.8.
Thursday: M3 Money Supply for November at 9:00 GMT; October +12.3% y/y, 3 month moving average +11.7%.
Friday: Services PMI for December at 9:00 GMT; November 54.1 Flash (1st issue) HICP for December at 10:00 GMT; November +3.0% y/y.
Thursday: Unemployment rate for December at 8:55 GMT; November 8.6%.
Wednesday: CIPS Manufacturing PMI for December at 9:30 GMT; November 54.4.
Friday: CIPS Services PMI for December at 9:30 GMT; November 51.9.
No economic statistics released
Chief Market Analyst
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