Tuesday October 24, 2006 - 16:45:06 GMT
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Market Directions October 16-20
The Week in Review
It is clear that though US statistics of late have made the case for a stronger American economy much more credible there is as yet little market appetite for driving the Usd beyond the lower limit of the current trading range. The Dollar made three weak attempts on the six month Euro bottom (1.2460) this past week but there was no weight behind the push, no stops were triggered, and the lows could not be sustained. On Thursday and Friday the Euro returned to the well trodden ranges above 1.2600 largely on the back of position squaring after the downside failure.
This week also saw the beginning of market speculation on the possibility that the ECB will join the Fed and suspend rate increases. Both the Wall Street Journal and Market News International published pieces positing the potential for an ECB rate pause in the New Year. The WSJ piece on Tuesday outlined the case for an ECB pause, mentioning Germanyâ€™s spending tax hike, lower oil prices and the idea that Europeâ€™s heavily regulated and unintegrated economy cannot grow as fast as the its American competition. Other considerations lending themselves to an ECB pause are the effect on a higher Euro on exports to the US and Japan, high German and French unemployment, Merkel's weak coalition government in Germany and the 2007 French elections. Politicians in Germany and France need continued economic growth and as many jobs as can be generated. Some in France have blamed the recent domestic unrest on the lack of employment among French youth, particularly minority youth. Unemployment among young French workers is much higher than the countrywide rate. With long term European growth near 2%, adequate job creation is one of Europeâ€™s biggest economic problems. Speculation about an ECB rate pause, however, is ahead of the game, as the Journal noted. No ECB official has yet mentioned it publicly and Trichet has consistently refused to be drawn into a statement on policy in 2007, saying only that conditions will determine bank actions. But with the US Federal Reserve firmly on hold and with recent US statistics supportive of Bernanke's cautious policy, market interest will naturally turn to the ECBâ€™s possible moves in 2007.
As of yet the American mid term election is generating little currency related talk. With the Fed widely seen as the main arbiter of international Dollar relations no policy change is expected regardless of election results. One cautionary note, if the Democrats assume control of both houses of Congress the potential for political and policy gridlock in Washington increases dramatically. Disunity and conflict in the American government will not, in the long term, favor the Usd. An interesting comment on the difference between European and American policy makers was the unnamed ECB official who characterized projected European growth in 2007 of 1.8%-1.9% as â€śgoodâ€ť. A sub 2% growth rate in the United States would not be a cause for cheer.
Economic Releases October 16-20:
The decline in the produce price index released on Tuesday at -1.3%, almost twice the market consensus of -0.7%, was largely due to a fall in gasoline prices. The core rose +0.6%, three times the expected rate of +0.2%. The headline monthly CPI number the following day dropped a bit more than was being considered, -0.5% opposed to -0.3%, again due to decreasing gas prices. The yearly CPI number came in at +2.1%. Fed concern will be focused on the core CPI number which at +2.9% is the highest rate in a decade. Balancing these inflation numbers and hewing to the Fed model of the slowing economy were housing permits which at 1.619 million were 6.3% lower than the previous release of 1.722, and the Philadelphia Fed Survey at -0.7% which reinforced the surprisingly weak September number. The August TICS data, a measure of foreign capital flows into the United States, at $116.9 billion, recorded a huge increase over July, $32.9 billion, and set an all time high for capital inflow. The average monthly capital accruing to the US for the first eight months of 2006 has been $70.3 almost the same as in 2005 when it was $69.8 billion. Rounding out the important releases were industrial production at -0.6%, considerably worse than the expected flat number and capacity utilization which also arrived slightly off expectations at 81.9%.
The important European releases were centered on Tuesday. Eurozone September HICP (CPI), at +1.7% (y/y) was an improvement over the previously issued flash number of +1.8%, and a improvement on the August rate of +2.3% and the July rate of 2.4% as well. The German October ZEW economic expectations survey came in at -27.4, below the previous issue at -22. It was the ninth monthly fall in a row; the long term average is +34.3. Fear of the pending 3% boost in the Value Added Tax (VAT) scheduled to take effect in January is now greater than concern about the effect an American economic slowdown could have on German exports. The ZEW current conditions index in Germany rose to +42.9 from Septemberâ€™s +38.9. The ECB remains on track for a further 0.25% rate increase this year, not the least because ECB officials have fostered a near certainly with their rhetoric. If the HICP numbers continue their downward run the ECB could have part of the necessary logic for a suspension of rate hike in 2007.
The minutes of the Bank of England Monetary Policy Committee meeting, with members voting 7-2 for no change in rate policy, were a bit of a surprise, as markets had expected 9-0 in favor. When this hawkish outcome is combined with the GDP numbers, +0.7% q/q and +2.8% y/y, and the CPI release for September, +0.1 m/m and +2.3% y/y, the expectation for an increase following the November MPC meeting remains intact.
The Week Ahead
The case for the Fed rate hold has been proceeding piecemeal, statistic by statistic. Bernanke has said repeatedly that the numbers will bear out the Fed analysis and thus far they have answered; there has been no strong and convincing trend otherwise. Housing has slowed, GDP growth has moderated and inflation has not runoff into the stratosphere, in fact it is barely in the troposphere. What is important to keep in mind is that this all began August 8th, not even three months ago and that inflation number are retrograde; the prices measured are past prices. One side of the Fed prediction has appeared to come true, the economy has begun to lose steam, or at least the housing market has deflated. But the necessary corollary, that the slowing economy will restrain prices has not yet been in evidence.
This week we will see some direct measures of American economic health, with third quarter GDP, Durable Good Orders and new Home Sales on tap. In Europe New Industrial Orders will give a sense of overall Eurozone activity and German IFO Business survey will be carefully watched.
After a brief flirtation with the idea that the Fed would soon begin reducing rates the market has returned to an essentially neutral view. For at least the first quarter of 2007 American rates are expected to continue on hold. US statistics will be interpreted in this light. The idea of a rapidly slipping American economy has been deserted; the market will look to have its new healthier interpretation of the US economy reinforced. As the obverse to an American economy not as weak as anticipated, is the notion that the Eurozone will not prolong its above trend growth into the New Year. Both represent a change in the market assumptions operating since mid summer. Better than expected American statistics, or worse than anticipated European statistics, are likely to give the Usd a greater boost than opposite figures will harm it. The Dollar is more vulnerable on the upside; the market will be looking for proof this week for its good Usd intent.
Key American reports begin on Wednesday with MBA Mortgage Application Index and existing home sales (prior 6.3 million, expected 6.2 million). Both will be scrutinized for signs of the end of the housing downturn. Existing Homes Sales is the more telling number. The Fed begins its scheduled two day meeting Tuesday but expect no comments or news quips from the governors until the rate announcement and accompanying statement is released on Wednesday at 2:15 ET. No rate increase is expected but the press release will be extensively parsed for meaning. Any relaxation of the inflation rhetoric will damage the Usd. Durable goods orders for September on Wednesday are predicted to increase 2.2%, an improvement on the flat reading for August; new home sales will, by consensus, sustain their August level of 1.050 million. As the declining housing sector, has, until this point, been the main proof of the economic contraction analysis, these numbers are largely old news. Weakness in this housing sales number, unless egregious, will be discounted, unexpected strength rewarded. Arriving Friday will be the third quarter GDP number, the median forecast is 2.0%, and chain store prices, with the median at 2.9%. The GDP number will be closely watched, with the above considerations on US growth in play. The University of Michigan Consumer Sentiment number, also Friday, is expected to improve slightly to 92.4; the last two reading were 92.3 and 85.4. Though this is a volatile index, it has lately been looked to for indications of whether the decline in the housing market has affected consumer spending.
Eurozone numbers are light this week. Tuesday new industrial orders for August are released. Median results are expected at +0.9% m/m and 9.8% y/y, which would represent a drop in the month to month numbers, 1.8% at last, and status quo for the yearly, last at 9.7%. As the predictions for fourth quarter 2006 and first quarter 2007 European GDP growth have recently begun to tail off these number have potential to harm the Euro if the come in as expected or worse. The market has not fully priced a Eurozone economy slowing to below 2.0% annual growth next year. German IFO number will be studied for notice on this topic as well. Fridayâ€™s money supply growth is a statistic that the ECB has noted on many occasions. At the last release both the year to year and the three month moving average were at 8.2%; median expectations are at 8.0%. German IFO Sentiment and Expectations on Wednesday will be the most closely monitored economic number from the continent this week. Previous figures were 104.9 for sentiment and 98.8 in expectations. Anticipation is for a slight decline in each to 104.4 and 97.9.
Market sentiment has taken the Dollar to near the six month high. The existing scenario pairs a declining American economy with an accelerating Eurozone, backed by an ECB raising rates and the Fed on hold. This week we will get a good indication of how much life is left in that view.
Chief Market Analyst
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