Tuesday November 21, 2006 - 00:56:58 GMT
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Market Directions November 13-17
The Week in Review
The dollar and the currency markets did more this week of what they have become very good at lately: little or nothing. Several American statistics pointed to a slowing economy but the continuing decline in the housing market has not yet created friction for the overall economy. There has been concern among many economists that an accelerating fall in housing construction and related industries could shave up to 0.5% from the last quarter 2006 GDP numbers. That concern remains. Housing starts sank almost 15 % in October over a month earlier. But the building permits number, which fell only 6.3%, is perhaps an indication that the bottom in housing construction may be near. Industrial production and Capacity Utilization rebounded from their declines in the prior month and expanded at a pace consonant with a moderate 4th quarter recovery in GDP. Inflation was subdued in the headline and core CPI numbers though several Fed officials kept up their strong anti inflation talk. The Federal Reserve is in the enviable position of being able to fight inflation expectations with words rather than rate increases, and for once the market, usually skeptical of jawboning, doesnât seem to mind. Richard Fisher, President of the Dallas Federal Reserve Bank, was quoted at the Frankfurt Banking Conference saying that the Fed remains âconstantly vigilantâ against inflation, and that he and other Fed officials could not take âmuch comfortâ with inflation running above 2%. The core American CPI rate slipped to 2.7% in October down from 2.9% in September. Market assumptions now have the Fed holding off on any rate hikes until at least mid 2007.
The economic scenario first outlined by the Chairman of the Federal Reserve Ben Bernanke in August, and sometimes called the Phillips curve --though he did not-- posits a trade off between GDP and inflation. As economic growth slows it drains inflation and inflationary expectations from the economy. Whether the Phillips curve is an accurate economic theory is perhaps important to academics, to traders, observed facts carry more weight. Inflation is diminishing and growth has tailed off dramatically since the first quarters torrid 5.6%. Since both the declining growth and the moderating inflation trends were predicted by the Fed and have been at least partially substantiated by the economic evidence, they have now become the market paradigm. Clearly the Fed can now wait upon further developments.
Mr. Bernanke has successfully turned the markets attention from the individual of the Chairman and the deliberations of the Fed itself to the economy and its statistical measures. The puzzle is not how the Fed may interpret statistics. Mr. Bernanke has clearly outlined his thinking. The question is what the statistics themselves tell about the health of the economy. Statistics are plural, very plural. Each release supplies a small portion of the overall story. No one statistic can possibly tell enough about the economy to foster a strong market reaction. If Retail Sales are strong then likely as not CPI was weak, if the Philly Fed Survey is crashing then the Empire State survey is charged. Even if one statistic is widely out of line, as the Philly Fed number was last month, the market reaction will necessarily be limited. There is always another statistic pending and the market will wait for corroboration before it makes a decisive move. I do not know if it was Mr. Bernankeâs intention to counter market volatility by affixing the telltale of its interest rate policy so firmly to statistics. But by doing so it has forced the market to take a longer than normal view; probably a longer view than it would like. In effect the Fed Chairman has forced traders to adopt the Fedâs time frame. It has become more difficult for the market to move without statistical support, speculation has been at least temporarily corralled by the incremental nature of modern economic statistics.
European economic growth began to show its first signs of slowdown. German and French Flash GDP released early in the week trended lower. The French GDP number, flat for the 3rd quarter, was considerably below the anticipated positive reading of 0.5%. Eurozone inflation, an unadjusted 1.6% year on year for October, was below the 2% ECB ceiling. The good inflation news did not stop the ECB in its campaign to prepare the market for at least one hike in 2007. A 0.25% increase in December is as foregone a conclusion as is possible in the realm of central bank rate policy. ECB Governor Klaus Liebscher from Austria warned that though the EMU growth trend remains upward, interest rates are low by any measure, and that interest rates are no obstacle to growth. A minor contretemps erupted mid week when Dominique De Villepin the French Prime Minister suggested that âEurope needs a monetary shieldâ, referring to the Euro strength and its effect on European exports. He called for more public debate by European governments on exchange rate issues. The German government reacted swiftly rejecting this call for more public debate and government control over European exchange rates saying that â Foreign exchange rate policy issues have to addressed with great sensitivity and the federal government (of Germany) sees no reason for a foreign exchange rate debateâ. European businesses and consumers do not need reminding that it was the Bundesbank and German insistence that put the anti-inflation backbone into the ECB charter. It was an unusual exchange, perhaps staged more for domestic consumption in France with a presidential election on tap for 2007. On Friday the French Socalist party chose SĂŠgolĂ¨ne Royal as their candidate for president. She is the first woman to stand for that office in France. Her likely opponent is Nicholas Sarkozy of the center right party Union for a Popular Movement (UMP).
Crude oil prices closed below $56 a barrel on Friday in New York, the lowest price in 17 months, nearly 29% off the July high of $78.40. A dropping oil price can be both positive and negative for a currency depending upon how the central bank views its effect on inflation. The Fed focuses on core inflation, what is called CPI ex food and energy, that is, inflation with changes in food and energy prices stripped out. In the Fed view the primary effect of lower oil prices to spur economic growth and consumer spending. Higher growth and spending tend to increase the risk of inflation, and that, in the Fed causal chain, leads to higher interest rates. In that view lower oil prices are a potential support for the dollar. The ECB on the other hand focuses on âheadline inflationâ the inflation reading including food and energy prices. With that outlook a reduction in oil prices directly reduces the main measure of inflation and thus decreases the chances for an ECB rate hike. In that view lower oil prices undermine the Euro. However, in either case the drop in oil prices would have to be sustained for several months at least in order to have a noticeable effect on GDP, consumer spending or inflation. The consumer as well as the oil futures trader knows that oil is subject to more economic, political and weather related buffeting than almost any other commodity. The potential for a return to $70 a barrel cured is very real.
In Japan the war of the words continued between the Liberal Democratic Party (LDP) political chieftains, who favor restrained rate hikes and various Ministry of Finance and Bank of Japan officials who favor restraining inflation with further rate increases. LDP party chief Nakagawa called rate hike talk âabsurdâ. That is relatively strong rhetoric in this particular debate. The BOJâs Fukui voiced the usual promises that BOJ action will be appropriate and âflexibleâ and that no rate hike timing has been ruled out. This is a long running contest with the decision almost always going to the politicians. With Japanese GDP growth steady it is unlikely we will get an upset win for the BOJ this year.
Economic Releases November 13-17
Moderate reading on 1st tier economic and inflation data highlighted the American week; unsurprising 2nd tier information on international Treasury funding and the FOMC minutes helped keep the market on an even keel throughout and both made for lackluster trading. Tuesdayâs Producer Price Index (PPI) at -1.6% for October (expected -0.6%) and the core reading at -0.9%, (expected +0.2%) were much weaker than general expectations and sponsored a small boost in the Euro trading rate from 1.2830 to 1.2870 in the few minutes after the release. The Retail Sales figures, issued at the same time on Tuesday, though closer to predictions, -0.2% (expected -0.4%) and ex-food and transport number at -0.4% (expected-0.3%) did nothing to inhibit the Usd fall initiated by the PPI numbers. The biggest surprises were the lower revisions to the September numbers, down to -0.8% from -0.4% for the basic sales number and down to -1.2% from -0.5% for the ex food and transport number. Though the Euro could not hold the 1.2850 level into the afternoon of the New York session on Tuesday these statistics helped set the mildly defensive Usd tone for the week. A benign Consumer Price Index (CPI) at -0.5% (expected -.3%) and CPI ex food and energy +0.1% (expected+0.2%) sent the Usd falling 30 points against the Euro and 25 points against the Yen on Thursday. Though these are numbers that will cheer the FOMC board core inflation is still running at 2.7% year on year. The remainder of the American statistics hewed a similar line. Industrial Production for October was as predicted +0.2% a substantial improvement on Septembersâ -0.6% reading. Capacity Utilization at 82.2% slightly bettered the Septembers figure, 81.9%, and was a bit more robust than the 82.0% prediction. The Philadelphia Federal Reserve Survey returned as anticipated at +5.1, allaying some of the concern generated by the last reading of -0.7. Housing Starts and Building Permits fell well below the hopes of those waiting for a bottom in the housing market. Housing Starts in October were 1.486 million (expected 1.675 million) 15 % lower than the prior month and Building Permits came in at 1.535 million, 6.3% lower than previous month. Since permits are a more forward reaching measure there is perhaps some comfort that its drop was considerably less than the shrinkage in housing starts.
Since Ben Bernanke set the standard for measuring the US economy back in August, none of the information presented to the market has given rate hike bulls reason for hope much less celebration. Back in October I observed that although the first half of the Bernanke scenario had begun to materialize, with slower GDP numbers and a shrinking housing sector, the translation had not yet been evident in the inflation figures. It seems we are now seeing some of that translation. Though none of statistics released this week are conclusive evidence that the US economy is dropping below its long term trends in both growth and inflation, they are becoming conclusive for Fed rate policy. Based on figures like those released this week the Fed will be on hold for the foreseeable future.
On Tuesday the flash estimate for GDP in the 3rd quarter at 0.5% month to month and 2.6% year to year matched market expectations but both were a decline from the 2nd quarter results of 0.9% and 2.7% respectively. Industrial production figures for September, -1.0% month to month and +3.3% years to year, were both lower than expectations (-0.2%, +4.4%) and also lower than the August numbers, +1.7% and +5.5%. The September figure in particular was much weaker than anticipated and created concern that the Eurozone economy may have peaked already. Though this number was dismissed by the ECB, much as the French GDP number had been previously, with the assertion that growth would resume shortly, it probably inhibited any positive reaction to the weak American numbers later in the day. Likewise the downward revisions to August retail trade figures, from +0.7% month to month to +0.5% and from +2.4% year to year to +2.0%, were discounted by ECB officials as a true representation of the Euroland economy. This weekâs numbers were the first sign that all may not be as rosy with the European economy as the ECB asserts.
The Week Ahead:
The US has a shortened week with markets closed Thursday for the Thanksgiving holiday. For many market participants Thursday is also the start of a four day weekend. There is only one statistics of major interest due to be released. Wednesdayâs University of Michigan Consumer Sentiment number will give further indication of the emotional state of US consumer. Much is riding on the pocketbooks and wallets of the American consumer. With the housing markets in a slough of as yet undetermined depth and business investment fading it is on the retail spender that most expansion hopes rest. This measure of consumer sentiment has been trending up since late summer. Gas prices are near $2.25 across the country and falling and with the elections complete a near repeat of last monthâs strong reading of 93.6 is forecast.
The Europeans have an equally sparse week with only Industrial New Orders set for release on Wednesday. Augustsâ numbers were +3.7% month to month and +14.3% year to year. Expectations have been lessened over the past few weeks and the current median forecasts are for -1.8% month to month and 10.4% year to year. These figures will not affect the determination of the ECB to hike rates once more in December but they will be part of the consideration for 2007. On Thursday the German IFO report is released. This is the most closely watched sentiment index in Germany and probably in Europe as well. Lately it has been tracking economic performance better than the ZEW survey. Forecasts are for a slight fall in the Business Sentiment portion of the survey from 105.3 in September to 105.1, and a drop in the expectations quotient from 99.2 in September to 98.5. The Current Assessment reading has been registering consistently higher than the forward looking aspect of the survey. Forecasts are for a small rise In Current Assessment to 112.1 from the current level of 111.8.
The Euro and Yen moved barely a big figure, 100 points, against the Dollar last week. It would be an incurable optimist who expected any substantial trading interest during this current holiday week. But lack of attention and absent players also means low liquidity and low liquidity can always harbor its own volatility surprise should anything in the markets begin to shake.
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