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Tuesday December 12, 2006 - 22:45:30 GMT
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Market Directions December 4 - December 8

The Week in Review

Several factors combined to check the Euro’s rise this week, culminating in a stop led decline on the London market which shaved 1.3% from the Euro’s value against the Usd on Friday. European and American statistics and a number of comments from European and American officials contributed to the change in market sentiment which led to Euro’s slide. Standing behind the market news and official comments were traders who were more than ready to take profits on the recent two week run up in the Euro. The most unequivocal statement came from American Treasury Secretary Hank Paulson while visiting Britain, who said that a “A strong dollar is clearly in our nation's interest and I feel very good today about the strength of the U.S. economy". This type of statement has long been a staple of the American Treasury. The market is well aware that Mr. Paulson recently returned from China where he advocated a very different policy, at least vis-à-vis the Chinese Yuan. More problematical were the ECB statement and Jean Claude Trichet’s press conference comments following the 0.25% rate hike on Thursday. The hike was long expected and fully factored into the market. Strong rhetoric against inflation is an ECB fixture. A repetition of several stock phrases in the prepared statement, primarily, monetary conditions are still ‘accommodative’ and that the ECB was ‘closely monitoring developments’, kept the anti-inflation mandate of the bank intact. However, when Mr. Trichet was asked by a reporter if the use of this phrase “closely monitoring” which has proceeded past rate hikes meant that rates might be raised in February, he replied “it would be a wrong interpretation”. While certainly not disavowing ECB rate policy this comment interjects a new caution into the bank’s outlook. It appears the Trichet is attempting to carve out the space for a policy option. The ECB may be moving to a type of statistic driven rate policy that is reminiscent of the Federal Reserve under Ben Bernanke. Certainly there are politicians in the EU who might wish for more emphasis on growth but only the French, with a presidential elections pending, are impolitic enough to say so directly. Their Trade Minister Christine Legarde characterized a “strong Euro [as] penalizing and worrying”. More usual was the comment from Joaquin Almunia, the EU Economic and Monetary Affairs Commissioner who said, “I have followed the French debate for years and I sometimes have the impression that the Euro can only ever be in two places: either too high or too low”. While that is a humorous put down of what the ECB and EU bureaucracies no doubt see as French inference in their monetary policy, the fact that a high level EU official found it necessary to respond means the ECB hardly feels secure from national government influence.


Several EU statistics issued this week could support a more restrained European inflation and economic outlook. PPI and Retails Sales were both below expectations. European inflation has continued to moderate. I t is currently below the 2% warning limit set by the central bank. ECB officials have stated that they expect it to reach over the 2% limit in 2007. The ECB itself has lowered its inflation projections for 2007 and 2008, though slightly raising GDP growth prediction for the same period. Adding weight to the economic moderation argument were German Industrial Production figures and third quarter labor costs, both weaker than anticipated.

American statistics proved surprisingly robust. Non Farm payrolls were stronger than the median though not outside the recent ranges. Payrolls have been a steady bright spot in the US economy and have continued to produce medium to strong numbers despite the fall in housing industry and home construction. More intriguing was the result for the November Institute of Supply Management (ISM) Non Manufacturing Survey which at 58.9 registered considerably higher than expected. The ISM Employment and New Orders numbers were in advance of expectation as well and at 51.6 and 57.1.


Japanese 3rd quarter GDP results on Friday disappointed analysts who were anticipating firm numbers as a prelude to a BOJ rate hike this year. The Japanese statistics undermined the Yen improvement that had taken place earlier in the week. That rise had been prompted by the widely reported comment from Bank of Japan board member Mizuno who said “not all data has to be strong” for the BOJ to raise rates. The public debate in Japan over the timing of the next 0.25% rate increase has not abated. But as we have said before, the BOJ rarely wins these arguments. The Tankan Survey released this Friday will go a long way towards determining if there will be a rate increase this year.


Economic Releases December 4 - December 8


United States
Non Farm Productivity and Unit Labor costs began the week on a positive note with revision to the 3rd quarter numbers. Non Farm Productivity improved to +0.2% from flat and Unit Labor Costs increase fell to 2.3% from 3.8%. Though both numbers were below expectations, which were +0.5% for productivity and +3.2% for ULC the economic result is a wash; the Unit Labor Cost is more important for restraining inflation. No doubt the Fed is pleased to see both numbers back on the positive track. The Euro moved 20 points higher (1.3342-1.3362) on the release but the rise was not sustained. Factory orders fell a bit more than predicted -4.7% (expected -4.5%) but the largest component in the drop was a dip in aircraft orders. The most interesting release on Tuesday was the Institute for Supply Management (ISM) Non Manufacturing Index for November. This number, the twin for the service sector of the economy of the better known ISM Manufacturing Survey, came in above forecasts at 58.9 (expected 56.0, October 57.1 ), as did the employment component at 51.6 (October51.0). The service sector represents upwards of 80% of economic activity in the United States. As with the manufacturing survey 50 is the general division between expansion and contraction. Unlike the ISM Manufacturing Survey for November (issued December 1st), which at 49.5 fell just below the contraction limit, the service sector sustains a healthy expansion. The dollar responded rising more than 30 points against the Yen (114.63-114.97) and 50 points against the Euro (1.3340-1.3290). The one caveat to the positive spin this survey gave to the US economy is that the service sector has a larger seasonal component than the manufacturing sector. November, the period covered by his number, is the beginning the Christmas shopping season, traditionally a period of temporary employment.

Friday’s Non Farm payroll produced another good number for the American economy. Payrolls added 132,000 jobs in November and 42,000 in revisions to September and October. The three month average is now 138,000, not far below the six month average of 150,000. The unemployment rate rose one tenth to 4.5%. Despite the losses in manufacturing and construction the US labor market remains healthy. The University of Michigan Consumer Sentiment number for December recorded at 90.5 (expected 92.0) It has been on a steady rise since midsummer. The Mortgage bankers Association (MBA) Mortgage Application Index rose for the week through December 1st 8.1% giving some indication that the slump in housing purchases might be easing. The prior week had showed a 3.9% decline.

The American economy continued to defy concerns of a housing market led general decline. Only a few months ago economic analysis was rife with the idea that consumer spending had been supported by equity loans inflated by the boom in housing prices. Despite the fall in the housing market American consumer spending has not withdrawn. If housing prices were a strong component of consumer outlook their decline would at best have been balanced by the drop in gas prices and consumer sentiment would have remained low, in fact consumer sentiment has risen substantially since the midyear. Consumers are rarely given credit for being rational analysts, able, like economists, to look beyond the immediate effect and to correctly gauge their long term interest. It is far more likely that consumer spending is supported by the availability of jobs than by semi-mythical home equity withdrawals based on inflated housing prices. After all, home equity loans are simply another form of credit; and the American economy is well supplied with consumer credit. No consumer who wanted to support the economy with more personal deficit spending would have to wait for a home equity loan. As long as jobs are plentiful the American consumer will continue to spend.



Eurozone
European economic planners received good news this week, whether they will be happy about it is another story. Eurozone Industrial PPI came in flat for October month to month and +4.0% year to year, (expected +0.2%, 4.1%). The fall in energy prices was the main reason, but there is still little sign of inflation in the price pipeline from manufacturers. October Retails Sales at +0.3% month to month and +1.1% year to year were somewhat below forecasts, (expected +0.4%m/m, +1.5% y/y), and September figures were revised lower to -1.0% m/m, +1.1% y/y from -0.6% and +1.4% respectively. The Reuters PMI reading for October at 57.6 (expected 56.5) offset the Retails Sales number with its unexpected strength. September’s figure was 56.5. Labor costs in Germany for the 3rd quarter rose only 0.1% m/m and +0.5%y/y, the slowest increases since the 4th quarter of 2005. 2nd quarter numbers were +0.3%, m/m and +0.7%y/y.

ECB officials do not seem to be comfortable with the current 2.5%+ GDP growth, nor the October HICP rate of 1.6%, because they are not seen as compatible. In their view that the rate of economic growth is above the long term European trend and will necessarily generate inflation. European economies are slower to change and adapt new technologies. In the past 15 years new technologies, primarily computers, helped the American economy raise its growth rate while keeping inflation subdued. Perhaps the Europeans are now seeing more of these same productivity benefits in their inflation and GDP numbers.





The Week Ahead


United States
American statistics this week will take a back seat to the FOMC meeting on Tuesday. Though virtually no one expects a rate change by the Fed, analysis of the accompanying statement will dominate the market news. As we have seen in the past, any alteration in the wording will be parsed for meaning. Given Chairman Bernanke’s recent hawkish inflation rhetoric do not expect any cessation of the rate pause and stringent rhetoric: ‘if it aint broker don’t fix it’, could be the current Fed epigram.

Wednesday provides an updated view of the consumer economy with Retail and Food sales and Retail and Food Sales ex Autos for November. Expected results are +0.1% and +0.3% respectively. September figures were -0.4% for both. Consumer spending remains the most consistent sector of the economy. Any faltering in these numbers will read immediately against the dollar. In addition, poor results will probably be taken as a predictor of a lackluster Christmas season for retailers. Friday brings the headline inflation numbers, CPI and CPI ex food and energy. Forecasts are +0.2% for both.
With further Fed rate increases discounted this cycle these numbers should have limited effect. A much stronger than anticipated result will not, by itself, returns the market to speculation on a Fed rate increase and a weaker number will confirm the current assumptions. Industrial Production and Capacity Utilization are also issued on Friday 45 minutes after CPI. At +0.1% and 82.1 expected, these number will be watched for confirmation of the moderately growing American economy. They should not, on their own, provide traders with much ammunition.




Eurozone
European wide statistics are scarce this week. Labor Costs for the 3rd quarter are issued on Wednesday, with the median forecast at +2.65%, slightly higher than that of the 2nd quarter 2.4%. Wednesday brings October Industrial Production Numbers, predicted at +0.4% month to month and +4.4% years to year. September results were -1.0% and +3.3% respectively. Final HICP (standardized European inflation) numbers for November are released on Friday; forecasts are for a flat month to month number and a rise of 1.8% year to year. The next ECB rate hike is very much a work in progress. This is the statistic that the Trichet has predicted will rise above the 2.0% limit in 2007, perhaps justifying continued rate hikes. If this number is softer than anticipated, the Euro will suffer and the possibility of an ECB pause will gain credibility.



Joseph Trevisani
FX Solutions
Chief Market Analyst

 

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