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Tuesday January 30, 2007 - 00:39:37 GMT
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Market Directions January 22-26, 2007

The Week in Review

The recent American economic resurgence underlay much of this week's trading action. But with few United States statistics and those holding no surprises traders were unable to break new ground in the Dollar. European politicians and finance officials provided volatility in the Eur/Jpy as they once again took the Japanese to task dropping hints that Yen undervaluation might be a topic at Februarys G-7 meeting. Their comments were a good excuse for concerted profit taking by traders. The outcry had more participants than the similar attempt before the last G-7 meeting which only had a brief effect on the Euro/Yen. Despite the jawboning the currency pair closed Friday less than two big figures (200 points) lower than its Tuesday peak. The market has clearly taken a wait and see attitude to this most recent European attempt to gin the outcome of a G-7 meeting. With another 0.25% ECB rate hike on the near horizon and the Euro well supported by Eur/Yen speculation and the ubiquitous carry trade, the attempt is cost free. If the G-7 includes Yen overvaluation in their communiqué the ministers will look powerful and effective bending the G-7 community to their will. The Eur/Jpy will then fall in earnest. If the G-7 says nothing, as is likely, they will have warned the market and obtained a two figure fall at the cost of a few verbal flourishes. The Eur/Jpy will of course then return to its uptrend, but it would have done that anyway. Friday’s +9.7% increase in the M3 money supply figure for December all but guarantees the next ECB rate increase of 0.25%. If the ECB Governing Council keeps to its hints the hike will be in early March, but with such strong and increasing money supply numbers a February increase becomes a distinct if unusual possibility.

The week’s news stories were dominated a non-market event. In Davos, Switzerland the best and the brightest of the world’s economies gathered for World Economic Forum’s (WEF) annual meeting and networking summit. This year’s modest theme was “The Creative Imperative”. Davos is an event in the same way Woodstock was an event for a certain American generation, what goes on is not important, it is only important that you were there. Little of substance devolves from Davos, there is no communiqué or post event press conference, but for journalists it is one of the world’s great interview opportunities, hence its non-stop coverage. Davos is popular with Europeans which may explain why there was little discussion of freeing continental economies from the regulatory straightjackets that have done so much to inhibit their growth and job creation. This is the first time in recent memory that there were no major American Administration officials in attendance. Full disclosure, I have never been to Davos.

The Saudis were, not unexpectedly, at Davos. The foreign minister Abdel Aziz Al Assaf was quoted as saying that Saudi Arabia will continue to peg its currency to the Dollar until the adoption of a single currency among the Gulf States—realistically that is, for the foreseeable future. He also voiced confidence in the US economy despite trade deficits, citing the attractiveness of the American market for investment. The Kingdom not only possesses the world’s largest proven reserves of petroleum, it also possesses the world’s largest spare pumping capacity. Several of the world’s top oil producers are nosily anti- western and anti-capitalist yet their economies are heavily dependant on the price of oil. No government has the degree of influence over the oil price as does that of the Saudi Princes. The Saudi Foreign Minister’s confidence in the US economy was a polite reminder to anyone listening of the limits of rhetoric on the price of oil.

The Federal Reserve Open Market Committee (FOMC) will end its two day meeting on this coming Wednesday, January 31st. The 2:15 pm EST statement will retain the “bias” towards raising rates that it has maintained since last June. There is no market expectation for a change from the current 5.25% discount rate. With recent economic statistics strong and next week’s 4th Quarter GDP and Non Farm Payrolls as yet unreleased the committee will have no incentive to change its view of the economy. Inflation is still above the Fed’s desired range and future decreases are at best unproven. In addition, the job market remains tight with unemployment at 4.6%, a rate long thought to be at or below full employment. The Fed’s own expectation for economic growth to accelerate later in the year can only reinforce its natural caution.

The Bank of Japan decision not to raise rates a week ago brought the ‘carry trade’ issue to the fore once again. While it is difficult to determine the extent of this practice, what is not difficult to divine is its motivation. The profitability of borrowing in a low yielding currency and depositing the funds in a higher yielding one is a function of the respective interest rates of the two currencies. No amount of European complaints or BOJ threats to raise rates by 0.25% will change that dynamic.

Economic Releases January 22-26

United States
The few notable American releases were clustered at the end of the week. Existing Home Sales for December 6.22 million (expected 6.25, November 6.28) and New Home Sales for December 1.120 million (expected 1.050, November 1.047), reinforced the idea that the housing decline is coming to an end. Although existing sales were slightly less than anticipated the inventory of homes for sale fell to 6.4 months worth from 7.3 in November. This is the smallest inventory since May 2006. Median sale prices also rose slightly, by $5,000. Building permits for December were revised up to 1.1613 million from the initial release of 1.596. While Friday’s December +3.1% Durable Goods number was only slightly higher than the predicted 3.0%, the ex-transportation component was very strong, +2.3% against a prediction of +0.5%. As the ex-transport component excludes sales of the Boeing Company, whose order book was considerable in December, the picture of the economy is considerably stronger than the -1.1% number recorded in November.

The chief European statistic this past week was the December Money Supply number which, at 9.7%, was well above the prediction of 9.3%; the November figure had been 9.3% as well. This result in a crucial ECB mandated statistic makes it almost impossible for the ECB to pause in its rate hikes or even to moderate is anti-inflation rhetoric. The three month moving average for Money Supply picked up to 9.2% in December, well over the 8.8% November rate. New Industrial Orders for November arrived at +1.4%, (expected +1.0%). The October number was revised up to -0.5% from -0.6% and the year to year reading was improved as well, to +12.8% from +12.5%. Money supply returns and growth statistics leave the ECB no room for deviation.

The Week Ahead

United States
It is a busy week for US economic results but the narrowest focus will be on Wednesday’s 4th Quarter GDP number and Friday’s Non Farm Payrolls. The positive run of American statistics over the past three weeks has caused many economists to revise their estimates of GDP. Late last month the median 4th Quarter GDP estimate was near 2.5%; it is now 3.1%. The 3rd quarter number was 2.0%. Equally important is the January Non-Farm Payrolls due at 8:30 am Friday. 160,000 jobs are expected to have been added to the job list; the December the reading was +167,000. This statistic has consistently surprised the market with better than predicted outcomes and that is reflected in an estimated number which is almost two thirds higher than the expectation had been for December, (+100,000). We also have two readings from purchasing managers this week. On Wednesday at 9:45 am the Chicago Purchasers Index for January is released, expected is 52.0, December was 51.6. The Institute for Supply Management (ISM) Index for January is due on Friday at 10:00 am. It is also expected to read 52.0 against 51.4 in December. Both numbers have been hovering just above the 50 recession-expansion line and that limit will again predict the market’s reception. Both numbers are used as indicators and it will be interesting to see if they conflict or reinforce the earlier GDP number. Two consumer sentiment numbers for January are extant this week; both were unexpectedly strong in December. The Conference Board (CB) result is due on Tuesday at 10:00 am, 110.0 is predicted. The 109.0 December result was one of the first important indicators underlying the recent Dollar move. The University of Michigan releases its Consumer Survey at 10:00 am on Friday, a reading of 98.0 is expected and December was 98.0 also. American consumer spending is the largest single factor in the economy and these sentiment numbers, changeable as they may be, are the best available window into future consumer expenditures. Several second tier statistics for December are also issued this week: Construction Spending on Wednesday 10:00 am, expected +0.1%, November -0.2%; Personal Income Thursday 8:30 am, expected +0.5%, November +0.3%; PCE Core Price Index on Thursday at 8:30 am, expected +0.2%, November +0.2%; Factory Orders at 10:00 am on Friday, expected +1.9%, November +0.9%. A full week. The spotlight is on the American economy, continued good numbers will propel the dollar higher; they may even revive speculation about the Fed’s next rate move.

The European week begins on Wednesday with the crucial January Flash HICP number at 10:00 am GMT, 5:00 am EST. The median prediction is for an inflation rate of 2.1%; in December the rate was 1.9%. Jean Claude Trichet, the European Central Bank (ECB) President, has said that he expects inflation to be above 2.0% in the New Year and has consistently cited this statistic as one of the factors driving the ECB rate hike policy. The Eurozone unemployment rate for December is also released at 10:00 am GMT, 5:00 am EST; it is expected to be 7.6% as it was in November. Also at 10:00 am GMT is the EMU Economic Sentiment Index, for January, expected 109.7, December 110.1. Pan-European statistics have not yet gained the market presence of their much longer lived US counterparts but they bear watching for their content if not for their market impact. On February 1st at 9:00 am GMT, 4:00 am EST the Reuters Manufacturing PMI estimate of activity for January is due, expected is 56.3, December was 56.5.


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