Friday June 15, 2007 - 22:35:20 GMT
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Market Directions - Sunday, June 17, 2007
Rate reality strikes the Dollar on Friday erasing all of its gains for the week.
The Chinese economy thunders on, the trade surplus and foreign direct investment both rise.
Euro/Yen reaches new heights on apparent Japanese unconcern over Yen depreciation.
The Week in Review June 11-15
United States
Some of the steam left the Dollar on Friday as the rate of increase in the American Consumer Price Index continued to fall. The decline helped to allay rate hike concerns that had been brought on by the dramatic rise in bond yields earlier in the week. And for currency traders on the right side of the recent Dollar strength, Friday is always a good time to take profit. In May the Core CPI rate was only 2.2%, down from 2.9% last September. Higher fuel prices have clearly not infected the overall consumer price structure. Industrial Production was flat in May and the April figure was revised lower by almost 50%.
The Dollar had been riding high of late on American economic performance, or rather, on the anticipation of US growth in the remainder of the year. Retail Sales in May were considerably ahead of expectations indicating strong activity in the consumer sector. But inflation is the direct link to Federal Reserve policy and when traders have to choose between near and far term influences, the near term will always win. If the US economy returns to trend growth in the last two quarters of this year will that pressure inflation higher? Yes, most likely it will. But this possible inflationary result will not manifest itself until next year at the earliest. In the nearer term the Fed is now a bit less likely to raise rates due to the CPI number, hence the Friday turn lower in the Dollar 's fortunes. And, to return to the rate question, benign inflation will not prompt the Fed to consider a rate cut or even a move to a neutral bias unless the economy is faltering, which it is not. Economic growth has not suffered from the Fed's tightening bias; in fact it looks set to reignite. If the economy is prospering with mild inflation and the potential for higher inflation in the future is increasing with returning economic growth is hard to envision a move to a neutral rate bias. For the Bernanke Fed less policy is more; the tightening bias will remain in place.
The American bond market had a notable week. The 10 year Treasury broke through the 5.25% level, fueling some of the mid week drive higher in the USD. But Friday's benign CPI results gave Eurodollar and US Treasury shorts a good reason for reversing some of those gains and both markets finished Friday considerably above their mid week lows.
Eurozone
Unmistakable moderation in economic growth surfaced for the first time in the European Monetary Union (EMU) as Industrial Output numbers for April came in well below all estimates at -0.8% for the month and +2.8% for the annual results. Markets had anticipated +0.2% and +4.3%. The fall was the sharpest since last September and was all the more striking because the March numbers had themselves been adjusted up to +0.5% and +4.0% from +0.4% and +3.7%. Continued moderation was also the story in European inflation. The May Harmonized Index of Consumer Prices (HICP) was unrevised at 1.9%, the same level as in April and March. This is the ninth month in a row that this European wide index has been below the ECB 2.0% target. However, the ECB president Jean Claude Trichet and other member of the governing council kept the market on notice that their anti inflation fight is unfinished.
China
The thunder out of the Middle Kingdom continued this week. China's trade surplus grew almost 1/3 from April to May and the January to May balance was 85% larger than the same period last year. China's trading partners were not amused. Although the American Treasury Department did not formally name the Yuan as a "manipulated currency" in its semi annual report to Congress it did call for China to let the Yuan rise faster. China's most vocal congressional critics, Charles Schumer, Lindsey Graham, Max Bacus and Charles Grassley have jointly sponsored a bill that would, if enacted, require the Treasury Department to take specific action against countries that "purposefully misalign" their currencies for trade purposes. No one can doubt the law is aimed primarily at China. Interestingly enough the action prescribed in the bill would involve filing complaints with the World Trade Organization (WTO). China's trade surplus is with much of the importing world not just the United States, perhaps the hope is that at the WTO the US would not be alone in accusing China.
The Peoples Bank of China (PBOC) China added another 50 basis point to the bank reserve requirements, the equivalent of removing 180 billion Yuan from circulation. The Yuan central parity rate, the midpoint around which the currency is permitted to fluctuate, was set on Friday by the PBOC at 7.6238 against the US Dollar , over 500 basis points lower than Monday's fix, 7.6785. But this is, in fact a less than 1.0% increase.
The Chinese government has, over the past several months, taken a number of steps to both cool the domestic economy and mollify its foreign critics. What the Chinese regulators have done so far has been insufficient to curb the Shanghai Composite Index, drain the excess financial liquidity from the economy, dampen inward investment activity or satisfy critics of Chinese mercantile trading practices, particularly those in the American Congress. But there is a basic misapprehension at work in the judgments of outsiders about the Chinese economy. Although none of these individual moves has been sufficient to force the slowing of the Chinese economy, the Chinese government is using the standard tools of macro economic policy. Certainly none of these rate and financial adjustments could have been expected to obtain results in so short a time. The Beijing government has for its part been signaling it intentions with the traditional monetary and financial tools: interest rates, reserve requirements and even the Yuan trading bands. And though Chinese investors, domestic and foreign, have responded, they remain unconvinced. The PBOC and MOF changes to date have been insufficient to dissuade them from their behavior. It is no doubt hoped by the Chinese Government that the accumulated pressure of these adjustments backed by the clear intent of the authorities will encourage the individual investors, domestic and foreign, to voluntarily rein in their speculative activities. But what will be Beijing's response when and if these signals are not obeyed.
It will be interesting to see if the authoritarian political instincts of the Beijing rulers can accept the relative freedom of the business sector especially when the businessmen and investors are not behaving as the Beijing government might wish. Will the Chinese financial authorities be true to their authoritarian instincts and resort to much heavier handed tactics to achieve their goals? In this situation the Chinese are not alone; they must consider not only the domestic ramifications, but the international ones as well. The Chinese government will no doubt continue to gradually tighten the financial and rate screws, exactly as this type of coercion is practiced in the west. When the PBOC announced all its rate, reserve and trading band changes on one day several weeks ago, it was the Shanghai B shares, those owned exclusively by foreigners, which fell the greatest amount. Western investors know well how to read the signals of a central bank, the Chinese investors are just learning. The relative economic freedom of the Chinese economy is about to test the patience of the Chinese economic central planners. Karl Marx and Adam Smith would enjoy the contest.
Japan
The Bank of Japan board of governors voted unanimously to leave rates at 0.5%, shocking not a soul. The members cited a 'moderately expanding economy' as they have many times before. But when Finance Minister Koji Omi was asked to comment on the recent Yen depreciation he said "Foreign Exchange should reflect fundamentals in markets. We are always watching exchange rate closely". This is ministerial language for 'we intend to do nothing'; currency traders are excellent translators. On Friday they bought the Euro/Yen to a new high at 165.29, and bid the Usd/Yen to 123.68, its loftiest level in over four years. In the Japanese government view Yen depreciation will not harm their economy. In fact, by adding some inflation, it may help end the deflation threat. If any confirmation were needed for the laissez faire rate outlook in Japan BOJ Governor Fukui said that he would need to have more certainty before raising interest rates. Obviously he has none at the moment.
New Zealand
The Reserve Bank of New Zealand (RBNZ) sold its own currency against the Usd in the first major central bank intervention since 2004 and the first for the RBNZ since the New Zealand Dollar was floated in 1985. The NZ Dollar duly fell almost a figure and a half (150 points) but by the end of the week it had regained most of the lost ground. With NZ rates the highest of all the world's major currencies and the renewed pressure from the carry trade it will take steady conviction and probably more intervention by the RBNZ to keep the lid on the antipodean currency.
Switzerland
The Swiss National Bank raised its three month LIBOR target rate by 0.25% bringing it to 2.50%. In the wake of the June 6th ECB increase the move was as expected and brought little comment or movement.
Economic Releases June 11 - 15
United States
American Retail Sales in May, released Wednesday, were more than double the forecasts, +1.4 for the overall number, and +1.3% for the ex food and auto number, +0.6% and +0.7% had been predicted. These results were impressive as they returned the all important consumer sector to growth after the April decline of 0.2%, itself the first drop since last October's -0.2% reading. The Dollar gained strongly after the issue, rising 40 points against the Euro and 25 against the Yen. The Federal Reserve Beige Book which surveys economic conditions through the eyes of the 12 Federal Reserve districts reported that "economic activity continued to expand [in all twelve banks] from mid April through May" and "continuing weakness in real restate and construction". The Beige Book for April had said that "Most Federal Reserve districts noted only modest or moderate expansions in economic activity", so the May survey sees definite improvement. The May book also noted a lack of serious wage or price inflation.
CPI in May rose 0.7% and 2.7% in the annualized number. But the core rate continued to slacken increasing only 0.1%, (+0.14978% unrounded) and 2.2% annualized. This is the lowest core CPI reading in over 12 months. The April unrounded reading had been +0.17729%, so the May reading represented a 15% decrease.
Industrial Production (IP) and Capacity Utilization for May were both lower than anticipated. IP was flat, it had been expected to rise 0.2% and the April number was lowered to +0.4% from +0.7. Manufacturing rose 0.1%. Capacity Utilization in May dropped to 81.3% from 81.6% in April.
The University of Michigan Consumer Confidence reading fell in June to 83.7 from 88.3 in May, as the 10% rise in gasoline prices in May weighed on personal finances.
Eurozone
Industrial Output numbers for April came in well below estimates at -0.8% for the month and +2.8% for the annual results. Forecasts had been for +0.2% and +4.3%. March numbers were revised up to +0.5% and +4.0% from +0.4% and +3.7%. .
Germany
Wholesale prices in May rose 0.3% and 2.4% in the annualized figure. April's statistics had been +0.8 and +2.9%. Core CPI rose 1.9% in May and had been 1.8% in April. ICON Consumer Confidence registered at 109.00, it has risen steadily since the beginning of the year.
United Kingdom
CPI slackened a bit in May gaining 2.5%, down from the 2.8% number in April. Core CPI rose slightly in May, 1.9%, as opposed to April's 1.8% reading. Nonetheless Mervyn King, the Governor of the Bank of England hinted at future rate increases. Retail Sales were slightly better than expected in May rising 0.4% for the month and at a 3.9% yearly clip. Forecasts had been for a 0.3% increase and +3.8% annualized. Gains in DCLG Housing Prices accelerated in April rising 11.3%; the March increase had been 10.9%.
China
The Consumer Price Index rose 3.4% in May on an annualized basis, slightly outstripping the median expectation of 3.3% and topping both March, 3.3% and April, 3.0%. The PBOC has said that it wants inflation to be no higher than 3.0% per year. This reading is the highest since February 2005 when it registered 3.9%. The price gains were limited almost exclusively to food which shot up 8.3% year to year, all other goods rose by only 1.0%. Money Supply (M2) growth fell slightly in May to 16.7% from the April level of 17.2%. The Chinese industrial economy continued to expand at an increasing rate. Industrial Production gained 18.1% in May, April had seen a 17.4% rise. Retail Sales moved ahead in May rising 15.9%; the April increase had been 15.5%.
The May Trade Balance was +$22.45 billion, almost 33% larger than April. The year to date figure was +$85.83 billion, 85% larger than the same period last year. These are not figures that will convince China's international partners, no matter how well disposed they may be to the principles of free trade, that the Beijing government is making progress towards normalizing its trading régime.
Japan
First quarter GDP numbers were revised up to +0.8% from the preliminary reading of +0.6%. The annualized reading was +3.3% upon revision, ahead of the preliminary result of+2.4%. Though both numbers were substantially better than the market had anticipated there was no reaction.
The Week Ahead Economic Releases June 18 - June 22
United States
It will be slow week in American statistics with only the housing market in the spotlight. The National Association of Home Builders (NAHB) issues its housing market index for June on Monday. The May reading of 30 was the lowest this downturn, matched only by the same reading last October. Housing Starts and Building Permits for May are released Tuesday. The number of new building permits granted in April, 1.457 million, was the lowest number this cycle. While Housing Starts were higher in April, 1.528 million units than in January February or March they were still 22% below the May 2006 level.
The Philadelphia Fed Survey of economic growth for June which reports on Thursday will be noted in lieu of other statistics. The survey has not been a good indicator of nationwide economic trends; the May reading was 4.2.
Eurozone
It is a sparse week for statistics in the European Monetary Union also. ZEW EMU Economic Expectation for June on Monday will give some idea of the attitudes of the European consumers but the EMU result is less watched than the individual country returns, particularly those for Germany and France. The May figures were 22.3 for Expectations and 81.8 for 'Current Conditions'. Construction Production for April is out the following day. The March results in this volatile statistic were +0.9% in the month to month and +11.4% in the year to year. Friday's Industrial New Orders will be the most watched EMU statistic this the week, particularly after the unexpected decline in Industrial Production in April. A drop of 0.8% is forecast for the month and an 8.4% rise for the year to year result. The March figures were +2.7% and +8.0%.
Germany
The German portion of the June ZEW Survey mentioned above is released on Monday. 'Economic Expectations' are expected to rise to 28.0 from 24.0 in May. 'Current Conditions' are forecast to be 88.5, a bit ahead of the May number 88.0. Friday the German IFO Survey for June arrives. Business Sentiment' is expected to drop to 108.4 from 106.6 in May; 'Business Expectations' is thought to fall to 104.5 from 104.8 and 'Current Assessment' should decline to 112.3 from 112.5.
China
There are no major statistical releases this week.
Japan
The Japanese Trade Surplus for May is issued Thursday. The April year to year result was 51.8% higher than the same months in 2006 and was 926.7 billion Yen.
*Joseph Trevisani will be on vacation in the coming week. There will be no Market Directions column on Sunday June 24th.
Joseph Trevisani
FX Solutions
Chief Market Analyst
[email protected]
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