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Friday July 20, 2007 - 21:02:00 GMT
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Market Directions - Sunday, July 22 2007


  • The Dollar cannot overcome pending hikes from the ECB and the BOE and falls to record levels against both currencies
  • The weak Dollar and powerful American equity markets attract record overseas investment to the States
  • The New Zealand Finance Minister threatens to suspend the central bank's inflation target

The Week in Review July 16 - 20

United States

Good economic news from the United States notwithstanding the Dollar could not prevail over pending rate hikes from the European Central Bank (ECB) and the Bank of England (BOE). Both increases are expected in September and with the Federal Reserve on long term hiatus the recent record rally in American equity indices had negligible effect on the trading rates of the Dollar.

Federal Reserve Chairman Ben Bernanke testified before both Houses of Congress this week but added little to his well known economic scenario. Inflation remains the "predominant policy concern". Potential inflationary worries in the chairman's view stem from the high rate of resource utilization, the possibility that consumer spending might cause a "rebound in economic growth above trend", rising commodity prices, and the decline in productivity increases. Mr. Bernanke said he did not expect the problems in the housing market to spill over into consumption but admitted that home sales could "weigh on economic growth over coming quarters. On the positive side he feels that the general economic conditions are "supportive of economic growth" which he expects to continue  "at a pace more consistent with sustainable expansion". He cited the creation of 850,000 new jobs this year, an unemployment rate of 4.5%, the rise in real compensation, and the moderate growth in consumer spending as evidence of an economy that is basically healthy. "Overall the US economy appears likely to expand at a moderate pace over the 2nd half of 2007". It is a familiar refrain but it is no less true and upbeat for all that. If the markets were perhaps a bit disappointed with the lack of new direction from the Fed Chairman the same cannot be said for the American worker and consumer.

The minutes of the July 27th and 28th Federal Reserve Open Market Committee (FOMC) meeting released on Thursday gave no hints of major policy shifts, strong dissenting views or even a sense of urgency about the economy among committee members. The Bernanke Fed has a sense of wary success about it.

The combination of a weak dollar and skyrocketing American stock market did help to set a record for overseas investment in the United States in May. The Treasury Department reported a net influx of $126.1 billion in long term securities purchases. This is equal to more than two months of the trade deficit which has been averaging $63 billion a month over the past year. Government purchase of US Treasuries accounted for only $11.5 billion of the investment flow; the balance came from private investors, individual and corporations.


The European Central Bank is nothing if not thorough. In case there was any doubt about its next rate intent, Governing Council Member and head of the Greek Central Bank, Nicholas Garganas laid out the economic rational for the widely anticipated 0.25% September or October hike in an interview in Athens. It is " insure price stability... risks to inflation have increased... [and] the Euro area economy is growing at a rate clearly above trend". The only lingering suspense is will the ECB cut into its August beach time and surprise the market with an early hike on August 2nd. Don't bet on it.


The widely respected ZEW Survey from the Centre for European Economic Research brought a more somber cast to the future of the German expansion while remaining upbeat about the 'current conditions'. "Export opportunities of German companies are being limited due to the appreciation of the Euro vs. the US Dollar", and, " the financial market experts expect an economic downturn within the next six months particularly in the consumption and constructing sectors which could be attributed to the upward trend of oil prices and higher interest rates" the report said. The 'expectations' reading of 10.4 is now 23 points below the long term average of 33 last touched in June 2006. "The expectations indicate", said ZEW President Wolfgang Franz, "that the German economy will start off with less momentum in the year 2008".

United Kingdom

All signs reinforced the market conviction that the Bank of England would soon weigh in with another rate hike and Sterling set new 26 year highs on four out of five trading days. Inflation measures for June were higher than market expectations and 2nd quarter GDP was above trend. The minutes for the Monetary Policy Committee (MPC) meeting of July 5th showed a 6-3 vote in favor of the 0.25% rate increase to 5.75%. As expressed in the BOE minutes the majority had enough concerns about demand growth, capacity utilization, monetary supply growth and goods price inflation to insure further hikes this year though probably not at the next MPC committee meeting August 2nd. The third BOE inflation report of the year is due August 8th, and, as before the last report in May, it is likely that the committee will wait for confirmation of its concerns before acting. Financial Britain will be deep into vacation season on August 2nd when half the London financial market will be on the way to the south of France. The real question for the 2nd is will the MPC meeting be convened in Provence.


The new government of Nicholas Sarkozy continued its tilt at the ECB and its restrictive monetary policy. Deputy Minister for European Affairs Jeanne Pierre Jouyet, in an interview with the International Herald Tribune, urged European Governments to confront the central bank directly over its monetary policy. "You can influence the ECB's decision by having a more open discussion about the motivation behind interest rate decisions", he said. And in lieu of that, he might have added, apply public pressure through the media. The ECB response was swift and predictable. In a statement issued by President Jean Claude Trichet's office the central bank noted that article 108 of the ECB treaty rejects any external political influence on the central bank's policy decisions. Sarkozy's government has a hard reform road ahead, the positive economic effects of which will not be felt for many months or years. In criticizing the ECB the government shows its populist concern for the French worker and consumer, whose allegiance or at least acquiescence it will need to enact labor market reforms. And by making its economic considerations so public it adds to the pressure on the ECB to halt or suspend its rate hikes. No matter what the ECB says, that tension will have its effect over time.


The Beijing authorities saw scant evidence that their campaign to cool the torrid rate of Chinese economic growth was having effect. The consumer and industrial sectors continued their rapid growth, with both areas adding to their yearly rates of increase in June. Inflation was almost 1.5% above the Peoples Bank of China's (PBOC) target of 3.0% in June and the yearly GDP growth in the second quarter was nearly a full percentage point above that of the first quarter. The Yuan continued it slow ascent with the central parity rate closing at 7.5612 against the Dollar on Friday, more than 1% higher in the past six weeks. At this pace the Yuan will provide little help in slowing the mainland economy or in draining excess liquidity from the financial system. Though American Congressional pressure on Beijing to hasten the revaluation of the Yuan has subsided as trade legislation is now sidelined until next year, the Chinese economic authorities are still looking for an effective combination of interest rates, reserve requirements and an external exchange rate to control their booming economy.

On Friday the PBOC raised domestic interest rates for the third time this year increasing one year lending and deposit rates by 27 basis points. The State Council then announced, 90 minutes after the PBOC, a cut in the withholding tax paid on deposit interest to 5% from 20%, with the stated purpose to" help to boost household savings income meeting the demands of economic development". Both moves were expected and the economic rational remains the same. With Chinese inflation topping on 3.0% and deposit interest rates at 3.33% even with the new increases, real interest rates are at or below zero. There is little incentive for Chinese consumers to save. One consequence is the raging Shanghai Composite Index 51% higher this year alone and up 3.76% on Friday after the announcements, another is the volcanic growth in retail sales, 16% higher in June over 2006. Further adjustments in interest rates, reserve requirements and the Yuan are practically foregone.

New Zealand

Finance Minister Michael Cullen gave a history lesson this week castigating the market for buying the New Zealand dollar and threatening to abandon the Reserve Bank of New Zealand's (RBNZ) 1-3% inflation target or Policy Target Agreement (PTA). The finance minister has the authority to suspend the PTA under the central bank enabling act. Traders have not heard such blatant threats since the collapse of the European Rate Mechanism in 1992. Now as then the promise is unlikely to be fulfilled. The first question is the simplest, if the PTA is eliminated what will take its place, an exchange rate target for the New Zealand Dollar (Kiwi)? Will the RBNZ cut rates, impose exchange controls or intervene until the Kiwi returns to a more export friendly level? The central bank would be writing a blank prescription for inflation if it did so. The underlying issue is, of course, political. Exporters and manufacturers have been had hit by the Kiwi's surge and more rate increases are in the offing from the RBNZ. The government faces an election next August and is trailing in the polls. No political party wants to run for re-election in a recession. In reality, to which Mr. Cullen will undoubtedly return, the RBNZ will retain its independence and the government will not revoke the inflation targets. But perhaps the government's populist economic outcry will resonate with the voters. RBNZ Governor Alan Bollard will have noted the sound and fury and properly judged its significance.

Economic Releases July 14 - 19

United States

Tuesday: Capacity Utilization and Industrial Production for June set off no market reactions as both reported in-line with expectations. Capacity Utilization was 81.7% a bit in advance of the forecast of 81.5% and better than the May result of 81.3%. Industrial Production gained 0.5% in June, better than the prediction of +0.4%. The May result was shifted down to -0.1% from 0.0%. The Treasury International Capital System (TICS) scored a record of $126.1 billion in net investment in the US as foreign investors sent $163.5 billion to the US in May and US residents wired only $37.3 billion overseas. The National Association of Home Builders (NAHB) Housing Market Index for July fell to 24, its lowest level since January of 1991; in June the index was 28.

Wednesday: CPI retreated to +0.2% in June (0.19143% unrounded), from the anomalous May reading of +0.7%. The forecast had been +0.1%. The annual rate of +2.7% remained unchanged from May. The core CPI result was +0.2% (0.23244% unrounded) as predicted; the May rate was +0.1%. The annual rate in June was unchanged from May, +2.2%. Housing Starts in June rose 2.3% to 1.467 million units; 1.450 million units had been predicted; May's result was 1.474 million units. Building Permits, generally a better gauge of future sector health, fell 7.5% in June to 1.406 million, the lowest level since June 1997. Although the pace of the decline has slowed dramatically from a year ago there is no sign of a reversal. The four month moving average sank to 1.522 million in April, the last month for which this average is available. Since April 2006,  when this average stood at 2.033 million, it has fallen over 25%. The bulk of that drop, 20%, came in the six months from April to October 2006. From November 2006 until April this year it has fallen only an additional 4.4%.


Monday: final HICP figures were as predicted +0.1% for June and +1.9% annualized. This is the 10th month in a row with the premier ECB inflation measure below the 2.0% target.

Wednesday: Construction Production for May rose 0.2% and 1.8% annually. It was the weakest yearly rate in more than 24 months. The monthly figures for the previous four months were all revised downward, a total of 0.6% for the period.


Monday: final inflation numbers for June came in as expected with HICP adding 0.2% for the month and 2.0% annualized; CPI rose 0.1% and 1.8% yearly. The energy component rose 0.9% year to year in June, more than in May, 0.3%, and April, 0.4%, sparking concern that energy prices may be turning higher.

Tuesday: the ZEW Research Institute Survey of Business Sentiment for July, 'economic expectations' were 10.4, forecast 19.5, June 20.3; 'current conditions' were 88.2, forecast 87.0, June 88.7.

United Kingdom

Monday: the Department of Communities and Local Government (DCLG) House Price Index showed a 10.9% increase in May, less than the 11.3% rise in May but not enough of a drop to allay inflation fears.

Tuesday: CPI, the equivalent of the Eurozone HICP and the current BOE inflation measure, was up 0.2% monthly and 2.4% yearly in June. Market expectations had been for a rise of 0.1% and 2.3%. In May the increase had been 0.3% for the month and 2.5% year on year. The core CPI inflation rate rose 2.0% in June, more than the median prediction of +1.9% and May rate of +1.9%. The BOE CPI target is 2.0%. The Retail Price Index, (RPI) the older and now superseded UK inflation measure was up 0.5% in June and 4.2% annualized on forecasts of +0.3% and +4.2%. May's results had been +0.4% and +4.3%. Until 2003 when the BOE changed its inflation statistic to the Consumer Price Index (CPI) the RPI had been the bank's target at 2.5%. It is still published by the Office of National Statistics.

Wednesday: the unemployment rate on the International Labour Organization definition, the ILO Unemployment Rate, dipped to 5.4% in May from 5.5% in April. The Claimant Count Unemployment Rate for June dropped 13,800, falling for the ninth consecutive month. A fall of only 8,000 had been expected. The May statistic was revised down to -11,000 from -9,300.

Thursday: Retail Sales in June rose 0.2%, a 3.4% yearly pace. This was slightly less than the median expectation of +0.7% and +3.9% but notably worse than the May figures of +0.4% and +3.9% There was no market reaction and the soft reading will have little play with the MPC when it contemplates its next rate move.

Friday: second quarter GDP was the same as the median estimates at +0.8% and +3.0%. Most economists estimate quarterly trend growth at +0.6% and this is the 2nd quarter in a row in which growth has exceeded trend; the first quarter was +0.7%. Sterling moved up 30 points on the news.


Thursday: CPI increased 4.4% on a yearly basis in June compared with May's 3.4% rate; this was the quickest clip since September 2004. The Peoples Bank of China's CPI target is 3.0%. PPI was a bit lower in June than May, 2.5% year to year against 2.8%. Retail Sales and Industrial Production continued to forge ahead in June. The annualized rates for sales rose 16.0%, slightly more than the 15.9% May increase. Industrial Production gained 19.4% vs. the May addition of 18.1%. GDP for the second quarter registered +11.9% yearly almost a full point above the +11.1% rate of quarter one.

The Week Ahead July 23 - 27

United States

Wednesday: Existing Home Sales for June from the National Association of Realtors at 10:00 am ET. The May figure was 5.99 million units. The Federal Reserve 'Beige Book' so called for the color of its cover, a summary of anecdotal information on current economic conditions, is released at 2:00 pm ET. It is expected to show continued moderate economic growth.

Thursday: Durable Goods, Durable Goods ex Defense and ex Transport for June at 8:30 am ET. The May numbers were -2.8%, -3.2%, -1.0%. New Home Sales for June at 10:00 am ET. The May result was 915,000.

Friday: the advanced (first) estimate of second quarter GDP at 8:30 am ET. This is the most important American statistic of the week and sure to set the tone for subsequent Dollar trading. The median forecast is +3.2% with a range of +2.9% to +3.5%. University of Michigan Consumer Sentiment for July at 10:00 am ET. June was 92.4.


Tuesday: Industrial New Orders for May at 9:00 GMT. Forecast: +1.1% for the monthly reading and +7.5% annually. In April the numbers were -0.4% and +12.2%.

Friday: Money Supply (M3) and M3 three month moving average from the ECB at 8:00 GMT. +10.7% and +10.6% are predicted. Both statistics were +10.7% in May.


Thursday: IFO Survey for July at 8:00 GMT. Forecasts: Business Sentiment 106.5, prior 107.0; Business Expectations 102.0, prior 102.8; Current Assessment 111.0, prior 111.4. Friday: (release time not announced), Preliminary CPI and HICP, month to month and year to year. Forecasts: CPI +0.4% mom, +1.8% yoy; HICP +0.4% mom, +1.9% yoy.

Friday GfK Consumer Confidence for August at 6:00 GMT. Forecast 8.7, prior 8.4.

United Kingdom

Wednesday-Friday: (release date not announced) Nationwide House Prices for July, month to month and year to year. The May results were +1.1% and +11.1% respectively.

Friday: Land Registry House Prices for June at 10:00 GMT, month to month and year to year. The prior month was +0.7% and +8.9%.


No statistical releases


Wednesday: Trade Balance for June at 8:50 JST, (23:50 Tuesday GMT). May was +8.1%.

Friday: National Core CPI year to year for June at 8:50 JST, (23:50 Tuesday GMT). The May result was -0.1%. Retail Sales year to year for June at 8:50 JST (23:50 Tuesday GMT). In May sales gained 0.1%.

Joseph Trevisani
FX Solutions
Chief Market Analyst

[email protected]

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