Market Directions - Sunday, July 29, 2007
- Risk reversal, the current hot market clich√©, defined
- US sub prime jitters roil the credit markets, but the Dollar gains
- Turkey re-elects the pro business AKP party but the Lira suffers in the retreat from risk
The Week in Review July 23 - 27
Risk assessment and risk reversal the currently popular terms for a dramatic change in market direction have an older and less analytic but far more descriptive name, profit taking. The recent exorbitant levels in the Yen crosses and to a lesser extent the Sterling and the Euro, not to mention the Dow and other equity indices, were almost purely driven by speculation. The up trend was strong, long extended and produced healthy profits; those profits are now being cashed. The trigger has been the extension of the sub prime problems in the United States, but there is no indication that the problem is spreading to the wider economy or even the wider housing market, depressed as it is. But a catalyst to speculative profit taking should never be mistaken for underlying economic reality. Second quarter American GDP was 3.4%, a substantial number, with exports and inventories providing the strength. There are two revisions to come. It is a notable turnaround and the markets responded by buying the Usd. Economically speaking even with the reduced PCE core deflator of 1.4% the Fed has no need to sponsor a rate reduction. The economy is growing, unemployment is low, inflation is receding, and rate bears have been forced into deep hibernation.
The farther end of the rate curve has steepened but a return to more costly financing while perhaps damaging for markets and businesses that have thrived on very low financing costs is really nothing more than a return to the normal (by percentage of existence) rising yield curve. It may be harder to finance housing construction and sell mortgages but we have not entered dire or abnormal economic or financial territory.
Foreign stock exchanges, both European and emerging markets followed the Dow lead, but in general these exchanges have had an excellent year and the logic driving them down is the same. Risk reversal in the currency markets benefits the Usd because it is sought as the safe haven currency, the best place to store profits and value.
The government of Gordon Brown has lost no time in bringing its inflation credentials to the market. The new Chancellor of the Exchequer Alistair Darling said his "first priority as chancellor is to stick to stability now and in the future so I will support the Bank of England (BOE) in the decision to meet the inflation target". The target is 2%. Deputy BOE Governor Sir John Gieve who is an ally of the hawks on the Monetary Policy committee (MPC), seemed to confirm that there will be no hike on August 2nd as he emphasized the value of "gradualism" and the need to gather more information before acting.
The current pace of Yuan appreciation would add another 4.4% to its value by the end of the year. This would make it 13% stronger than mid 2005 when the revaluation policy began and the Peoples Bank of China ended the Dollar peg. This probably not enough to stymie protectionist legislators in the American Congress. But then again there is really no amount of appreciation that could silence these Congressional critics. Their primary interest is the domestic political capital gained by blaming China and by default the administration. Bashing China is domestic US politics and the perceived advantage is far too great for Congress ever to forego this favorite whipping post. Be assured that whatever China does this essentially unserious criticism from Congress will continue.
The Justice and Development Party (AKP for the initial of the name in Turkish) led by Prime Minister Recep Tayyip Erdogan scored a convincing victory in the parliamentary elections this past Sunday raising it vote percentage 12 points to 46%. It now has 340 seats in the legislature out of the total of 550; the nearest competitor party has 112. With the highest voter turnout since 1994 the AKP can claim a mandate. The Turkish Lira strengthened over 300 points against the Dollar from Friday to Monday but lost all of that gain and more in the latter part of the week as worldwide risk aversion against emerging markets and emerging market currencies took hold. The immediate key for the Lira will be the AKP approach to the Turkish Presidency. This past election was precipitated by a dispute between the AKP and secularists in parliament and the military over who should occupy the post. The AKP had nominated Abdullah Gul while the secularist opposition and the military have demanded an official who will "defend the secular constitution". With Turkish support for European Union membership at a low ebb and the anti membership Nicholas Sarkozy newly elected in France, businesses and investors, especially overseas investors are nervous, despite the generally good economic and investment performance of the AKP while in power.
Economic Releases July 23 - 27
Friday: 2nd quarter GDP bested expectations with a 3.4% reading. The median prediction had been 3.2%. Personal consumption grew at 1.3% the slowest paces since +1.2% in the fourth quarter of 2005. This was more than offset by government spending, exports and inventory additions. Durables and service spending was also higher but non durables shrank 0.8% the biggest fall since e-2.8% in Q4 1991, during the recession of that year.
The core PCE price index the Fed"s prime inflation barometer rose only 1.4% in the second quarter after the 2.4% hike in first quarter. A sub 2.0% PCE number has not been seen since mid 2005 and 2004, albeit only briefly in each year.
The final University of Michigan Consumer Sentiment figure for July slipped slightly from the preliminary release of 90.4. The earlier reading had been 92.4. Even with the reduction the reading is almost three points above the average of the prior five months.
Wednesday: Existing Home Sales slipped 3.8% in June to 5.75 million units, well below the median forecast of 5.87 million units. The May number was revised down to 5.98 million from 5.99 million. This is the lowest reading since November of 2002 when it registered 5.73 million. The supply of unsold homes rose to 8.8 months. The Federal Reserve "Beige Book", which reports anecdotal information from the 12 Federal Reserve districts said that sales " in a number of districts [were] mixed or below expectations" and that consumer spending "rose at a moderate pace". Depicting moderate growth with some local weakness the report was essentially unchanged from last month.
Thursday: New Home Sales for June dropped to 834,000 well off market expectations of 890,000 and May was also adjusted down to 893,000 from 915,000. The median sales price shrank by 1.3% as well to $237,000. Most homes in this category are held in inventory by builders whose willingness to cut prices to move unsold inventory is considerably greater than the largely individual home owners in the Existing Homes category. The fall in units sold despite this price flexibility seems to indicate more declines for the sector. The brief bounce in April and May has not represented a leveling but just a temporary response to lower prices; it does not mean the market has reached market clearing price level. Durable Goods New Orders for June expanded 1.4% not quite as much as the forecast of 2.0% but well ahead of the May drop of 2.8%. The Boeing order book for the month rose to 132 from 92 in May and was the largest component in the expansion.
Tuesday: Industrial New Orders for May were slightly better than predicted +1.7% monthly and +9.1% yearly, +1.0% and +7.2% had been forecast. The April results were revised down to -0.6% and +11.8% from -0.4% and +12.2%. The combined April and May average exceeded the Q1 average by 1.9%. Reuters Purchasing Managers Manufacturing Index (PMI) for July was 54.9, less than the prediction of 55.5 and less than the June number of 55.6. The services component was 58.1 as forecast but lower than the June reading of 58.3. The manufacturing sector grew at the weakest pace since last February and services has cooled from the June 12 month record. Rising oil prices and the ascendant Euro dampened growth.
Thursday: the EMU Money Supply (M3) expanded 10.9% in June outstripping the prediction of 10.7% and the May result the same 10.7%. M3 growth continues to accelerate. The official ECB target is 8%, but that level has not been seen since last year and four of the six months this year it has been over 10%. A question may occur to the ECB. With CPI at or below the 2.0% target for 10 months in a row is the M3 measure less relevant than originally thought? Is inflation a money supply phenomenon as predicted by monetarist thought or does the more recent idea of controlling inflationary expectations play a more prominent role in squeezing inflation from the economy?
Friday: Flash HICP for July was +0.7% month to month and +2.2% yearly. Predictions had been +0.4% and 1.9%. CPI was as expected +0.4% and +1.9%. German officials have been anticipating a return of inflation to above 2.0% after more than 10 months below, oil prices are the prime culprit.
Thursday: the IFO Survey detected a slight weakening in the economy in July. The Business Sentiment number was 106.4, a bit les than the anticipated 106.5 and the June number of 107.0. Current Conditions were 111.3, slightly better than expected 111.0 and similar to the June reading 111.4. Expectations dropped as well slipping to 101.8 in July a full point lower than the June statistic of 102.8 and a trifle lower than the forecast of 102.0. IFO head Nerb said that he expects an ECB rate hike in September or October, and that a Euro over 1.4000 would clearly pose a problem for EMU economies, both are uncontentious positions. He also said that there no need for the ECB to hike further, a contention that the ECB would not doubt dispute.
Monday: right move House Prices rose 0.3% in July to a yearly rate of 10.3%. This is an improvement over the June numbers of +0.8% and +13.2% but not nearly enough to head off the next BOE rate increase.
The Week Ahead July 30 - August 3
Tuesday: Chicago Purchasers Index for July at 9:45 am ET. The June issue was 60.2.
Wednesday: Institute for Supply Management (ISM) Index for July at 10:00 am ET Median expectation is 55.5; the June result was 56.0. National Association of Realtors (NAR) Pending Home Sales for June at 10:00 am ET. The prior release was 97.7.
Thursday: Factory Orders for June at 10:00 am ET. The May result was -0.5%.
Friday: Non Farm Payrolls for July at 8:30am ET. Median expectation is +125k; the June issue was +132k. Unemployment Rate for July at 8:30 am ET. The forecast is 4.5%; the June result was 4.5%. Institute for Supply Management (ISM) Index for July at 10:00 am ET. The June issue was 60.7.
Tuesday: Flash HICP (y/y) for July at 9:00am GMT. Median expectation is 1.9%; the June result was 1.9%. Unemployment Rate for June at 9:00am GMT. The forecast is 7.0%; the May result was 7.0%.
Friday: Retail Trade (m/m) for June at 9:00am GMT. The May issue was -0.6%. Retail Trade (y/y) for June at 9:00am GMT. The May result was 0.5%.
Tuesday: FSO Retail Sales for June at 6:00am GMT. Current assessment 1.4/-1.5; Prior was -1.8/-3.7. Unemployment Rate for July at 7:55am GMT. Median expectation is 9.1; the June result was 9.1.
Wednesday: Icon Consumer Confidence for July (release time not announced). Prior release for June was +108.
Sunday: Hometrack House Survey for July at 23:01 GMT. The June result was 0.9/6.4.
Monday: Mortgage Approvals for June at 8:30am GMT. The May issue was 114.
Tuesday: Nationwide Consumer Confidence for July at 32:01 GMT. Prior release for June was 95.
Wednesday: Halifax House Prices for July at 8:30am GMT. June result was 0.4/10.7.
Thursday: BOE MPC Rate Announcement for August at 11:00 am GMT. July issue was 5.75%
Friday: Mortgage Possessions for Q2 at 8:30am GMT. Prior results are not available.
No statistical releases
Sunday: Elections for the upper house of the Japanese Diet are expected to produce a resounding defeat for Shinzo Abe and the ruling Liberal Democratic Party (LDP). If the LDP and its coalition partner the New Komeito Party percentage falls below 50% Abe may be forced to resign as Prime Minister, at the very least there will be a cabinet reshuffle. The ability of a weak LDP government to continue reforms of the Japanese economy will also begin to be questioned and the potential for a 0.25% rate hike by the Bank of Japan at the August 22nd and 23rd meeting will diminish. A hike is now estimated to be 60% priced into the market.
Monday: Industrial Output (m/m) for June at 13:30 JST (4:30 GMT). Previous results for May were -0.4%.
Tuesday: Unemployment Rate for June 8:30 JST (23:30 GMT). May issue was 3.8%.
Thursday: Monetary Base (y/y) for July at 8:50 JST (23:50 GMT). June result was -4.1%.
Chief Market Analyst
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