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Market Directions Sunday August 26, 2007


  • Credit markets stabilize but the Feds hopes for the 'discount window' are unfulfilled
  • The ECB keeps a stiff upper lip on rates
  • The BOJ asserts its independence but denies its own wish to raise rates

The Week in Review August 20 - August 24

United States

Last Friday's statement by the Federal Reserve accompanying its discount rate cut, 'that downside risk to the economy have increased appreciably', has been widely interpreted as a change to an easing bias by the Fed, replacing the restrictive attitude it has held since last July. Likewise its assertion that if credit markets conditions do not improve the Fed stands ready to act, is seen as nearly a promise to cut the Fed funds rate at the next FOMC meeting September 18th, or ever earlier if conditions warrant. To some degree last Friday's discount rate cut has provided the sensible slap that the Fed intended and Treasury instrument rates have climbed back from the extreme lows of Monday. The rates had gone into free fall as investors sought the safety of US government guaranteed debt instruments over the perceived danger of almost any private market obligation. The other two thirds of the Fed policy initiative, extending the term of discount window borrowing to 30 days and broadening the categories of acceptable collateral to accept many of the questionable debt market securities have been less successful. As of Wednesday only $2 billion had been borrowed from the discount window, all of it by four major US banks, Citi, JPMorgan Chase, Bank of American and Wachovia at $500 million each. No doubt Mr. Bernanke had hoped for much wider participation.

Signs of unease remain in the financial markets but most measures of risk have fallen since their peak last Thursday. Equity markets have been stable or gaining, credit spreads have narrowed, and the direction of almost all currency moves were reversed this week over last, the yen crosses being the biggest gainers.

As the Fed correctly observed the credit market problem has been a withdrawal of liquidity not a lack of liquidity in the system. Banks have had plenty of money to lend, they have simply chosen not to because they wanted to make provision against a doubtful future. The issue was information, market participants were unsure of how far into their own portfolios and those of their clients, the sub prime rot had spread and in defense they sat on piles of cash. Buyers in the money markets could not find sellers because the sellers had gone home. The return of confidence to lenders has been greatly helped by the very public commitment by the Fed, the ECB and other central banks to the safe and smooth functioning of the financial markets. It has also been aided by the lack of any other bad news, no other hedge funds, banks or mortgage companies have failed in the interim, and even if others now do so the impact will be far less than it would have been before confidence was restored.

But the return of money market rates to more nearly normal levels has not supported the Dollar as traders focus on Fed's next rate move. Until the onset of the liquidity crunch in the credit markets the operating assumption was that the Fed would hold rates steady through the end of the year, with the direction of any subsequent moves still very much up in the air. That expectation has been dashed and the Fed is now expected to cut rates by at least 0.25% in September. Once the panicky rush from currency risk and into the Dollar subsided the Euro reversed and it has risen over 2.25% against the Usd since last Thursday. The Euro/Yen is up 6.5%, the Aud/Yen over 11% and the Nzd/Yen more than 12% in the same period. For these crosses the recovery has been more than 50% of the fall since their respective August peaks.

As the panic spread in the credit markets causing the massive withdrawal of liquidity by private participants so a similar reaction hit the risk averse Yen crosses causing large amounts of stop loss selling. After the action and the reaction the markets have returned to more prosaic modes of analysis. But the unsettled nature of the current rate discussion for the ECB and the Fed ensures that the weeks ahead will be full of interesting trading prospects and volatility.


The ECB meets September 6th. Until 2 weeks ago a 0.25% rate increase was a foregone conclusion. Bank President Jean Claude Trichet had ostentatiously deployed the rate hike code 'strong vigilance' at his impromptu news conference after the last ECB meeting. The ECB would no doubt still like to raise rates, its own projections call for the EMU inflation rate to rise back above the 2.0% target to 2.4% or more by the year end. The liquidity crunch in the credit markets only came to full public attention last Thursday when the ECB added massive funds to the European money markets in an effort to forestall a serious credit squeeze. The question asked by many now is, does it make sense for the ECB to add liquidity one month and raise rates the next? The French Finance Minister Christine Lagarde applauded the Fed cut in the discount rate and wondered why the Europeans didn't look at a rate cut as well and she certainly speaks for many in the European business and political communities. Market expectations are changing fast and the public pressure to hold the line at 4.00% can only burgeon in the next weeks. So far Mr. Trichet has kept a stiff upper lip proclaiming that ECB rate policy was set on August 2nd when he deployed the code for a September rate hike, but few believe that this is the final word on ECB policy. As Mr. Trichet likes to say the ECB does not predetermine rate policy. Indeed.


The Bank of Japan declined to raise the overnight call rate above its current 0.5% level. The vote in the Thursday meeting was 8-1 against an increase. In a post announcement news conference Bank of Japan Governor Toshihiko Fukui made it clear that the bank will continue its move away from the zero rate policy which ended last July. "Distortions and the misallocation of resources could occur if interest rates are kept at levels inconsistent with the economy", he said. He also characterized the low rate policy as "risky" for Japan's economic growth if held too long. Until the financial and credit turmoil of the past two weeks many commentators had expected the BOJ to raise rate 0.25% at this meeting. The BOJ governors desire to do so has been public for some time though opposed by the LDP government of Shinzo Abe. But the government's recent severe losses in elections for the upper house of the Japanese Diet had given the BOJ the political opportunity to hike until the credit markets rout intervened. When asked whether the BOJ had made its decision with reference to the policies of other central banks, Fukui said that the BOJ makes its "own decision", but his comments about risk assessment and the sub prime problem in Japanese and world markets made it evident that the financial market situation was uppermost in the minds of the board. The next meeting for the BOJ is September 19th, one day after the Federal Reserve is expected to cut the Fed Funds rate. Current market estimates put the chance of a 25 basis points hike by the BOJ at the September meeting at about 40%. The financial markets upsets have strengthened the Yen and driven the Nikkei 225 stock average down more than 5% in August as investors have dumped the long running carry trade and potential economic complications of a recession in US have devalued stocks in the export driven Japanese economy.


As widely anticipated The People's Bank of China (PBOC) hiked one year Yuan deposit and lending rates. Borrowers will have to pay 0.18% more, 7.02% to obtain funds, and lenders will receive an additional 0.27%, 3.60%. It is the fourth hike this year. As with the previous rate increases the purpose is to draw deposit funds into the banking system and to diminish the pace of lending, attacking both sides of the inflation nexus. But with CPI running at a 3.6% average for the second quarter and jumping to 5.6% in the first month of the third, and with the biggest component of the rise food prices, which all households pay, it is not likely these moves will entice sufficient Chinese spenders to become savers. The PBOC said the increases were to "stabilize inflation expectations" and to slow the equity market. The Chinese equities and financial sectors have been largely immune to the global turmoil of the past few weeks.

Economic Releases August 20 - August 24

United States

Friday: New Home Sales for July rose to 870,000 units a 2.8% increase and much better than the 820,000 prediction. The supply available for sale at the current selling rate fell slightly to 7.5 months; the June supply was 7.8 months. June sales were revised higher to 846,000 from 834,000, while both May and April were shifted lower, May to 881,000 from 890,000 and April to 907,000 from 930,000. Durable Goods for July were almost six times as strong as expected, +5.9% versus the median forecast for a gain of 1.0%; June was +1.3%. It is the fifth increase in this volatile statistic in the past six months. Since February all months have surpassed the previous except May which was 2.8% lower than April. July is the best reading since September 2006 (+8.8%). All areas except electronics, -1.2%, advanced with the strongest showings in communications equipment, +20.7% and motor vehicles, +9.8%.


Tuesday: Construction Spending grew 0.6% in June , a +2.7% annual rate. May's results were adjusted lower to +0.1% monthly from +0.2% and to +1.6% annually from +1.8%. Results from January, February and March we revised lower as well. The figures have declined each quarter starting with fourth quarter of 2006, +1.8%, to +1.6% in the first quarter of 2007, and to -0.277% in the second quarter.

Wednesday: Industrial New Orders shot up 4.4% in June, more than double the median forecast of 2.0% and almost two and a half times the May rise of 1.7%. The annualized rate was also a surprise at +13.8%, +12.3% had been expected; May was 9.1%. However, the boom was largely due to volatile transportation industry orders which rose 15.7% for the month, 38.6% annualized. Without transport  industrial orders gained only 1.4% in June, a +7.0% annual pace. The three month moving average was +1.9% in June, +1.1% in May.

Friday: Preliminary (flash) Reuters Manufacturing PMI for August was 54.2, less than the median estimate of 54.5 and lower than June's reading of 54.9. The 'services' result matched expectations at 57.9 but was lower than the July reading of 58.3. This is the weakest reading of the manufacturing sector in this monthly poll of purchasing managers since January of 2006. Both output and input prices were lower on the manufacturing side and in the services sector input prices were less and output prices steady.


Tuesday: the Center for European Economic Research (ZEW) 'Economic Expectations' survey for August fell more than 17 points to -6.9, much lower than the median forecast of -1.0 and well below the July reading of 10.4. It is the lowest reading since December 2006. The 'Current Conditions' figure was 80.2, also less than the expected, 84.5 and under the July reading 88.2. It was the third monthly decline in a row for both numbers. This survey is conducted among German financial 'experts' and recent market turmoil may have contributed to the depressed outcome.

Thursday: second quarter GDP arrived as expected at +0.3% seasonally adjusted q/q, +2.5% not seasonally adjusted y/y and +2.5% (wda) y/y These are weak results in view of the record of the past two quarters: 4th quarter 2006 (wda) +1.0% quarterly and +3.0% annually; 1st quarter 2007, (wda) +0.5% quarterly and +3.6% annually.

United Kingdom

Monday: British property website released its House Prices for August and they showed a gain 0.6% over July, a 12.8% yearly clip. July had reported at +0.3% monthly and +10.3 annually. Commercial Director of Rightmove, Miles Shipside anticipates change in the near future in the housing market, "Until this stock market turmoil blows over there is a risk to the housing market too. Next year we will see a definite slowdown".

Wednesday: The Confederation of British Industry (CBI) Industrial Trend Survey for 'Total Orders' was unexpectedly strong in August, +9.0 on forecasts of -2.0 and a July reading of -6.0. The August result was the highest since May 1995: The survey was conducted from July 24th to August 15th. The percentage of managers who expected to be able to increase their prices rose to 16% from 11% in June. The Bank of England has often cited corporate pricing intentions as one of their inflationary risks.

Thursday: Business Investment improved 0.8% q/q in the second quarter and +7.4% year to year. Investments in construction and services were higher and those in manufacturing industries fell.

Friday: Second quarter GDP was unrevised on its second release at +0.8% in the quarterly comparison and +3.0% in the yearly. Household spending was up 0.8% in the quarterly and likely added 0.5% to GDP. Most economists assume that trend GDP growth for the British economy is +0.6% - +0.7% per quarter.

The Week Ahead August 27 - August 31

United States

Monday: Existing Home Sales for July at 10:00 ET, expected 5.70 million, June 5.75 million.

Tuesday: Conference Board Consumer Confidence for August at 10:00 ET, July 112.6

Thursday: 2nd quarter preliminary GDP (second release) at 8:30 ET, prior (adcanced) +3.4%.

Friday: Personal Income for July at 8:30 ET, June +0.4%. Personal Expenditure for July at 8:30 ET, June +0.1%. PCE Core Chain Weight Price Index for July at 8:30 ET, June +0.1%. Chicago Purchasers Index for August at 9:45 ET, expected 53.0, July 53.4. University of Michigan Consumer Sentiment for August at 10:00 ET, expected 82.5, July 83.3. Factory Orders for August at 10:00 ET, July +0.6%.


Tuesday: Money supply (M3,y/y) for July at 8:00 GMT; expected +11.1%, June +10.9%. Money Supply (M3,y/y) three months moving average for July at 8:00 GMT; expected +10.9%, June +10.6%.

Friday: Flash HICP (y/y) for August at 0900 GMT; expected +1.8%, July +1.8%. Unemployment rate for July at 9:00 GMT; expected 6.9%, June 6.9%.Aug


Tuesday: IFO Survey for August at 8:00; Business Sentiment, expected 105.5, July 106.4; Current Assessment expected 111.0, July 111.3; Business Expectations expected 100.3, July 101.8. Preliminary HICP for August (release time undetermined) expected -0.1% m/m, 2.0% y/y, July +0.7 m/m +2.2 y/y. Preliminary CPI for August (release time undetermined) expected -0.1% m/m +1.9% y/y,July +0.4% m/m +1.9% y/y.

Wednesday: GfK Consumer Confidence for August at 6:00 GMT; expected 8.5, July 8.7.

Thursday: Unemployment Rate for August at 7:55 GMT expected 8.9%, July 9.0%.

Friday: Total Retail Sales for July (release time undetermined), June +0.7% m/m seasonally adjusted, -3.2% y/y seasonally adjusted.

United Kingdom

Wednesday: Land Registry House Prices for July at 11:00 GMT, June +0.4% m/m, +9.1% y/y.

Thursday: Nationwide House Prices for August at 7:00 GMT, expected +0.5% m/m, +9.6% y/y. CBI Distributive Trades Survey (Reported Volume of Sales) for the third quarter at 11:00 GMT, expected 14, July 18.

Friday: GfK Consumer Confidence for August at 10:30 GMT, expected -7, July -6.


No important statistical releases.


Thursday: Retail Sales for July at 23:50 (prior day) GMT, June -0.4% y/y.

Friday: National Core CPI for July at 23:30 (prior day) GMT, June -0.1% y/y. Unemployment Rate for July at 23:30 (prior day) GMT, June 3.7%.

Industrial Output at 23:50 (prior day) GMT, June +1.3%,

Joseph Trevisani
FX Solutions
Chief Market Analyst

[email protected]

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