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Monday September 10, 2007 - 11:27:08 GMT
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Market Directions Sunday September 9, 2007

Market Directions Sunday September 9, 2007

  • US job growth plummets, the Fed dusts off its white hat
  • The ECB quick steps to a new economic tune, but promises to remain true to the old standards
  • China raises the banking system reserve requirement for the seventh time this year

The Week in Review September 4 -September 7

United States

The Non Farm Payrolls (NFP) on Friday gave the Federal Reserve its economic rational to cut the US Fed Funds rate. The loss of four thousand jobs in August shocked all markets; most observers had looked for the creation of 100,000 new jobs. The reaction against the Dollar, the Dow Jones Industrial Average and the Yen crosses was swift and permanent.

The markets are now presented with a new economic scenario and a new set of Fed and ECB assumptions; neither development has been fully priced.  The Dollar fell more than two figures against the Yen, a figure against the Euro and 200 points versus the Sterling. The ECB  has been forced to act against its better instincts, the Fed will soon be. This is an unusual situation for the world's central bankers who have been practicing a new brand of transparent communication with the financial and currency markets. Until now the inflation targeting by both banks has been viewed as a success. Inflation rates have responded as predicted and the communication skills of the bankers have produced very few surprising moments. But inflation targeting is a poor policy guide for disruptions of the type the credit markets have witnessed since early AugustAnd by acting under duress and only after other remedies were tried, both central banks have created an additional non transparent source of worry and a heightened sense of unease. Former Fed Chairman Alan Greenspan must have had a satisfied afternoon on Friday; his view of the close and important connections between the financial markets and the economy is looking correct right now.

The Fed Chairman, Ben Bernanke, can now reduce interest rates with reference strictly to the economic fallout from the credit markets and without the appearance of bailing out Wall Street institutional investors and investment banks. In the two months of the third quarter to date, payrolls have averaged only 32,500 per month, barely one fourth of the monthly average in the second quarter. It is likely that the employment fallout from the financial sector layoffs, let alone from the worsening construction industry, has barely begun to hit the payroll numbers. Things will get worse before they get better. The potential cycle of job losses, falling wages, shrinking consumer spending and rising mortgage foreclosures could easily propel the economy into recession. With such a large overhang of poor quality mortgages the downdraft on the economy could be powerful.

Over the next few weeks almost $1 trillion in commercial debt, specifically asset backed commercial paper (ABCP), will enter the credit markets needing refinancing. This is more than five times the amount of debt that has come due since the credit market problems began one month ago. A good portion of this debt has little to do with sub-prime mortgages and much has nothing to do with mortgage securitization at all. If the issuers of the debt cannot find buyers in the market then some of this paper could end up on the books of the banks that structured the original debt instruments and provided contractual back up credit lines for the issuers. In many cases the banks are obligated to buy back the debt if it cannot be sold on the open market. More than anything else it is this unknown addition to their balance sheets that is making the banks very wary about lending and it is why they are keeping their cash close to home instead of lending it out to the credit markets--they cannot now tell how much of this asset backed commercial paper will be on their books at the end of the quarter September 30th or the end of October. A cut in the Fed Funds rate will do very little to alleviate this worry.


Despite the deliberate implication of a 0.25% rate increase at the August second meeting of the ECB, financial events have supplanted intentions. The ECB did not raise the refinancing rate at their Thursday policy meeting. It remains at 4.00%; the vote to stay was unanimous. Jean Claude Trichet, the central bank president, avoided using the code "strong vigilance' and then, as he had done at the August 2nd meeting where he did utter the phrase, he pointed out to all the reporters at the press conference, that he did not say 'strong vigilance'. "I did not pronounce the word 'strong vigilance' and I don't want to comment any more than that", he said. OK, one is bound to think, we get it. He also stressed that the bank 'compass' remained fixed on "price stability" but that, "We have to care for an appropriate functioning...of the money markets at whatever price, at whatever interest rate".

The ECB analysis is very similar to that of the US Federal Reserve, Mr. Trichet is just more oblique in his statements. EMU economic growth is strong though recently signs have crept out that the expansion peak has passed. And though inflation is subdued, is not absent. But it not enough for 'main street' to feel secure, financial markets must function smoothly. To borrow a line from the novel Dune 'the credit must flow'. The ECB does not have to comment on the wisdom of the wholesale creation of asset backed instruments in the past few years nor on the habit of funding many of these long term instruments with short term credit. They know that a severe credit market contraction will damage indiscriminately, good credit worthy firms will be shut out of funding as well as poor substandard ones. In the current situation the weight of the risk has changed dramatically since early August and ECB clearly feels compelled to support the economy as opposed to targeting inflation.

On Friday ECB governors were at pains to tell the markets and the financial press that the central bank remained very concerned about inflation. No doubt they are, but their worry for the economy is far greater. "As we say in German delaying something does not mean that it has been ruled out.....The process of adjusting [interest rates higher] has not ended', said Alex Weber. While Jurgen Stark commented that the link between trend inflation and money growth is intact and leads to inflation within two or three years. And that every surge in money growth is followed by inflation. ECB Money supply growth (M3) was 11.7% in July far beyond the 8.0% target. 

It is quite possible that in two months time the credit markets will  have resumed normal functioning and the ECB will again take up its inflation quest. Unfortunately it is just as possible that the credit market  contraction will seriously damage the 'real economy' and that  ECB rate hikes are over for this cycle.

United Kingdom

The Bank of England (BOE) left if main interest rate unchanged at 5.75%. But, in what was an unusual move for the bank, it also issued a statement explaining its action. Most BOE policy decisions are unaccompanied by justification. The Thursday statement cited financial market disruptions and concerns over asset backed securities as part of the background that led to the MPC decision.


The People's Banks of China (PBOC) raised the reserve requirement for Chinese banks another 0.5% to 12.5%, effective September 25th; it was the seventh increase this year. The PBOC also promised to let the markets have more said in determining the Yuan exchange rate. What that promise might mean for the appreciation of the Yuan was not elaborated. Premiere Wen Jiabao said that growth was a bit fast and credit a bit loose. The Beijing government has been less than successful at reining in speculation and inflation in the Chinese economy. There is no reason to think that this latest move will suffice. But there may be help on the horizon in the form of slower economic growth in China's Western export markets.

Economic Releases September 4 - September 7

United States

Monday: The August Institute for Supply Management (ISM) Index came in on point for August; the headline figure was 52.9 against the prediction of 53.0 and 53.8 in July. Prices moderated to 63.0 as predicted, down from 65.0 in July and employment improved to 51.3 from 50.2 in July. The ISM has not, in the past, been swayed by market events, and the continued moderate expansion does not, and should not be expected to reflect the recent financial market turmoil. Construction Spending slipped 0.4% in July, worse than the flat reading that had been forecast, but as the June number was revised higher the identical amount to +0.1% from -0.3%, the overall effect was moot.

Wednesday: the National Association of Realtors (NAR) Pending Home Sales record dropped 12.2% in July to 89.9; June was 102.4. It was the largest decline in the history of the series and leaves the sales figures down 16.1% year to year. This statistic tracks home sales that are "in contract", that is a price has been agreed between the parties but the deal has not closed. NAR suggested that disruptions in the mortgage markets are causing mortgage commitments by lenders to be withdrawn. The Federal Reserve 'Beige Book' became the latest official acknowledgement of the financial market turmoil, saying that recent problems have "deepened" the housing slump. But the overall tone of the economy as reported in the 12 reserve districts was still positive, "reports... indicate that economic activity has continued to expand" at a moderate or modest rate though the pace of activity has slowed in some districts. While noting that the declines in the housing and construction sectors were continuing, "Outside of real estate, reports that the turmoil in financial markets had affected economic activity during the survey period were limited".

Thursday: Unit Labor Costs for the second quarter were revised down to  1.4% from 2.1% in the prior release. However, the total increase remained brisk at 4.9% over the last four quarters. Productivity in the second quarter was adjusted to a +2.6% annual rate from +1.8%. One of the major gauges of the service based US economy the Institute of Supply Management (ISM) Non Manufacturing Report showed consistent strength in August measuring 55.8, the same as in July and substantially better than the median forecast of 54.5. New Orders scored 57.0 well ahead of the July reading of 52.8. The Employment number fell to 47.9 in July, much weaker than June's 51.7, which was the lowest score since December 2003. The report was a mixed bag with the headline number depicting moderate growth and a robust new orders component but a weakening employment picture. According to ISM Survey Chief Anthony Nieves, "A steep drop in the...non-manufacturing employment index reflects caution and not an actual decline in business conditions".

Friday: Non Farm Payrolls registered a fall of -4,000 jobs in August; the median prediction had been for a gain of 100,000. Payrolls for June and July were also revised down a total of 81,000. The Dollar suffered an immediate penalty, in the first five minutes after the release at 8:30 am it dropped 70 points against the Euro, 90 against the Yen and 85 versus the Sterling. The Euro/Yen dropped more than 50 points. The carnage in job creation was universal: the construction industry shed 46,000 jobs, retail trade 27,000, and even government payrolls sank by 28,000. The unemployment rate stayed at 4.6%, despite the job losses, due to the end of temporary summer employment for many thousands of students.


Tuesday: Real GDP for the second quarter was unrevised at +0.3% quarterly and +2.5% yearly. The yearly figure for the first quarter was adjusted slightly higher to +3.2% from +3.1%. Annual EMU GDP peaked in the third quarter 2006 at 3.3% and was 3.2% in the fourth. Several reasons are postulated for the decline: a delayed effect from the increase in the German value added tax (VAT) that took place in January, the drag of the high Euro on exports to the United States and the high price of imported oil. Except for the North Sea production, EMU nations import virtually all their crude oil. The Produce Price Index (PPI) gained 0.3% in July a +1.8% annual clip; +0.2% and +1.7% had been forecast. The annual rate for June was revised to +2.2% from +2.3%.

Wednesday: Retail Sales for July gained less than anticipated at 0.1%, median expectation had been +0.3%. The June results were adjusted up to +0.6% from +0.4 and the year to year result was moved up to +1.0% from +0.9%. May was revised down 0.1%.


Thursday: Total Manufacturing Orders fell 7.1% in July, much more than the 3.2% decline predicted. The June version of this volatile series was revised up to +5.1% from +4.9%.

Friday: July Industrial Output rose only 0.1%, forecasts had been for a gain of 0.7%. The June number was revised up to +0.2% from -0.4%. The Manufacturing Output for July moved ahead 0.2%; the June result was revised up to -0.3% from-0.5%.

United Kingdom

Monday: British Retail Consortium (BRC) Retail Sales rose 1.8% year on year in Aug, one third better than the July figure +1.2%. July had been the lowest gain since last November. Total Sales rose 3.7% annually in August compared with 3.1% in July a gain of 3.0% had been forecast.

Tuesday: the Chartered Institute of Purchasing and Supply (CIPS) Manufacturing PMI for August scored a three year high at 56.3, up from 55.7 in July. It is the 20th month in a row that it has been above the 50 dividing line between contraction and expansion.

Wednesday: the CIPS Services PMI for August rated 57.6, well over the median expectation of 56.5; July was 57.0. Input Price Inflation was 57.5 in August the same as in July and the lowest level since October of last year. Prices Charged were stronger in August 53.1 from 52.2 in July, indicating that firms are more sanguine about being able to raise prices in the future. Services are 75% of the UK economy and the Monetary Policy Committee (MPC) of the Bank of England said the relatively low level of current price inflation contributed to the MPC decision not to raise rates.

Thursday: Manufacturing Output for July fell 0.3% leaving the elapsed year at +0.8%. Both numbers were well below the median prediction of +0.2% monthly and +1.2% yearly. Industrial Production for July fell 0.1% monthly, the yearly result was +0.9%; +0.2% and +1.0% had been forecast. The May and June monthly figures were each adjusted down 0.1%.


Tuesday: The monetary base for August rose 0.7% over a year ago. It was the first expansion in 18 months, and far ahead of the July when it contracted 2.3%.

The Week Ahead September 10 -September 14

United States

Tuesday: International Trade Balance for July at 8:30 am; expected -$59.5 billion, June -$58.1 Billion.

Friday: Retail Sales for August at 8:30 am; expected +0.6%, July +0.3%. Retail Sales ex food and Autos at 8:30 am; expected +0.2%, July +0.4%. Industrial Production for August at 9:15 am: expected +0.3%, July +0.3%. Capacity Utilization for August at 9:15 am; expected 82%, July 81.9%. University of Michigan Consumer Sentiment for September at 10:00 am; expected 83.5, August 83.4.


Wednesday: Industrial Production for July at 9:00 GMT, m/m and y/y; June -0.1% m/m, +2.3% y/y.

Friday: Final HICP for August at 9:00 GMT m/m and y/y; expected -0.2% m/m, 1.8% y/y.


Friday: Final CPI for August at 6:00 GMT m/m and y/y; expected 0.4% m/m, 1.9% y/y. Final HICP for August at 6:00 GMT m/m and y/y; expected 0.5%

United Kingdom

Monday: Output Produce Prices for August at 8:30 am GMT m/m and y/y; expected +0.1% m/m, +2.4% y/y. Input Produce Prices for August at 8:30 am GMT m/m and y/y; expected -1.0% m/m, +0.6% y/y.

Wednesday: ILO Unemployment Rate for July at 8:30 am GMT; June 5.4%, Average Earnings including Bonus for July at 8:30 am GMT three month average y/y; expected +3.4%, June +3.3%. RICS House Price Survey for August at 23:01 GMT; expected +10.0%, July +12.6%.


Monday: Producer Price Index for August, release time unannounced ytd; July +2.4%.

Tuesday: Consumer Price Index for August, release time unannounced ytd and, y/y; July +5.6% ytd, +3.5% y/y.

Wednesday: Retail Sales for August, release time unannounced, ytd and y/y; July +16.4% ytd, +15.5% y/y.

Thursday: Industrial Output for August, release time unannounced, ytd, y/y; July +18.0% ytd, +18.5% y/y%.

Friday: Fixed Asset Investment for August, release time unannounced, y/y; July +26.6%.


Monday: Second quarter revised GDP at 23:50 GMT (prior day): first release +0.1%. Money Supply for August at 23:50 GMT (prior day): July +2.0%.

Tuesday: Machinery Orders for July at 23:50 GMT (prior day): June -10.4%.

Wednesday: Consumer Confidence for August at 5:00 GMT; July 44.4.

Friday: Revised Industrial Output for July at 4:30 GMT; June +1.3%.

Joseph Trevisani
FX Solutions
Chief Market Analyst

[email protected]

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