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Market Directions Sunday, September 23, 2007

Market Directions Sunday, September 23, 2007

The Week in Review September 17 - September 21

  • The Fed, the Fed, the Fed and the 0.5% cut
  • The ECB pulls its rate punches
  • The worldwide rate reduction cycle begins?

United States

It would be hard to overstate the effect that the Federal Reserve decision to cut the base American interest rate, the Fed Funds, had on market perceptions this week. The Fed move instantly shifted the economic focus from inflation to growth and from confidence to concern. No central bank in the industrial world can afford to discount Fed policy and by the end of the week recognition of that fact was heard in statements from the European Central Bank (ECB) and the Bank of England (BOE). In the aftermath of the Fed the Dollar reached a new low against the Euro, surpassing even the nadir of its trading against the old German Deutsche Mark , and the Yen crosses returned to popularity. The speculative Dollar Index also sank to a record level.

In his appearance before Congress on Thursday, Ben Bernanke offered no elaboration on the terse policy statement issued by the Fed on Tuesday accompanying the rate announcement. He did, however, warn Congress against the 'moral hazard' of legislating a bail out for parties in the sub-prime debacle. That warning must hold as well for Fed policy. Inflation readings have helped give the Fed the leeway to cut rates, though it is likely Mr. Bernanke would have cut at least 0.25% even if inflation was considerably higher. But commodity prices are rising and gold traded at a 27 year high during the week.

By surprising the markets with a large reduction Mr. Bernanke has purchased time for the financial system to return to normal. The next Fed policy meeting is not until October 31st and by then many of the unknowns in the asset backed market should have been vetted and refunded. Inflation has not vanished from the American or the world economy. The US economy is growing as is the EMU, and the financial picture may well look very different in six weeks. The Fed has not changed its opinion that the financial turmoil of the last weeks is not an economic collapse, it has simply given the market time to discover that fact for itself.


The European Central Bank began the post Fed week on Wednesday with brave words about inflation and price stability. Klaus Liebscher, head of the Austrian National Bank and governing council member, said that the ECB "must do what is necessary "   to preserve price stability.    He implied that the Federal Reserve rate cut did not prevent the ECB from hiking again.

The next ECB policy meeting is October 4th in Vienna. By then the board members will have the August money supply and credit supply figures. Noting that worldwide energy and commodity prices have risen sharply, Mr. Liebscher said "I would not be surprised if in the next few months we see higher inflation rates than we have seen in the past". He was repeating the standard ECB analysis on inflation. It is not necessarily wrong, even though the HICP inflation rate in the EMU zone has now been at or below the 2.0% target for 12 straight months. During the same period the money supply figures have been between 9% and 11%, well beyond the ostensible ECB target of 8.0%. His view on the market turbulence of the past six weeks echoes the original reaction of Ben Bernanke, the Federal Reserve Chairman. The financial market problems are for the banks themselves to settle. "I don't see now that you can solve the problem if the banks and the financial intermediaries do not react immediately…we can only give advice to the industry". Mr. Liebscher also predicted that the market turmoil  "will continue for a certain period of time", and that "surprises should not be excluded". That was on Wednesday, one day after the Fed surprise.

On Thursday French President Nicholas Sarkozy called for the ECB to lower rates. "When the US central bank lowers its rates, everything picks up; when we don't lower rates we go down. I'm telling Mr. Trichet look what others are doing". This is not a new position for the French President. He made the same criticism during the election campaign and his ministers have voiced similar sentiments since they came to power.

On Friday, Lorenzo Smaghi, ECB Executive Board member, spoke in approving tones of the long time United States "strong Dollar policy ".    He characterized the oft repeated US Treasury official mantra not as an attempt to manipulate the exchange rate but as a recognition of a basic economic fact, that a strong American currency is good for the United States and the US economy. Among other uses of a strong currency is the check it provides on domestic inflation.

And lastly, also on Friday, Jean Claude Trichet the ECB President said that the bank has been successful in "very solidly" anchoring price stability in the EMU. If inflationary expectations are 'anchored', then why does the bank need to continue to raise rates? This question will be asked across Europe and in all public forums as the next ECB meeting approaches. If the Euro is "a currency that inspires confidence" surely it no longer requires the support of an aggressive monetary policy.

European economic growth appears to have peaked in the 4th quarter of last year. The EMU Purchasing Managers Index (PMI) for September fell in all categories. The manufacturing index slid to 53.2, much less than the median forecast of 53.9 and more than a full point below the August figure of 54.3. The services sector scored only 54.0, well behind the 57.5 prediction and the August return of 58.0. It was the lowest result for the services measure in two years and the largest monthly drop in the history of the series which began in 1998.

If the Fed and then the Bank of England are cutting rates, if EMU economic growth is slowing and inflation is under control and if EMU exports are suffering from the pains of an expensive currency, can the ECB remain stationary for long? The real question is when will the currency markets begin pricing the almost inevitable ECB rate cut?


The Bank of Japan (BOJ) declined to raise the overnight call rate beyond its current 0.5%. The vote was 8 to 1. Board member Atsushi Mizuno voted against leaving rates unchanged as he had at the previous two policy meetings. The BOJ last increased its base rate in February when it hiked 0.25%. The bank launched its "flexible and gradual" series of rate hikes in July 2006, when it boosted rates for the first time in six years. BOJ Governor Toshihiko Fukui has made public his desire to 'normalize' the Japanese rate structure but he has been thwarted by political opposition from the ruling Liberal Democratic Party (LDP). The BOJ is worried that low interest rates could encourage artificial additions to Japan's manufacturing capacity which would add to the potential for price deflation. Governor Fukui has also stated that inflation expectations are "the biggest enemy" for a central bank. However, inflation in Japan is very tame. The July national core CPI was actually 0.1% lower than a year earlier and down for the sixth month in a row. Second quarter GDP was revised lower to -1.2% from the initial +0.5% reading. Industrial Output and Household  Spending were both negative in July as well, though the Japanese government has said that they expect a substantial rise in output in August. Despite BOJ intentions and inflation concerns the chance for further rate increases this cycle is vanishing.

The LDP will choose it new leader on Sunday to replace Shinzo Abe, the former prime minister who resigned earlier this month. In Japans' parliamentary system the leader of the party with control of the lower house of the Diet, the legislatureautomatically becomes Prime Minister. The two leading candidates are former chief cabinet secretary Yasuo Fukuda and the LDP's current secretary-general, Taro Aso. Fukuda is ahead in opinion polls and among LDP members. Both are long time LDP politicians and will offer few new ideas or initiatives. The Japanese public is already tired of the economic reforms of Junichiro Koizumi and concerned about the widening rift between the wealthy and the rest of the populace.

Economic Releases September 17 – September 21

United States

Tuesday: the Producer Price Index (PPI) for August was much lower than forecasts at -1.4%, with the core reading as predicted at +0.2%. The year on year rate for both measures is now 2.2%. Falling energy prices in the month lowered the overall number without affecting the core result. The National Association of Home Builders Housing Market Index fell to 20 in September down two from August, its seventh monthly fall in a row since it scored 39 in February of this year. The September reading equaled the record low from January 1991; the series has been kept since 1985. Net Long Term Securities transactions as reported by the Treasury International Capital system of the Treasury Department listed a very modest inflow of $19.2 billion in July. A total of $24.7 billion were purchased by overseas buyers, $20.3 billion from private sources and $4.4 billon by official sources. American bought $5.5 billion of foreign securities.

Tuesday: the Producer Price Index (PPI) for August was much lower than forecasts at -1.4%, with the core reading as predicted at +0.2%. The year on year rate for both measures is now 2.2%. Falling energy prices in the month lowered the overall number without affecting the core result. The National Association of Home Builders Housing Market Index fell to 20 in September down two from August, its seventh monthly fall in a row since it scored 39 in February of this year. The September reading equaled the record low from January 1991; the series has been kept since 1985. Net Long Term Securities transactions as reported by the Treasury International Capital system of the Treasury Department listed a very modest inflow of $19.2 billion in July. A total of $24.7 billion were purchased by overseas buyers, $20.3 billion from private sources and $4.4 billon by official sources. American bought $5.5 billion of foreign securities.

Wednesday: the Consumer Price Index (CPI) fell slightly in August 0.1%, bringing the year on year rate to 2.0%.; a flat number had been predicted. The core rate rose 0.2%, a year early rate of 2.1%. The core annualized rate for July and August based on the unrounded monthly results is now 2.32%, the three month rate is 2.48%. Energy prices fell 3.2% in the month, mostly on gasoline and natural gas price declines which made the overall rate less than the core. But with crude oil at more than $80 a barrel and commodity prices rising, the string of lower core results going back to January are probably at an end. Housing Starts in August shrank 2.6% from July to 1.331 million units, a twelve year low. The July figure was adjusted down to 1.367 million from 1.381 million. Single family house starts skidded 7.1%, but multi-family starts jumped 12.8%. Building Permits plunged 5.9% to 1.307 million with single family permits falling 8.1% to their lowest level since June 1995.


Thursday: European Monetary Union (EMU) construction Output in July was flat, the elapsed yearly rate was at +1.7%. The June number was revised down to +0.5% from +0.6%, the yearly to +2.6% from +2.7%.


Tuesday: the ZEW Survey of financial experts for September's 'economic expectations' dropped for the fourth month in a row coming in at -18.1 below the expected16.0. The August reading was -6.9. The 'current conditions' number was short of the median prediction of 75.0, reaching only 74.0. August had registered 80.2. It is the third monthly drop in succession. "The second considerable decline of business expectations since the beginning of the sub-prime crisis makes clear that the financial experts do not rule out the possibility that the crisis could spill over to the German economy", the ZEW statement said.

United Kingdom

Tuesday: the Consumer Price Index (CPI) for August was up 0.4% and elevated by 1.8% for the year, the same as the monthly estimate and very close to the prediction for the yearly number of +1.6%. July's results were was -0.6% and +1.9%.

Thursday: Retail Sales in August performed better than expected rising 0.6% for the month, 4.9% better than a year ago. A flat monthly had been the median prediction with +4.0% for the year. In July sales rose 0.7% and 4.4% on the year. Confederation of British Industry (CBI) monthly Industrial Trends Survey reported a 0.6% gain in 'total orders' for September; in August it rose 0.9%.

The Week Ahead September 24– September 28

United States

Tuesday: Case-Shiller Home Price Index for July at 9:00 ET; June 217.07. Conference board Consumer Confidence for September at 10:00 ET; August 105.0. National Association of Realtors (NAR) Existing Home Sales for August at 10:00 ET; July 5.75 million.

Wednesday: Durable Goods Orders for August at 8:30 ET; July +5.9%, 'excluding defense' +4.9%, 'excluding transport' +3.7%.

Thursday: final GDP for the second quarter at 8:30 ET; preliminary +4.0%. New Home Sales for August at 10:00 ET; July 870,000.

Friday: Personal Income for August at 8:30 ET; July +0.5%. Personal Expenditures for August at 8:30 ET; +0.4%. Chicago Purchasers Index for September at 9:45 ET; August 53.8. Final University of Michigan Consumer Sentiment for September at 10:00 ET; preliminary 83.8. Construction Spending for August at 10:00 ET; July -0.4%.


Monday: Industrial New Orders for July at 9:00 GMT; June +4.4% m/m, +13.8% y/y.

Thursday: Money Supply (M3) for August at 8:00 GMT; July +11.7% y/y, +11.1% three month moving average y/y.

Friday: Initial 'Flash' Harmonized Index of Consumer Prices (HICP) for September at 9:00 GMT; August +1.8% y/y. EMU Economic Sentiment Index for September at 9:00 GMT; August 'Economic Sentiment' +110.0, 'Industry Confidence' +5, 'Consumer Confidence' -3, 'Business Climate Indicator' 1.41.


Tuesday: IFO Survey for September at 8:00 GMT; August 'Business Sentiment' 105.8, 'Current Assessment' 111.5, 'Business Expectations' 100.4.
Wednesday: GfK consumer Confidence for October at 6:00 GMT; September 7.6.

Thursday: Unemployment Rate for September at 7:55 GMT; August 9.0%. Preliminary CPI for September-release time unannounced; August -0.1% m/m, +1.9% y/y. Preliminary HICP for September-release time unannounced; August -0.1% m/m, +2.0% y/y.

Friday: Import Prices for July at 6:00 GMT; June +0.3% m/m, +0.4% y/y. Export Prices for July at 6:00 GMT; June 0.0% m/m, +1.6% y/y.

United Kingdom

Monday-Friday (date unannounced) Nationwide House Prices for September at 6:00 GMT; august +0.6% m/m, +9.6% y/y.

Wednesday: second quarter GDP 3rd release at 8:30 GMT; prior +0.8% q/q, +3.0% y/y.

Thursday: CBI distributive Trades survey for September at 10:00 GMT; August 17.

Friday: GfK Consumer Confidence for September at 9:30 GMT; August -4. Land Registry House Prices for August at 10:00 GMT; July +0.1% m/m, +8.8% y/y.


No significant releases


Monday: markets closed for Autumnal Equinox holiday.

Friday: National core CPI for August at 23:30 GMT (August 27); July -0.1% y/y. Central Tokyo CPI for September at 23:30 GMT (August 27); July 0.0% y/y. Unemployment Rate for August at 23:30 GMT (August 27); July 3.6%. Household Spending for August at 23:30 GMT (August 27); July -0.1%. Industrial Output for August at 23:30 GMT (August 27); July -0.4% m/m. Retail Sales for August at 23:30 GMT (August 27); July -2.2% y/y.

Joseph Trevisani
FX Solutions
Chief Market Analyst

[email protected]

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