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Friday September 28, 2007 - 16:44:04 GMT
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FX Briefing - More signs of economic slowdown in US and eurozone

FX Briefing 28 September 2007

·        Highlights

·        Inflation rises in Germany, but eurozone inflation remains on track

·        Further decline in industrial and consumer sentiment in the eurozone

·        US housing market slump still continues

·        US new orders levelling off, consumer confidence waning


More signs of economic slowdown in US and eurozone

The dollar continued to weaken this week. EURUSD hit a fresh high of 1.4198. Emerging market currencies such as the rand, real and Turkish lira firmed particularly, gaining more than 1%. The Australian and New Zealand dollar and the Norwegian krone also did really well. In contrast, the yen only inched forward to about 115.30 against the dollar. After having fallen to 150 in August, EUR-JPY is now back to around 163.50, slowly coming within reach of the record highs reached in mid-July. The high was at 169. It looks rather as though carry trades might become more popular again.


The widespread belief that the US economy is slowing down significantly and that consequently the Fed will cut interest rates by at least a further 50 basis points, is the main argument against the dollar. The latest US economic indicators did not offer any big surprises that could have altered this belief; they underlined the negative trend. The housing market situation deteriorated again in August. Existing home sales declined by 4.3%; theoretically, it would take 10 months to sell the houses currently on the market. The new home sales situation looks even worse: compared to July, sales fell sharply by 8.3%, partly due to financing problems; the preceding months’ figures were revised down quite sharply. The median price was 7.5% lower than last year. Due to a structural shift towards lower priced houses, the price drop could have been distorted downwards, however. Nevertheless, according to the S&P/Case-Shiller Home Price Index, which tracks price developments in city areas, prices dropped by almost 4% year-on-year in July. In August and September, pressure on prices is likely to have increased. Thus all in all, it looks as though house prices are now declining significantly.


Apart from the housing market, there are more and more signs pointing to an economic slowdown. The Conference Board’s consumer confidence deteriorated markedly in August and September. It is now just over 100 – the lowest it has been since autumn 2005. Americans have become much more pessimistic about the current situation, particularly about the availability of jobs. In this environment, private consumption is only likely to have recovered moderately in Q3 after a weak second quarter, and in Q4, consumption could slow down significantly.


Up to now, the manufacturing sector has been quite robust. It looks as though production in Q3 was just as strong as in the previous quarter, presumably partly due to lively demand from abroad. However, durable goods orders seem to be levelling off. The backlog of aircraft orders will keep things going here for a while, but new orders dropped to more normal levels in August. Ex transportation, the development has been much more moderate, particularly bearing in mind that in July and August the US Department of Defense placed more orders than average. Orders for capital goods ex defence and aircraft seem to have remained flat in the third quarter, and the same goes for deliveries in this category. Consequently, investment in machinery and equipment probably only grew moderately in the third quarter.


Whereas almost all US data are indicating that an economic slowdown is underway, the signs coming from Europe are mixed. Sentiment has dimmed considerably in the eurozone. The ifo business climate index fell in September for the fourth consecutive time. Business expectations are now on a neutral level again; companies’ assessment of the current situation, which had been favourable up to now, is becoming less positive. In the manufacturing sector, most of the single components such as new and existing orders, production plans and stocks held, have deteriorated.  Industrial confidence is falling in most other eurozone countries as well, with the exception of France, where the automobile industry seems to be booming at the moment.


Consumer sentiment is deteriorating sharply too, and this also goes for France. Apparently the financial crisis and rising energy and food prices are having a negative impact. In Germany it looks as though turnover in the classic retail sector has fallen again in Q3. The only exception here are car sales, which seem to be recovering slightly, but they are still below last year’s level.


As far as the real economy is concerned, the prospects for the eurozone are dim. But given the euro’s strength, the question uppermost in market participants’ minds is whether this makes ECB interest rate cuts more likely. Up to now, the central bank has been tight-lipped on this subject. According to comments made by some central bank representatives, the ECB is more likely to consider resuming tightening at some point in time.


The unexpectedly steep increase in the German inflation rate to 2.5% year-on-year in September worried market participants initially. On the eurozone level, inflation is still within the expected target range. Nevertheless, if there is no respite from energy prices, the inflation rate in the eurozone could remain over 2% until spring 2008. In the short term, there are even upside risks due to the oil price situation and rising food prices.


This price environment makes it difficult for the ECB to react to the economic risks. A preventive rate cut is not very likely. At its meeting next Thursday, the ECB Council will presumably highlight economic uncertainty, while at the same time pointing out the inflation risks, as at the beginning of September. This wait-and-see attitude could push the euro even higher. In the medium term, however, inflation prospects have not deteriorated markedly, quite the contrary. Demand is slackening, and due to the appreciation of the euro and significantly higher money market rates, monetary conditions are getting much tighter


Stephan Rieke +49 69 718-4114

Economics Department

+49 69 718-3642

[email protected]

Foreign Exchange Trading

[email protected]

Jörg Isselmann

+49 69 718-2695

Matthias Grabbe / Klaus Näfken

+49 69 718-2688


This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHF-BANK Group") solely for the information of its clients. The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results. This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it. BHF-BANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities. This publication must not be distributed in the United States.

© 2007 BHF-BANK Aktiengesellschaft

All rights reserved. Please mention source when quoting from it.


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