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Sunday October 14, 2007 - 23:47:48 GMT
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Market Directions Sunday, October 14, 2007


Market Directions Sunday, October 14, 2007

  • Credit markets amnesia, will the Central Banks put away their knives?
  • The Europeans learn to love a strong Euro?
  • The G7 meets and meets and meets?

The Week in Review October 8 - October 12

Two weeks of inconclusive movement have left traders looking outside the market for new impetus. If the Federal Reserve now appears much less likely to cut rates at its next meeting October 31, so to does the ECB when it convenes on November 8th. If the EMU economies seem to be defying the third and fourth quarter slowdown anticipated by many just four weeks ago, so the American consumer has hardly paused working and spending. The surmise that the US economy has more to fear from the sub-prime and credit markets has carried the Euro to historic levels against the Dollar, but is it still justified? Is the Euro really leading the way?

Because ECB and BOE rate cut expectations, predicated almost solely on the financial market turmoil which began in August, have diminished as well as that of the Fed, the Dollar has been left no better off. Officials of all three central banks have been at pains to remind the markets of the still extant inflation threat and their own determination to rein it in.

The G7 meeting this coming Friday in Washington will not produce an agreement to support the Dollar. As if to underline this American President George Bush said in a interview with the Wall Street Journal published Friday that a strong dollar policy is the "correct policy", and that the "best way [to value] a currency is through the market".

The basic assumption driving the Euro has been the risk evaluation that the Fed preventive rate cut was substantive, that the US economy courted recession in the coming months and the Fed would be forced to cut again. But so far the evidence has not proved the case. If anything it has pointed the other way with US job growth and consumer spending remaining strong. US GDP expansion could well be above 3.0% in the third and fourth quarters with European growth falling to 2.5% or less. Even in the 2nd quarter the differential between the US and EMU economies was 1.3% in favor of the Americans.

The decisive move of the past two weeks has been the resurgence of the Euro/Yen and the Yen crosses. These currencies thrive in a stable rate environment. If a retreating US economy promised further Fed rates decreases, market judgment would also assign a higher probability to a future ECB reduction. If the ECB was going to cut rates, even if only for precautionary reasons, where would that leave the Euro/Yen? Currency markets are predicting that the August credit market panic is history, that it will not foster a worldwide economic slowdown and that the US economy will emerge largely unscathed. Otherwise the risk averse Yen crosses would not be within a hair of their all time high. The Yen crosses are the bell weather of today's currency markets, not the Euro or even the Dollar.

Central Bank Rate Actions
Bank of Japan leaves the overnight call rate at 0.5%.
Reserve Bank of Australia keeps the cash rate at 6.5%.

The Week in Review October 8 -October 12

United States

The September 18th FOMC vote to cut the Fed Funds rate was unanimous. The minutes cited two reasons for this "prudent action". First was the concern for the impaired functioning of the financial markets, and second was the potential for reduced economic growth from that impact. Perhaps a bit surprisingly the FOMC members disregarded the August Non Farm Payroll numbers of -4,000. They assumed that "employment was probably not as weak as the most recent monthly data had suggested". The committee was right on target as the upward revision of the August number revealed a week ago.

Also from the FOMC minutes was the prescription for rate policy, "future actions would depend on how economic prospects were affected by market developments and other factors". The major economic statistics from this past week do not indicate a serious slowdown in the US economy. Weekly Jobless Claims have continued to decline. Retail Sales were much better than expected and PPI, particularly core PPI without the automobile price reductions, was very active. Clearly there are building price pressures in the consumer goods pipeline.

There are less than three weeks until the next Fed policy committee. This coming week we will see Industrial Production, core CPI and the 'Beige Book'. None of these are likely to convince the Fed that another rate cut is necessary to float the US economy. The 'moderate expansion' term of the last 'Beige Book' is more indicative of an economy poised for increased growth than one slipping. The US economy has been under stress and a cloud of worry since the third quarter of last year. It is important to remember this background when one charts future prospects. All is not as dire as the economic projections tell. Projections are by their nature linear, people and the economy are not. The statistics will tell the story; it behooves traders to listen to exactly what they are saying. Or, to paraphrase John Maynard Keynes, 'If the facts haven't change, why change your mind?"

Despite the greatly reduced expectations for a Fed Funds rate cut at the October 31st Fed meeting the Dollar Index is only 0.5% above its all time September 28th low.


ECB officials deployed their public comments this week promoting the dangers of EMU inflation and the bank's steadfast role in countering it. The commotion among the united currency's finance ministers early in the week when they met, ostensibly to consider the 'strong Euro' came to naught. The ministers could not even agree among themselves that the current Euro level was a problem. Except for France and Italy, none of the other finance ministers appeared to think it was.

Industrial Production recovered nicely in August and the second reading of GDP for the second quarter at 2.5% is one that the ECB can live with, wary as it may be of its effect on inflation. ECB economists consider that GDP rate near the limit for non inflationary growth.

Despite the curious comment from Jean Claude Trichet on Tuesday's that 'the headline M3 number may overstate [its] actual strength', in testimony before the EU parliament, the bank left no doubt that it still considerers inflation the primary threat. "We need further gathering of data but the baseline scenario [good economic growth and potential inflation] is very much confirmed at the present moment", said Mr.Trichet.


German Finance minister Peer Steinbrueck would rather have a strong Euro than a weak one. "I love a strong Euro", is his now famous formula. And as a finance minister who wouldn't adore a strong currency. It restrains domestic inflation, reduces government financing costs, draws private investment and promotes business efficiency. Hank Paulson, the American Treasury Secretary, and his predecessors have long said the same thing.

United Kingdom

British officials, like their continental counterparts, returned the focus to inflation. There were no hints in the Pre Budget Report of the Bank of England Governor Mervyn King that a rate cut is being considered. As a prescription for financial panic he said that the Monetary Policy Committee (MPC) will not "insulate" the banking sector from the re-pricing of risk. It is not likely he would have made such a comment if he thought there was real chance of returning credit market turmoil.

Chancellor of the Exchequer Alastair Darling reduced the government estimate for 2008 GDP growth forecast to 2.0%, specifically "because of the problems...coming out of America this summer are now affecting economies across the world..." But like King, he was careful not to infer monetary policy from his observation.

The Business and Financial Services sector is the largest industry in Britain, comprising one quarter of the economy and responsible for almost all private sector job growth. Though it has not yet showed in the statistics the financial market events of the past three months must necessarily have negative effects.


Economic Releases October 8 -October 12

United States

Thursday: the International Trade Balance sank in August to -$57.5 billion almost 2.5% under the median projection of -$59.8 billion; July's deficit was trimmed slightly to -$59.0 from -$59.2 billion. The Euro rose 30 points against the dollar on the release. Imports fell 0.4%, the most in six months; exports rose the identical amount. The 2.4% decline from July to August in the overall deficit came despite a 7.0% hike in the cost of oil imports, the biggest increase in five months. The trade balance is currently benefiting both side of the equation, with a slower US economy importing less and a weak dollar prompting foreign buying from American producers.

Weekly Jobless Claims for the week ending October 6th fell 12,000 to 308,000 substantially more than the expectation of -2,000 and 315,000. The four week moving average slipped to 310,250 continuing the downward trend begun a month ago.

Import Prices jumped 1.0% in September as predicted with a 5.4% rise in petroleum accounting for the entire increase. Non petroleum prices fell 0.2.

Friday: Retail Sales in September at +0.6% doubled estimates, the markets had been looking for +0.3%; August was unrevised at +0.3% but July added 0.1% to +0.6%. Sales ex auto was also better than forecast, +0.4% as opposed to +0.3%; August was unchanged at -0.4%. The Dollar gained 25 points against the Euro on the release but stalled and then reversed at 1.4150.

Most consumption estimates for the third quarter are now north of +3.5%, which should put GDP for the quarter near 3.25%, a very respectable number in the post sub prime world. Analysis of the details of the Retail Sales report varied with the beholder. Some commentators found the overall reading, twice the market expectation, indicative of an unworried consumer and robust spending heading into the holiday season. Others focused on the fact that price inflation in the two strongest selling categories, gasoline and food, accounted for almost all their increase.

The Produce Price Index (PPI) for September jumped 1.1% more than twice the predicted +0.4%. The PPI core (ex food and energy) rose only 0.1%, half the preliminary estimate. Automobile prices are included the PPI core measure and were the reason the core increase was moderate. Car prices fell 1.8% in September and light truck charges dropped 0.5%. Without this drag the core would have risen a much more inflationary 0.3%. Other categories displaying large increases were pharmaceuticals +0.5%, home furniture +0.5% and alcohol +0.6%, this last particularly worrisome heading into the holiday season.

Consumer Sentiment in October, according to the University of Michigan preliminary reading, deflated to 82.0, below the forecast of 84.0 and the lowest result since August 2006, when it was also 82.0.


Thursday: second quarter GDP was unrevised on its second issue at +0.3% for the quarter and +2.5% for the elapsed year. The yearly result for the first quarter was revised up 0.1% to +3.2%; the quarterly figure was unchanged at +0.7%.

Friday: Industrial Production expanded 1.2% in August, much more vigorously than the expected +0.3%. July was adjusted higher by 0.1% to +0.7%. The yearly rate was 4.3% in August; the prediction had been +2.1%; the July rate was +3.7%. EMU planners can now look for Industrial Production to add substantially to GDP growth in the third quarter; it had slowed in the second.


Monday: Total Manufacturing Orders for August at +1.2% were well under the expectation of +2.0%, but as July was revised up by almost the same amount that August was under, to -6.1% from -7.1%, the effect was moot. The seasonally adjusted Trade Balance for August was +E15.3 billion, less than the +E16.4 billion median projection. Imports rose 5.6%, exports gained 3.0%. In July both had fallen, 2.8% for imports and 0.3% for exports. The overall July number was adjusted to +E16.5 billion from +16.4.

Tuesday: Industrial Production rose 1.7% in August, more than three times the forecast of +0.5%. The growth was led by manufacture of consumer durable goods. July's result gained slightly on revision, to +0.2% from +0.1%.

Wednesday: the German Chamber of Industry and Trade (DIHK) Balance of Business Expectations fell in September to 15 from 24 in August. This trade group polls 25,000 companies each month and calculates this indicator by subtracting the number of those firms whose business expectations to be poor from those firms who judge expectations to be good. "The economic euphoria is over", said DIHK. The trade group also cut its GDP forecast for 2007 to +2.5%, it had been +2.8%.

Thursday: Wholesales prices as recorded by the Federal Statistical Office (FSO) rose 0.9% in September, the highest monthly increase since April of last year. The annual rate was 4.0%; in August the yearly rate was 2.5%.

United Kingdom

Monday: Manufacturing Output in August reached its highest level in six years gaining 0.4% for the month and +0.6% year to year. July's results were -0.3% and +0.8% respectively. Industrial Production rose 0.1% in August, +0.7% on the year; the July statistics were -0.1% monthly and +0.9% yearly. Output Producer Prices jumped 0.1% in September, a +2.7% yearly rate. In August these prices rose 0.1% and 2.5%. Core Output Prices gained 0.2% m/m and 2.2% y/y in September. Input prices rose a dramatic 3.2% in September more than twice the forecast of +1.5%. The yearly rate was +6.4%, also well in advance of the prediction for +4.5%. In August the same 'input' statistics were -0.5% m/m and +0.6% y/y. Soaring crude oil prices were the greatest contributing factor in the input price rise.

Wednesday: British Retail Consortium (BRC) Retail Sales in September were twice as strong as forecast, +3.0% versus +1.5%.; August had registered +1.8%. British consumers seem to be unaffected by the Northern Rock bank rescue by the BOE early in the month.

Thursday: Royal Institute of Chartered Surveyors (RICS) House Price Survey which measures the difference between gainers and losers in house prices exhibited -14.6 in September, nearly three times the -5.0 forecast. The August reading was revised down to -3.3 from -1.8. House buyer inquiries were at the lowest level since 2003.


Friday: the Trade balance in September fell 4.3% to +$23.9 from Augusts' +$24.9 billion. Nevertheless, the balance for the first nine months of 2007 was +$185.66 billion an astonishing 69% higher than the same period in 2006.

The Week Ahead October 15 -October 19

United States

Tuesday: Treasury International Capital System (TICS) net long term securities transactions for August at 9:00 ET; July +$19.2 billion. Industrial production for September at 9:15 ET; August +0.2%. Capacity Utilization for September at 9:15 ET; expected 82.2%, August 82.2%. NAHB Housing Market Index for October at 13:00 ET; September 20.

Wednesday: CPI for September at 8:30 ET; August -0.1%, core +0.2%. Housing Starts for September at 8:30 ET; August 1.331 million units. Building Permits for September at 8:30 ET; August 1.322 million units. Federal Reserve Beige Book, September "moderate expansion' in 10 of 12 Federal Reserve districts.

Thursday: Jobless Claims for week ending October 13; prior week -12,000 to 308,000.


Tuesday: ZEW Survey for October at 9:00 GMT; 'Expectations' -20.3 in August, 'Current Conditions' 65.6.

Thursday: Preliminary Trade Balance for August at 9:00 GMT; seasonally adjusted -E0.6 billion, non seasonally adjusted +E4.6 billion in July. Final HICP for September at 9:00 GMT; preliminary +0.1% m/m, +1.7% y/y. Construction Production for August at 9:00 GMT; August 0.0% m/m, +1.7% y/y.


Tuesday: Final CPI for September at 6:00 GMT; preliminary -0.1% m/m, +1.9% y/y. Final HICP for September at 6:00 GMT; preliminary -0.1% m/m, +2.0% y/y. ZEW Survey for October at 9:00 GMT; September 'Economic Expectations' -18.1, 'Current Conditions' 74.4.

Friday: PPI for September at 6:00 GMT; September 0.1% m/m, +1.0% y/y.

United Kingdom

Sunday: Rightmove House Prices for October at 23:01 GMT; September -2.6% m/m, +9.6% y/y.

Monday: DCLG House Price Index for August at 8:30 GMT; July +12.4% y/y.

Tuesday: Core CPI for September at 8:30 GMT; August +1.8% y/y. HICP for September at 8:30 GMT; August +0.4% m/m, +1.8% y/y.

Wednesday: ILO Unemployment Rate for August at 8:30 GMT; July 5.4%. Average Earning including bonus for August at 8:30 GMT; July +3.5% y/y. BOE minutes for the October 3&4 Monetary Policy Committee meeting.

Thursday: Retail Sales for September at 8:30 GMT; August +0.6% m/m, +4.9% y/y.

Friday: Third quarter GDP, first estimate, at 8:30 GMT; second quarter +0.8% q/q, +3.1% y/y.


Monday: Consumer Confidence for September at 5:00 GMT; August 44.0. Industrial Output for August at 4:30 GMT; July -0.4%.

Wednesday: Tertiary Index for August at 8:50 GMT; July -0.5%. Revised Leading Index for August at 5:00 GMT; July 72.7, 'Coincident Index' 70.0.


No important releases

Joseph Trevisani
FX Solutions
Chief Market Analyst

[email protected]

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