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Sunday October 21, 2007 - 16:17:10 GMT
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Market Directions Sunday, October 21, 2007


There is still a week and a half before the next FOMC decision on October 31st. Fed Chairman Ben Bernanke has said repeatedly that the decision will be determined by the state of the economy as reflected in the statistics. But the Fed now has a new worry, the equity market. If Thursday's poor jobless claims number had tilted the speculative see-saw toward a 0.25% cut then the Friday collapse in stocks will keep the lever pinned to the ground. Can the Fed not cut rates again?

Even though several important statistics will be released before the Fed decision, the futures market had, by late afternoon on Friday, fully priced in a 4.5% Fed Funds rate. The day before the same futures pricing had predicted only a 48% chance for a rate cut. None of the pending statistics, Durable Goods Orders, Consumer Sentiment, the Chicago Purchases Index, 3rd quarter GDP and three housing figures will allay the Fed's economic fears. When the Fed meets it will also be able to consider the pre release ISM, PCE inflation and Non Farm Payroll numbers for October. Even the best results for these numbers are now unlikely to prevent additional Fed rate cuts and none will provide support for the Usd.

No one statistic of the past several weeks has been strongly Dollar negative. Most have shown continuing moderate growth in GDP and consumer spending but the Dollar has continued to fall. The problem for traders is that the market sentiment is overwhelmingly against the USD. That sentiment cannot be altered by rationed good news or a moderately expanding economy. The governing market assumption, one might call it the 0.5% thesis, is that the strains on the US economy will keep the Fed on the defensive and the economy from trend growth for the next two quarters. Bad sentiment cannot be driven out by mediocre news; the Dollar cannot recover while the Fed is the only central bank reducing rates.

The logic for this FOMC meeting is the same as it was for the September 18th assembly  last month. The danger posed to continued moderate economic growth outweighs the potential exacerbation of inflation. If the Fed had this one good reason to cut rates last month does it now have any good reasons not to cut? What could the Fed view as more important than economic growth? Moral hazard in the financial markets? The six month horizon for inflation? The falling Dollar? None of these possibilities can overcome the economic damage from a recession. In fact all of these concerns, while real, will be made measurably worse if the economy slips into recession. Inflation is tame. Growth worries can only have been made worse by Friday's equity slide and the credit market problems have not vanished. The question can be asked again. What good reason does the Fed have for not cutting rates? It is difficult to formulate an answer. In addition, it would be rare in modern Fed history for the bank to cut rates only once in a cycle. If the Fed cuts on the 31st logic predicts further cuts as well. If the Fed rate reduction horizon has just lengthened then the decline of the Dollar has also.

In the something for everyone department the G7 communiqué is one of the best. The foreign exchange paragraph of this communiqué is worth quoting in its entirety. “We reaffirm that exchange rates should reflect economic fundamentals. Excess volatility and disorderly movements in exchange rates are undesirable for economic growth. We continue to monitor exchange markets closely, and cooperate as appropriate. We welcome China's decision to increase the flexibility of its currency, but in view of its rising current account surplus and domestic inflation, we stress its need to allow an accelerated appreciation of its effective exchange rate”. Issued by the assembled finance ministers after Friday’s meeting in Washington its virtue is to please all without offending any. Anyone that is, as long as one is not from Beijing. “Excessive volatility” satisfies those Europeans who dislike a high Euro and Euro/Yen; China’s mention satisfies all manner of trade warriors; “monitor” and “cooperate” keeps the internationalists happy. Every finance minister and politician can find in the text the appropriate phrase for reference during their news conferences back home, whatever the inclinations of the national audience.

Central Bank Rate Actions

Bank of Canada left the main overnight rate unchanged at 4.5%.

The Week in Review October 15 - October 19

United States

The descent of the US housing market accelerated this week, postponing any serious hope for recovery well into 2008. All three major housing market indicators recorded worse than expected results, but the news had little direct effect on the Dollar. There has been so much bad news from this sector that almost anything short of a complete cessation of all sales is already factored into the market. The dollar took its biggest single hit on Thursday from Weekly Jobless Claims a volatile and relatively minor statistic. The reaction to this number evidenced the extreme fragility of the Dollar to anything that indicates weakness in the US economy particularly in job creation.

Projections for weak 3rd quarter corporate profits from American heavy equipment manufacturer Caterpillar and other corporates, on Friday slammed the major US equities averages and returned what had been a mildly recovering Dollar to the defensive. The equities have been one of bright spots in a wary economic picture.

The sub prime and credit crunch which began two months ago took its toll of foreign investment in August with the net long term capital flows registering their first decline since 1995. This is the second month in a row that capital funding has been less than the amount needed to offset the US trade deficit.

The Fed Beige Book prepared for the Oct 30-31 meeting of the FOMC showed continued expansion in all districts, but it cited decelerating growth since August. Consumer spending rose but reports varied from district to district. Real estate continued to weaken. All in all this book reflects the trend we have been seeing in this anecdotal survey for many months, with slowly accumulating pressure on economic growth and heightened uncertainty among responders about the economic outlook. GDP in the 4th quarter appears that it will be considerably weaker than in the third.


Economic growth in the EMU is slowing but for an ECB very uneasy about inflation it has not been enough to make them break inflation cover and reduce interest rates. If the economic picture continues unchanged then logic and their own statements would put them on hold until the end of the year. If however, the Fed cuts American rates at the end of the month and the Euro then reaches 1.4500 and higher, the game changes. It will be hard for the European central bank governors to deflect the outcry from politicians and the media. And, more importantly, their own economic projections will point to the same dangers currently so evident from Washington. The ECB governors may not quite admit it but their next rate decision will probably be determined on Halloween in Washington.

United Kingdom

Retails sales for September were six times the expected rate and will certainly give the Monetary Policy Committee (MPC) pause when it contemplates its next rate decision on November 8th. But recent inflation numbers may lean the MPC in the opposite direction. Headline CPI was 1.8% in September, better than expected. And, most impressively, core CPI was only +1.5% year on year, much lower than the +1.8% prediction and a large improvement from the +1.8% rate in August and the +2.0% in June. MPC had voted 8-1 for unchanged rates at beginning of the month. The majority on the committee is shy of cutting for two reasons: lower rates could ward off the economic slowdown predicted in their August report and that the MPC expects to keep a lid on inflation; secondly, they did not want to appear to be overly supportive of the financial markets in its recent troubles. Preliminary GDP for the third quarter, +0.8% and +3.3% annualized was the highest quarterly figure in three years and is perhaps another militating factor against a rate cut. If the main argument for reducing rates is the potential for economic slowdown from housing and lingering financial markets effects then the accuracy of that view is undermined by the recent retail sales that were the driving force behind 3rd quarter growth. Given the distribution of votes on the Monetary Policy Committee, the recent economic results and the relative calm in the credit markets rate cuts might not be granted for some time. Much will depend on the world reaction to the US equity fall on Friday.


With the end of the 17th Communist Party Congress market expectations are for further Peoples Bank of China rate increases. Food inflation is a serious concern for the Beijing Government. The average Chinese family spends almost 40% of its budget on food and the potential for political unrest in the poorer provinces is never far from the government's mind. The end of the twice a decade Beijing political chautauqua frees policy makers from distraction and they will return their focus to the rampant growth and speculation that are their main concerns.

At the Party Congress President Hu Jintao said that the Chinese economy continues to strengthen and pledged to make economic growth more balanced instead of relying on investment and exports. For investment read Foreign Direct Investment, for exports read replace exports with domestic consumption. China's biggest development problem is the income disparity between the booming wealthy coastal cities and the rest of the country. The party's biggest problem is that poverty, corruption and economic envy in the hinterland is a potentially explosive political situation. If the government is to encourage domestic consumption and investment then it must find a way to spread growth and wealth to the interior of the country.

Economic Releases October 15- October 19

United States

Tuesday: Industrial Production gained 0.1% in September as predicted, but Augusts' number lost 0.2% on revision to flat. Auto manufacturing output fell 3.3% in the month largely due to the two day General Motors strike. Non auto manufacturing added 0.3%, a reasonable recovery after the flat result in August and the financial market upsets.

Capacity Utilization was 82.1% in September as expected, virtually unchanged from 82.2% in August.

The Treasury International Capital system (TICS) in August registered the first decline in net long term capital flow since 1995 at -$69.3 billion. About half of the deficit was due to foreigners selling US assets and half to the overseas investments of US residents. Foreign investors sold $34.9 billion of US Securities, $24.2 billion by official institutions and $10.6 billion by private investors. US residents bought $34.5 billion in foreign securities. It was the first net sale of securities by foreigners since 1998. Private investors and hedge funds sold US equities and central banks sold US Treasuries. Overseas investors had been forecast to purchase $60 billion of US debt instruments. Coming after July's far below average inflow of just $19.2 billion the exodus aroused concerns about the funding of the US trade deficit which requires about $60 billion a month of net purchases. The credit crisis in August forced many owners of US debt to sell all or part of their holdings. Net sales by private investors were predominantly in equities and corporate paper exactly what one might expect in a credit panic. But the demand of these same private investors for US Treasuries and government agency debt, the least risky class of securities, rose. The TICS number has always exhibited a great deal of month to month volatility. Two months do not make a trend and with US equities staging a strong recovery in September and October, a return to the US market for foreign capital can be expected.

The National Association of Home Builders (NAHB) Housing Market Index for October at 18, 2 down from September, was the lowest score for this series since inception in 1985.

Wednesday: consumer inflation in September rose 0.3% a 2.8% yearly rate; the core rate gained 0.2% or 2.1% yearly. Though both numbers were largely as predicted, the core rate has ceased falling in August and September. Prior months had dropped steadily from February's 2.7% rate.

Housing Starts fell 10.3% in September to 1.191 million units the smallest number since March 1993 and well off the 1.3 million expected. Building Permits shed 7.3% to 1.226 million also the lowest since 1993.

Thursday: weekly jobless claims for the week ending October 13th rose 28,000 to 337,000 against the expectation of 312,000. A labor Department official said that a 'portion' of the rise was due to 'seasonal adjustment volatility'. Weekly numbers by nature vary widely but these results did nothing to alleviate the gloom gathered about the Dollar. The Euro reached 1.4311,  in the aftermath.

NAHB Housing Market Index fell to 18 in October, down two from September and a new low record for the series which began in 1985.


Tuesday: final September HICP was unrevised at +0.4% and +2.1%, the highest yearly reading since +2.3% in August 2006. It was the first time in 13 months that the harmonized index has been at or above the 2.0% ECB target. The rate in August was 1.7%.

Thursday: Construction Output improved +0.4% in August, a +2.8% yearly rate; for July the rates were revised down to -0.1% monthly and +1.4% yearly from 0.0% and 1.7%, June results were also dropped to +0.3% from +0.6%. A surge in German output was the largest component in the EMU statistic.


Tuesday: final HICP for September came in as expected +0.2% but the +2.7% yearly figure was the highest in six years. The last time this standardized EMU statistic was above 2.0% in Germany was July 2006. Final CPI for September rose 0.1% to 2.4%. Though this was slightly better than the forecasts of +0.2% and 2.5%, the annual rate was the highest in two years. It was last at 2.5% in September of 2005.

The ZEW Survey for October showed business attitudes largely unchanged from the prior month: 'expectations were -18.1 the same as in September and 'current condition' fell slightly to +70.2 from +74.4. Both numbers were as forecast.

Friday: PPI accelerated in September to +0.2% and +1.5%, double the monthly rate in August and half again the yearly rate. Though PPI was less than the forecasts of +0.4% and +1.8%, and was led by volatile energy prices, with oil touching $90 a barrel this week there is no comfort in these numbers for the ECB.

United Kingdom

Monday: Rightmove house prices from the online property site jumped 2.7% in October erasing the 2.6% decline in September. The yearly rate moved up to 10.4% from Septembers' +9.6%. The DCLG House Price Index dropped one percent in August to +11.4% from the July result of +12.4%. This statistic records an actual transaction price, an simply the asking prices. The apparent contradiction between the two widely used house price surveys is due to a new government reporting requirement. Known as the Home Information Pack this puts a reporting burden on sellers who may have been rushing to complete sales before the September 10th deadline.

Tuesday: CPI in September at +0.1% and +1.8% for the year was lower than the forecast of +0.2% and 1.9% and cleanly below the BOE 2.0% target measure. Core CPI was flat and up 1.5% annually, well under the 1.8% expected yearly rate. Sterling dipped 45 points on the release.

Wednesday: ILO unemployment rate stayed constant in August at 5.4% as expected. Average Earnings rose at a 3.7% three month moving average yearly rate. In July it gained 3.5%.

Thursday: Retail Sales volume surged 0.6% in September to 6.3% for the elapsed year. It was the highest annual rate in three years, and well ahead of the median forecasts, +0.1%, +5.6%.

Friday: preliminary GDP gained 0.8% in the third quarter and 3.3% yearly, slightly better than the +0.7% and +3.2% forecast .


Monday: The People's Bank of China raised the reserve requirement effective October 25th for the eighth time. The 50 bps point hike brought the reserve to 13.0% the highest ever and brings the increase this year to 400bps. The PBOC has already raised rate five times this year and the reserve requirements seven times.

The Week Ahead October 22 - October 26

United States

Tuesday: Richmond Federal Reserve District Manufacturing Index at for October at 10:00 ET; September 14.

Wednesday: Mortgage Bankers Association (MBA) Mortgage Application Index for the week ending October 19th at 7:00 ET; prior week +0.7% to 656.3. Existing Home Sales for September at 10:00 ET; August 5.50 million.

Thursday: Jobless Claims for the week ending October 20th at 8:30 ET; prior week +28,000 to 337,000. Durable Goods Orders for September at 8:30 ET; August -4.9%, ex defense -5.4%, ex transport -1.8%. New Home Sales for September at 10:00 ET; August 795,000.

Friday: Final University of Michigan Consumer Sentiment for October at 10:00 ET; preliminary 82.0.


Tuesday: Industrial New Orders for August at 9:00 GMT; July -4.0% m/m, +10.9% y/y.

Wednesday: Current Account for August at 8:00 GMT; July seasonally adjusted +E36.6 billion, not seasonally adjusted +E3.3 billion. Flash (1st issue) Manufacturing PMI for October at 9:00 GMT; September 53.2. Flash (1st issue) Services PMI for October at 9:00 GMT; September 54.2.

Friday: Money Supply (M3) for September at 8:00 GMT; August +11.6% y/y, 3 month moving average +11.4% y/y. Loans to private sector for September at 8:00 GMT; August +11.2% y/y.


Thursday: IFO Survey for October at 8:00 GMT; September 'business sentiment' 104.2, 'current assessment' 109.9, 'business expectations' 98.7.

Friday: GfK Consumer Confidence for November at 6:00 GMT; October 6.8.

United Kingdom

Monday: CBI Industrial Trends Survey for October at 11:00 GMT; September 'monthly orders balance' 6. CBI Quarterly Industrial Trends Survey for Q4 at 11:00 GMT; Q3 'business optimism balance' -2. .

Tuesday: Nationwide House Prices for October at 7:00 GMT; September +0.7% m/m, +9.0 y/y.

Thursday: Chancellor of the Exchequer Alistair Darling testimony to the Treasury Committee at 11:00 ET.

Friday: Land Registry House Prices for September at 11:00 GMT; August +0.2% m/m, +9.4% y/y.


Friday: National Core CPI for September at 23:30 GMT (October 25); August -0.1%. Central Tokyo CPI for October at 23:30 GMT (October 25); September -0.1%.


Monday: Q3 GDP (release time undetermined); Q2 +11.5% y/y. CPI for September (release time undetermined); August +6.5% ytd, +3.5% y/y. Fixed Asset Investment for September (release time undetermined); August +26.7% y/y.

Joseph Trevisani
FX Solutions
Chief Market Analyst

[email protected]

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