Consolidation in the Euro this week gave no comfort to advocates for the return of the Dollar. Weak economic statistics from the US and a partial return to US investing by foreign purchasers kept traders from capitalizing on the relatively strong position of the Dollar early in the week. The best level for the US currency against the Euro came on Monday, a day when US markets were closed. European statistics point to a slipping industrial base coupled with rising inflation, a central bankerâs nightmare. But future consumer spending on the continent is not thought to be hostage to a collapsing housing market and thus less likely to damage future economic growth. Nor has the European Central Bank (ECB) been forced to lower interest rates to ward off serious economic problems. Estimates for American economic growth in the last quarter of this year and the first of next are now between 1 and 2%, a long way from the projected 5% growth in the third quarter. It is not that the future does not look troubled in Europe, it does. But the view in Europe is mostly of worry; in the US worry is starting to become reality.
Sterling depreciated sharply pressured by concerns over financial sector weakness, an inflation report from the Bank of England that seemed to predict two 25 basis point rate cuts in 2008 and poor retail sales and housing numbers. The financial sector in the city of London is the largest single creator of jobs in the British economy. Contraction there will have a disproportionate on unemployment in the country.
After this week the case is strong that the economic bad news for the Sterling and Dollar is priced into the market; the vulnerability for the Euro is that it is not. European statistics have only started to report what US and British figures have already revealed. Due to both the later reporting of many EMU statistics -- for instance October retail sales for the Euro area will not be released until December 5th, (US retail sales for October were out November 14th), EMU industrial production for October is not issued until December 12th (US industrial production for October was released on November 16th) and Euro area consumer confidence for November is reported November 30th (University of Michigan consumer confidence for November was reported on November 9th) -- and because the number of Euro area statistics is far less and so less frequent, the Euro can benefit from this relative economic opacity when the news is poor. Because any decline in EMU statistics is reported later, bad news from the US for the same month affects the Dollar first and is not counterbalanced from Europe until weeks after. Because there are fewer statistics for the EMU as a whole than for the US, there is simply less bad news to report. The psychological impact on the market of the continual update of poor US statistics against the relative sparsity of EMU statistics should not be underestimated.
The commodity currencies, the Australian, New Zealand and Canadian Dollars all recovered from their precipitous declines which began on November 7th, but with economic growth estimates shrinking worldwide the immediate future for them remains downcast. The Yen crosses augmented the change in fundamental outlook for these currencies adding their highly speculative liquidity to the cascade of positions looking for an exit.
The Week in Review November 12 â November 16
Ben Bernanke the Federal Reserve Chairman has promised greater transparency for the Fedâs deliberations and economic projections. The central bank under his leadership has already greatly altered its relations with the press and the market. And though his predecessor Alan Greenspan is best remembered for his cryptic comments and witty asides, rare in public economists, he had also done much to open the Fed to outside scrutiny. It is only in retrospect that Mr. Greenspan appears close with his communication. The question for market participants is will this new transparency add or detract from volatility. Many factors have worked to lower volatility in currency markets in the past fifteen years but one of the most effective has the spread of information. Volatility thrives in the absence of knowledge. The more the Fed reveals of its information gathering and analysis the more traders will be able to discern correctly its future policies. The more traders know the less room there will be for speculation. The unexpected development will never disappear, witness the almost overnight eruption of the credit crisis in August, but the speculative charge given to the market as it anticipates Fed policy will continue to diminish.
The immediate response to CPI and Core CPI at +3.5% and +2.2% was the thought that such levels would limit the Fedâs ability to reduce rates if further reductions become necessary. However, as Mr. Bernanke has clearly proven, in such a case the Fed would probably lower rates anyway, even if immediate inflation prospects would argue restrain in a normal economy. In a perverse way the higher inflation represented by the CPI numbers confirms the basic Fed scenario, faster growth in quarters two and three may have spurred inflation, slower growth should keep inflation in check.
Industrial production and capacity utilizations fell unexpectedly in October, reinforcing the market pricing of a Fed 0.25% rate cut at the December 11th meeting. Part of the fall in industrial production was due to weather related declines in electric and natural gas production from warmer temperatures, much like a similar drop in industrial production in January. All categories of production fell, manufacturing, autos and housing and related industries.
Nicholas Sarkozy, the French president, pushed for more public participation in debates on monetary policy, including with the ECB. âEurope has chosen democracy and in a democracy one must be able to debate everything: monetary policy, budget policy, trade policy industrial policy, fiscal policy, all policies whatever they may beâ. In the past the ECB has always responded vigorously to attempts by European politicians to pressure its decisions. This time there was no response. The EU is seen by many European voters as bureaucratic and without much popular legitimacy or loyalty. Voter loyalty in even the long established members of the EU lies with the national government and not with Brussels. Officials of EMU institutions, including the ECB have consequently felt a need to vehemently defend any threats to their independence from national politicians.
Barclays Bank will write down ÂŁ1.3 billion, $2.66 billion in losses associated with credit products. UBS was reported in the Wall Street Journal to face more than $7 billion in similar write downs but neither story swayed market conviction that the risk center of the credit crisis is in the United States.
The inflation report of the Monetary Policy Committee of the Bank of England predicted that CPI would be well below the 2.0% target if rates are kept at the current 5.75% level and that it would be at 2.0% two and three years out at market rate assumptions. Since market pricing assumptions have rates at 5.5% by the first quarter of 2008 and 5.2% in the first quarter of 2009, the reportâs implication of at least two 0.25% rate cuts was more of an admission than expected and contributed to the Sterling sell off.
In November the yen has traded in almost a 6 % range against the Dollar, rising almost 4.5% on the week to Fridays close. Normally this type of volatility brings Japanese officials leaping to the microphones to decry âexcessive currency volatilityâ or some other such complaint. In the context of this rising Yen the comments from Chief Cabinet Secretary Machinura are most striking. âFrom the long term perspectiveâŠa rising Yen should not be rejected, but I emphasize, long termâ. âI think that Yen appreciation is desirable for the economyâ. The yen has not yet improved so much that it is a drag on Japanese exports and a strong Yen does serve as a backstop against inflation, should it arise. 110.00 Yen per Usd is probably near the center of the range that Japanese manufacturers and economic planners find comfortable. Since by several measures the Yen is as undervalued or more so than the Chinese Yuan and Japanese competitiveness benefits as the Yuan rises, and the Chinese government has faced increasing criticism from other industrialized nations for the value of the Yuan, now does not appear to be a politic time for Japanese officials to complain about currency movements or the appreciating Yen.
The Bank of Japan voted 8-1 to leave rates at 0.5% at its regular policy meeting on Monday. The last rate change by the BOJ was the 25 basis point increase in February.
Economic Releases November 12 - 16
Tuesday: National Association of Realtors (NAR) pending Home Sales gained 0.2% in September to 85.7, a much better performance than the 2.5% decline that had been predicted. But the index remains off 21% since last September.
Wednesday: Retail Sales rose 0.2% in September as expected; the September result added 0.1% on revision to +0.7%. Sales minus food and automobiles added 0.3% also as expected. The increases in both numbers were due to the gasoline and food components which reflected higher prices not higher volumes. The Produce Price Index was benign in headline and core numbers in October. The core rose only 0.1%, less than the +0.2% predicted and the headline number gained 0.1%, a quarter of the 0.4% gain anticipated. The yearly rate was +1.1%.
Thursday: CPI rose 0.3% in October. The 3.5% yearly rate was the highest since last August. The core rate added 0.2% in the month, 2.2% on the year. Both CPI statistics were exactly as expected.
Friday: Industrial Production contracted 0.5% in October against an expected 0.1% rise. All categories of production fell, led by utilities, which suffered from unusually warm weather, but seconded by auto, housing and manufacturing. The September figure was revised 0.1% higher to +0.2%. Capacity Utilization dropped to 81.7%, undercutting the 82.0% forecast and the 82.0% figure in June. Net US capital flows failed to meet the current account deficit for the third month in a row. The Treasury International Capital System (TICS) accounted a net loss in totals flows of $14.7 billion; the September figure was revised up to -$150.7 billion from -$163.0. Net long term securities transactions were positive at $26.4 billion; in August the flow was reversed at -$70.3 billion. The current account deficit, commonly called the âtrade gapâ has averaged a little more than $59 billion per month this year. Long term securities flows have collapsed in the third quarter averaging -$24.7 billion per month; in the first half of the year they measured +$85.9 on average per month. Since mid June the Dollar has depreciated 10.6% against the Euro. Europeans are the largest overseas investors in the United States economy.
Monday: Industrial Production contracted 0.7% in September, more than three times as much as the predicted -0.2%. In August production had expanded 1.2%. Industrial Production was 3.5% ahead of the level last year but that was much less than the 4.7% gain predicted. The August year on year rate was revised 0.2% higher to 4.5%.
Wednesday: third quarter GDP rose 0.7% as expected, a 2.6% annual rate. Though the monthly addition to GDP was more than twice that of the second quarter (+0.3%, +2.5%) the recovery is forecast to be short lived as the predicted US slowdown and remaining credit market problems exact their toll on EMU growth. .
Thursday: the harmonized inflation index (HICP) for October was unchanged from its flash estimate at +0.5% for the month and +2.6% for the year. These are the highest reading since September 2005. Prices were largely driven by increases in oil products and seconded by rising food prices. Though some analysts see inflation reaching 3.0% annually by the end of the year the ECB is not likely to hike rates, worried by signs of slipping economic growth and repercussions of the credit market contractions.
Monday: the ZEW survey of financial experts for November turned in some of its lowest reading in a decade. The headline âeconomic expectationsâ category registered -32.5, well below Octoberâs -18.1 and the lowest reading since February 1993. It was also the fifth decline in six months and the largest drop since the sub prime and credit problems surfaced in early August. The long term average is 31.8. Wolfgang Franz, ZEW President, blamed the decline on the âfinancial crisisâ and âthe depreciation of the US Dollar. âCurrent conditionsâ fell slightly in November to 70.0 from 70.2 in October. It was the weakest reading since March.
Wednesday: GDP added 0.7% in the third quarter as anticipated, a 2.4% yearly rate according to the Federal Statistical Office (FSO). It was the fastest quarterly growth this year, (Q1 +0.5%, Q2 +0.3%).
Thursday: HICP inflation reached a six year high in October at +0.2%, +2.7% for the year, confirming the flash estimate. It was the second 2.7% month in a row. As in the EMU, prices were led by increases in oil and food. October oil prices were counted against the much lower price base for oil which existed last October when crude oil was around $60 a barrel.
Monday: Department of Communities and Local Government (DCLG) House Price Index rose 10.8% in September, a 0.5% drop from the August rate. The Royal Institute of Chartered Surveyors (RICS) saw a 22.2% fall in October prices reported by its members in the prior three months. It was the most negative balance since June 2005. New buyer inquiries fell for the 11th straight month.
Tuesday: CPI added 0.5% in October, breeching the 2.0% BOE target in October by pushing the yearly rate to 2.1%; +0.3% and +1.9% had been predicted. The core rate rose 0.3% for the month and 1.5% for the year, the same as in September; +1.7% had been predicted. Gas and food prices led the way to the highest monthly rate since June.
Wednesday: the ILO unemployment rate was stable in September at 5.4%. Average earnings advanced 4.1% in September over a year prior, greater than the 4.0% predicted and the highest reading since March. Earnings gained 3.7% in August. Private sector earning rose 4.7%.
Thursday: Retail Sales sank 0.1% in October well under the +0.1% median prediction. The 4.4% yearly growth was 0.2% below predictions. Septembersâ results had been +0.6% and +6.3% respectively. Sterling fell on the release.
Tuesday: 3rd quarter GDP added 0.6% and 2.6% in the yearly accounting; +0.4 and +1.8% had been forecast. 2nd quarter GDP was lowered 0.1% to -0.4%
Tuesday: the Consumer Price Index (CPI) was 6.5% higher in October than in the same period a year ago. It was the fastest rate of inflation on the mainland in more than a decade and above the 6.2% rate in September. Food price inflation was the strongest driver with non food CPI gaining only 1.1% for the month.
Wednesday: Retail Sales in October rose 18.1% over a year ago, it was the largest increase this year; in September the year on year rise was 17.0%
Thursday: the yearly gain in Industrial Productions fell slightly in October to 17.9%; 18.5% had been expected; in September the gain was 18.9% over the prior year.
Chief Market Analyst
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