Monday September 27, 2004 - 21:37:58 GMT
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Currency Markets At The Mercy of Oil
DailyFX Fundamentals 09-27-04
By Kathy Lien, Chief Strategist at www.dailyfx.com
· US New Home Sales Surge By Largest Amount In 14 Years
· German Business Confidence (IFO) Weakens Modestly
· Yen Weakens As Oil Prices Hit New Highs
The biggest news in the market today is the rapid rise in oil prices. NYMEX crude tested its record high of $49.40 after eight consecutive days of gains on fears that fresh violence in Nigeria will cause supply disruptions and that shorter-term disruptions will occur in the US as a result of Hurricane Ivan. If you recall, the rally in oil prices in the first half of August took a significant toll on the global economic recovery. Central banks around the world cautioned about the threats to their country’s growth if oil continues to rise. In the first 2 1/2 weeks of August, the 6.7% rise in oil prices coincided with an approximately 400-pip rally in the euro. Looking back from the early 70's forward, there are observable and dramatic changes in GDP growth in relation to changes in the world oil price. The price shocks of 73-74, the late 1970s/early 1980s, and early 1990's were all followed by dramatic recessions, which have then been followed by a rebound in economic growth. The pressure of energy prices on aggregate prices in the economy created problems for the economy as a whole. Additionally, there have been three global recessions in the past 30 years, and all of them were pre-dated by a sharp rise in oil prices. Higher oil prices erode the purchasing power of both consumers and corporations and if history is a good future benchmark, then traders should hang on for what may be a deeper slide in global growth. The only immediate respite would be a more generous release of oil from the US’ Strategic Petroleum Reserve. The White House did announce that they would release a limited quantity in response to Hurricane Ivan. However, the 3m barrels over the course of a few weeks is nothing compared to the daily global demand of 80m barrels. Meanwhile in Europe, the German IFO survey of business sentiment weakened modestly to 95.2 from 95.3. This indicates that although there was no growth, sentiment is still consistent with a modest recovery.
The dollar weakened despite a 9.4% surge in new home sales during the month of August. The sharp demand for new housing contrasts with the 2.6% decline in existing home sales reported last week. Although the Federal Reserve has increased interest rates three times this year, the relatively low level of interest rates still spurs housing market demand. The average rate on a 30-year mortgage decreased from 6.06% in July to 5.87% in August. Although nearly everyone in the market is calling for a top in the housing boom, we have yet to see any compelling evidence of this doomsday scenario. However, it is a trend that requires monitoring since most consumers have their wealth in stocks or real estate. If the housing market does turn and oil prices remain elevated, consumers will become increasingly thrifty, which will filter into corporate earnings, and then we would have a big problem at hand.
The pound is recouping its losses for the third consecutive day as it plays off of general dollar weakness. There is a lot of important economic data due for release from the UK over the next few days including house prices, GDP, the current account balance, consumer credit and the GfK consumer confidence survey. Data is likely to be mixed with an upward revision to GDP and most likely weaker house prices and consumer confidence. The BBA reported today that mortgage lending fell 4.1% during the month of August. Although this is exceptionally weak, the slowdown in the housing market is an undisputable reality. As such, further evidence supporting this fact has only led to a nominal currency reaction. Instead, the pound has been supported by talk of a big dividend payment (possibly 1 billion GBP) to a UK bank from a dollar denominated asset. Once the flow passes though, gains in the pound should be limited.
The dollar extended its breakout against the Japanese yen today as the yen suffered from net portfolio outflows and rising oil prices. For the week ending September 17th, Japanese investor demand for foreign bonds outstripped foreign demand for Japanese bonds by $10.7 billion. The corporate service price index for the month of August fell –0.3% yoy. Given that we are expecting consumer price inflation data later this week, the decline in prices could be a “leading indicator” for July. If this is the case and CPI does also trend lower or remains stagnant, it gives the Bank of Japan less of a compelling reason to begin tightening rates. If you recall, the BoJ has previously indicated that they will need to see multiple months of stronger growth before considering changing monetary policy. Another possible “leading indicator” for future data due out this week was the BSI large manufacturing survey released this morning. The BSI is the MoF’s business outlook survey. It indicated that business conditions improved in the third quarter. Some view the BSI as a leading indicator for the quarterly Tankan survey due out on Friday.
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