The Stoics of the ECB – (Forex Hound)

The currency market sensitivity to global economic risk was graphically demonstrated by the reaction to comments by Yves Mersch, European Central Bank (ECB) board member and head of the Central Bank of Luxembourg. He was quoted on Wednesday saying that risks to economic growth in Europe have increased, that the ECB can “look through” the temporary inflation jump, that the ECB should be cautious given the economic uncertainty and that there are factors that mitigate inflation risks.

Market Directions Sunday, January 20, 2008

• The ECB tests the waters?
• The return (yet again) of risk aversion
• US worries grow


The currency market sensitivity to global economic risk was graphically demonstrated by the reaction to comments by Yves Mersch, European Central Bank (ECB) board member and head of the Central Bank of Luxembourg. He was quoted on Wednesday saying that risks to economic growth in Europe have increased, that the ECB can “look through” the temporary inflation jump, that the ECB should be cautious given the economic uncertainty and that there are factors that mitigate inflation risks.
From the market response you would think no one from the ECB had ever voiced such opinions before. In fact Jean Claude Trichet, the bank president, referred to an “inflation bump” several weeks ago to no discernable  interest. But Wednesday was a different day and traders took Mr. Mersch’s comments to heart sending the yen crosses and euro cascading down through a series of stop runs that lasted more than an hour. The euro, the euro/yen and the gbp/yen each lost more than two figures before recovering. This was in marked contrast to the market reaction to the strongly anti inflation remarks of Jurgen Stark and Alex Weber, also ECB board members, earlier, which had spurred little if any movement to the upside in the euro or the yen crosses. Mr. Weber had said that the bank will “counter resolutely” inflation expectations consolidating above the 2.0% target.


The difference between the two market responses is the perceived state of the US economy and the probable effect of its slowing on the rest of the world. When Mr. Trichet made his comment a US slowdown was feared but not supported in statistics. We have since had a dismal Non Farm Payrolls and negative December Retail Sales. The US slowdown looks much more real than it did in December. And Mr. Mersch seemed to verify what many traders now suspect, if the US economy heads south, the Europeans will soon follow. But what really exercised traders’ interest, and why the relatively unknown Mr. Mersch touched off such a slide is the notion that the ECB board may be coming around to the same opinion and that Mr. Mersch was giving its first airing.


When the market hears something that confirms its view it acts and when it hears something that contradicts its opinion it often ignores the information. Until recently traders had punished the dollar for weak US statistics. American figures were very poor this week, much worse than expected and the dollar closed Friday on its high against the euro, more than 300 points below its immediate post Retails Sales peak on Tuesday.


What drove the market lower was stop loss selling in the euro and the yen crosses. But what are stops but market judgment on risk? The risk now lies to the downside for these currencies and conversely on the upside for the US dollar. It is not of great importance that the change in risk perception is generated by an increasingly negative outlook for European growth and the consequently increased chance for an ECB rate cut rather than positive news from the US economy. What is important is that a European slowdown and a potential ECB reduction, and even a possible global slowdown, are not priced into the current euro/usd levels and certainly are not part of the yen crosses. All three eventualities, a European slowdown, an ECB rate cut and more negative US news are more likely than they were two weeks ago. The first two are barely priced. Adjustment to the new reality in the euro and the yen crosses has just begun..


The Week in Review January 14– 18


United States


Headline PPI and CPI were well over expectations but the core numbers were only a bit excessive. Even if  Ben Bernanke the Federal Reserve Chairman had not made it clear that growth and the financial markets are its main concern these numbers, particularly the core figure would not elicit rate hike fears.


The Federal Reserve survey of economic condition in the twelve Federal Reserve districts, the ‘Beige Book’, so called for the color of its cover, prepared for the January 29-30 FOMC meeting, showed a further moderating of economic conditions from the prior edition. Seven of the Federal Reserve districts mentioned “a slight increase in activity”, two reported “mixed conditions” and three said “activity… was slowing”. Retail spending was subdued in most areas. Positive observers can take solace that the report still shows expansion and a level of activity higher than one might expect during or leading up to a recession. Pessimists can note the sustained downward trend in activity. Optimists can see the continued expansion, however slight, despite tremendous negative pressure from the housing slump and the credit market meltdown. The survey summarized reports from mid November to January 7th.


In the early part of the week one could view the euro as either strong or weak. Strong because it held up despite the poorest German ZEW survey in 15 years or weak because it fell despite the very poor US retail sales number. The ECB was uncharacteristically uncoordinated with various board members giving contradictory opinions about the immediate EMU future. But in the end traders made up their own minds and sent the euro substantively lower.




The Peoples bank of China (PBOC) raised the reserve requirement, the level of deposits that lenders need to keep at the central bank, by 50 basis points. It was the first increase this year. For most commercial banks the requirement is now 15%. “The adjustment is aimed at further tightening monetary policy, continuing to enhance banking system liquidity management and curbing the fast growth of money supply and credit”, said the accompanying PBOC statement.


Economic Releases January 14 – 18


United States


Tuesday: the producer price index (PPI) shed 0.1% in December but was up 6.3% year on year, the largest rise since 1981. A flat result had been predicted for December. The primary culprit in the yearly rate was the 3.2% gain in last month’s PPI. The core rate (without food and energy prices) was 0.2% higher on expectations for a 0.1% addition; November had been +0.4%. The December yearly rate was 2.0%. Retail Sales for December at -0.4% were a major disappointment, the sharpest decline since June of last year (-0.8%) and lower than the flat expectation. For 2007 sales were up 4.2%, which is the softest since 2002 when they rose only 2.4%. In 2006 retail sales were up 5.9%. Excluding purchases of food and automobiles, retail sales still fell 0.4% on expectations for a flat November result. Both prior months were revised lower, November to +1.0% from +1.2% (ex auto to +1.7% from +1.8%) and October to 0.0% from +0.2% (ex auto to +0.2% from +0.4%).


Wednesday: CPI rose 0.3% in December. The 4.1% annual rate was the fastest since 1990. Core CPI, without food and energy prices, gained 0.2%, +2.4% for the year. Both numbers were as anticipated. It is not expected that the core number, though over the 2.0% Fed guideline, will block a rate cut at the next FOMC meeting at month end. The National Association of Home Builders (NAHB) Housing Market Index was 19 in December up one from November’s downwardly revised result of 18. This index has been in a two point range since September of last year, indicating that executives of residential construction companies have not improved their outlook but they haven’t worsened their view either. The Treasury International Capital System (TICS) report for November showed a strong interest in US investment from overseas. Net long term securities purchased by foreigners were $90.9 billion, the breakdown being– private purchases $58.6 billion, purchases from official sources $11.8 billion and US resident sales of foreign securities $20.6 billion. Net inflow of $149.9 billion was broken out into $79.7 in new long term securities, $36.5 billion in short term and $33.7 in bank net dollar denominated liabilities. The August and September 2007 numbers (August -$70.5 billion, September $15.4 billion) which caused so much hand wringing among commentators and economists that the weak US dollar was causing foreigners to abandon the States as an investment destination seems to have been debunked. Temporary portfolio adjustment and capitulation brought on by the explosion of the sub prime and credit crisis is the most likely reason for the outflow in August and the weak September investment as foreign owners of us securities sold holdings to answer capital requirement and other financial exigencies. Industrial production was flat in December, slightly better than the -0.1% predicted; November had risen 0.3%. Manufacturing production was flat as well for the month. Capacity Utilization fell to 81.4 in December, November had been 81.6. .
Thursday: housing starts crashed 14.2% in December to 1.006 million, falling in all regions of the country. Building permits sank 8.1% 1.068 million, dropping in all regions except the Northeast where they rose 1.6%. Housing starts normally fall in December as the industry pares back for the winter but these numbers are far above seasonal adjustment and seem to predict another acceleration of the decline in housing. In 2007 housing starts fell 24.8%; in 2006 they slid 12.9%.
Initial jobless claims were down 21,000 in the week of January 12 to 301,000, the lowest level since September 12th 2007, when they were 300,000. A rise of 18,000 to 340,000 had been forecast. Continuing claims rose 66,000 to 2.751 million in the January 5th week. The four week moving average was 2.726 the highest since November 2005.


Friday: University of Michigan Consumer Sentiment (preliminary) number for January was unexpectedly higher at 80.5; December had been 75.5.




Monday: industrial production in November fell 0.5%, slightly better than the forecast of -0.8%, the yearly number was +2.7%, 0.1% below the forecast. The October figure was revised 0.1% higher to +0.5%. Consumer durable production slid 1.9%, capital goods dropped 0.7%. The November decline erased the October gain leaving the two month results from October and November just above the 3rd quarter average. DCLG House Price Index rose 9.5% year on year in November and improvement over October’s 11.3% rise. Producer Prices in December jumped 0.5%, +5.0% for the year; +0. 3% and +4.5% were the estimates. Prices remain at 16 year high, led by food and fuel costs. The rise in November had been +0.5% and +4.5%.


Wednesday: the final HICP for December was unchanged from the preliminary, +0.4% for the month and +3.1% for the year. The annual result was the same at November a 6 ½ year high.


Thursday: construction output declined 0.8% in November leaving the year over year rate at -0.8% as well. The yearly rate in October was revised to +2.8% from 2.4%; the monthly rate was unchanged.





Tuesday: the ZEW Survey of financial experts for January registered a 15 year low in its ‘economic expectations’ at -41.6, 40.00 had been predicted and December had been -37.5. The long term average is far away at +31.0. ‘Current conditions’ at 56.6 was also below expectation, 57.5 and December’s 63.5. It is the 7th consecutive month the survey has fallen. According to the survey the danger of recession in the United States is the largest risk for the German economy, along with the drag from the strong euro. ZEW researcher Matthias Koehler, interviewed on CNBC said, “At the moment it seems that the level of interest rates still are accommodative to economic growth in Europe but the ECB should be aware that further high interest rates rises could negatively impact economic growth in Germany and of course also in Europe


Wednesday: final HICP was unaltered from the preliminary (flash) for December at +0.7%, +3.1% for the year. CPI was also unchanged at +0.5% and +2.8%.


United Kingdom


Tuesday: CPI for December was +0.6%, +2.1% for the year, even with expectations of +0.5% and +2.1% but slightly ahead of November’s +0/3% monthly rate. Core CPI also rose 0.6% in December but the yearly rate was just +1.4%, as predicted. Though the main CPI rate was slightly over the BOE target of +2.0%, and food and fuel prices are set to rise further, these results do not foretell a change in monetary policy. As in the US, the BOE will probably err on the side of growth rather than inflation control.


Wednesday: RICS House Price Survey dropped to its lowest level since 1992 at -49.1, November had been -40.6. Unsold properties increased 7.1% in the month. The unemployment rate was steady in November at 5.3%. Average earnings (including bonus) gained 4.0% in November, the same rise as in October; the consensus estimate had been +3.9%.


Wednesday: November machinery orders fell 2.8%, a far cry from October’s 12.7% increase.


The Week Ahead January 21 – 25


United States



Monday: Martin Luther King holiday, markets closed.


Thursday: Jobless Claims for the week of January 19th; ?????. Existing Home Sales for December from the National Association of Realtors at 10:00 ET; November 5.00 million units.





Wednesday: industrial new orders for November at 10:00 GMT; October 2.5% m/m, 10.9% y/y.


Friday: flash (1st issue) manufacturing PMI for January at 9:00 GMT; December 52.6. Flash services PMI for January at 9:00 GMT; December 53.2.





Monday: PPI for December at 7:00 GMT; November +0.8% m/m, +2.5% y/y.


Thursday: IFO Survey for January at 9:00 GMT; December ‘business sentiment’ 103.0, ‘current assessment’ 108.1, ‘business expectations’ 98.2.


Friday: GfK consumer confidence for February at 7:00 GMT; January 4.5.


United Kingdom

Monday: Rightmove House Prices for January at 00:01 GMT; December -3.2% m/m, +4.8% y/y.


Tuesday: CBI Industrial Trends Survey for January at 11:00 GMT; December monthly orders balance 2, Q1 business optimism 5.


Wednesday: BOE minutes for January 9th and 10th meeting; 9-0 vote for unchanged rates. First estimate for Q4 GDP at 9:30 GMT; Q3 +0.8% q/q, +3.3% y/y.
Friday: Hometrack House Price Survey for January at 00:01 GMT; December -0.3% m/m, +3.0% y/y. Nationwide House Prices for January at 7:00 GMT; December -0.5% m/m, +4.8% y/y.


Joseph Trevisani
FX Solutions
Chief Market Analyst