Once again what didn’t happen this week was more interesting than what did. Non Farm Payrolls was far weaker than expected, dipping into negative territory for the first time in four years. But despite this disappointment the dollar did not collapse. Against the euro it ended Friday in the middle of the weekly range and a figure higher than where it was before the Non Farm numbers were issued.
Looking for Clues – Market Directions Sunday, February 3, 2008
- The reluctant euro
- Bad news is good news?
- A trader’s disbelief
Once again what didn’t happen this week was more interesting than what did. Non Farm Payrolls was far weaker than expected, dipping into negative territory for the first time in four years. But despite this disappointment the dollar did not collapse. Against the euro it ended Friday in the middle of the weekly range and a figure higher than where it was before the Non Farm numbers were issued. At 8:15 am on Friday morning the euro was trading at 1.4890, at the release it rocketed to 1.4953. It then spent the rest of the session drifting down to close just below 1.4800.
What are we to make of this? The bad news absorbed by the usd over the past two weeks is considerable, a 75 basis point emergency cut in the Fed Funds rate, a further 50 basis point reduction at the scheduled FOMC meeting and expectations of another 50 point in March. Negative job creation, a barely 50 manufacturing ISM, weak retail sales, a swooning housing market and a hammered stock market. One might ask what else does the market need to see before it takes the euro higher? Or to ask the question another way, is there any statistic that will convince traders that, for one– the Europeans will not shortly have a slowing economy of their own to contend with and two—the ECB will not soon begin lowering EMU rates. Yes, spokesman for the ECB have been adamant and on message — inflation is our concern, inflation is the target, price stability is paramount, we will fulfill our mandate. But to judge from the trading levels of the euro there is deep skepticism in the currency markets for that program. Perhaps another factor is the still unresolved accounting of many European banks relating to the American sub prime credit problem. How many more losses are waiting to be unveiled? Certainly the massive Societe Generale trading loss did not help market psychology. Currency traders are not happy buying the euro. Will they soon begin to sell? When the market wants to go in a certain direction sooner or later it finds the necessary rationale and the appropriate trigger.
European Central Bank – There is no market expectation for a change in the ECB rate policy or its unofficial tightening bias at Thursday’s meeting. The refinance rate will remain at 4.00%, the tightening bias will emerge intact.
ECB council members have kept to the bank official position without variance. The latest was Nicholas Garganas Governor of the Bank of Greece who said in an interview with Bloomberg News, that he was “very concerned about the high inflation risk”, noting that core inflation was at 2.3% in December and a year earlier it had been 1.6%. “Our monetary policy is not led [by] what the markets expect. Our monetary policy depends on the assessment we make on the economic situation”.
The market expectation for an eventual ECB rate decrease is not just a wish. Traders and analysts are not simply talking their book knowing that lower rates are good for business or helpful to bank profits or for some other purely selfish remunerative reason. The market ‘expectation’ for a lower ECB refinancing rate is an expression of its collective judgment on European monetary policy and on how the ECB will respond to a future economic situation that is deemed to be very likely. If the market’s judgment differs from that of the ECB and its public policy pronouncements, that does not negate its validity. The ECB has several reasons, not all of them economic, for retaining its public anti-inflation mandate. Remember that the US markets had priced in rate cuts long before they occurred and remember too the Fed statements in the weeks between the onset of the financial and sub prime crisis in August and its first rate cut in mid September. Or recall Chairman Bernanke’s very deliberate rhetoric for much of the subsequent time. It is only very recently that the Fed has publicly subordinated inflation to growth. Even so, the Fed has been accused of caving to market desires. The ECB has even more policy strictures because of its inflation mandate so it also has a grater need to preserve its independence and credibility.
Federal Reserve – The Fed Funds target rate has now been reduced by 2.25% since the August sub prime crisis blew up. At 3.0%, with core inflation over 2.0 % and headline inflation much higher real interest rates are just marginally positive. Monetary policy is clearly loose. In retrospect, it slipped out of neutral back in September, but the fact was disguised somewhat by the Fed’s anti inflation flourishes.
In the final analysis the Fed’s ‘expected’ 50 basis point cuts in both the Fed Funds and Discount rate on Wednesday seemed not quite so expected as both the Dow and the dollar sold off after the announcement. The Fed’s statement while it did drop the use of “appreciable” to describe downside risks to growth and added that “earlier actions should help to promote growth over time…”, is not a neutral pronouncement. The rate reduction bias is in place. No other interpretation is possible after the recent events and no Fed rhetoric in the coming weeks will alter that perception. The next FOMC meeting is March 18th and expectations will remain high for further rate cuts, no other future would be rational at this point.
Bank of England -There is little doubt that the Monetary Policy Committee (MPC) will cut rates by 0.25% on Thursday, and equally little doubt that they will mention their serious ongoing inflation concerns.
Mervyn King was reappointed to another five year term as Governor of the Bank of England (BOE) and Chairman of the Monetary Policy Committee. He is know as an inflation hawk and has repeatedly voiced the opinion that rate cuts are not a foregone conclusion. David Blanchflower, the most outspoken dove on the MPC said that the bank should cut rates “to get ahead of the curve”. It appears Mr. Blanchflower will get his way.
The Week in Review January 28 – February 1
United States – The economic news was not nearly as bad as it seemed in the shadow of the Non Farm Payrolls.
Manufacturing ISM at 50.7 was well over expectations and when joined with the strong Durable Goods number of +5.2%, the economy still appears to be growing heading into 2008. The negative NFP result for January will probably be revised into positive territory next month, as was last Augusts’ -4,000 reading. The weekly jobless claims over the next few weeks will clarify whether the employment picture is really weakening to recessionary levels. The current four week average is well below recessionary totals, but the most recent week added 69,000 to 375,000 and that is considered to be on the threshold of recession if sustained. There is one interesting note from the January survey. Purchasing mangers were asked if the turmoil in the financial markets was affecting their firm’s ability to obtain financing, 92.6 said no there was no appreciable effect. In the echo chamber of Wall Street, the financial markets and the media a credit disaster is much feared and discussed but, at least so far, there is nothing to indicate that the economy on as a whole is suffering a credit shortage.
Eurozone– The M3 money supply, one of the ECB’s main inflation indicators, moderated to 11.5% in December, its first reading below 12.0% in three months. Economic sentiment and business climate indicators were much lower than forecasts but inflation was higher, unemployment steady and manufacturing PMI rose. There is nothing in these statistics to precipitate a reconsideration by the ECB of its rate policy. The economic situation will have to become a good deal more gloomy for the ECB to lose its public nerve.
Yet the judgment of the currency markets seems to be that sooner or later the ECB will have to abandon its inflation concerns. Thus the reluctance to take the euro through its old high against the dollar and the continuing skittishness in the yen crosses.
Germany – IG Metall the large German metalworkers union currently in negotiation with German industry has said that its members will strike by mid February if there is no settlement. The union is asking for an 8% wage increase on a twelve month contract for workers in Eastern and Western Germany. Oliver Hobel, the chief union negotiator disregarded ECB warning of a wage-price spiral if the union won it demands, “ I believe that one of the problems of the current economic situation is rather that the share of wages on the overall economic development has declined”.
Finance Minister Peer Steinbrueck said that the expected the financial distress from the US subprime crisis would damage European economies. “The hope that the turbulences will be restricted to the financial market sphere will sadly not be fulfilled”, said Mr. Steinbrueck in a speech at the Frankfurt Stock Exchange on Monday. “One has to assume a marked weakening of growth [in the US]. In Europe and Germany we will also feel it in the real economy”.
Economic Releases January 28 – February 1
United States – Monday: New Home sales continued to drop away, sliding 4.7% in December to 604,000. The November total was revised down as well to 634,000 from 647,000, or 2.01%. Sales are at their lowest level since 1995 and the number of months supply on the market rose to 9.6 from 9.3. That is the highest total this cycle and since 1981. Sales are now down 56% from their July 2005 peak and down 40.7% from December 2006. The median home price dropped 10.4% year on year in December, and though this measure is considered an imperfect measure of selling prices it is the largest decline in this statistic in 37 years.
Tuesday: Durable Goods Orders in December were much stronger than expected at +5.2%, on a median prediction of +1.5% and November’s result was revised up to +0.5% from +0.1%. The ex-transportation number was +2.6%, November had seen a fall of 0.7%. The ex-defense number was +2.9%, November had been +1.2%. The commercial aircraft Boeing obtained 287 new orders in the month, 110 more than in November. The Case-Shiller 20 City comparative Home Price Index dropped 2.1% in November to 188.82. Conference Board Consumer Confidence was a bit higher in January than predicted 87.9 versus 87.0; December was 90.6.
Wednesday: Federal Reserve cuts the Fed Funds rate by 50 basis point to 3.0% and the Discount rate by 50 points to 3.5%. The first release of fourth quarter GDP confirmed a hard slowing of the US economy to which expanded only +0.6%, this was half the median forecast of +1.2%. Third quarter was +4.9%. The GDP number will be revised twice more.
Thursday: Personal Income rose 0.5% in December ahead of the +0.3% forecast and better than the 0.4% gain in November. It was a solid addition for this statistic which underpins consumer spending. Personal Expenditures added 0.2% in December as predicted but a far cry from the 1.1% gain in November. Weekly jobless claims shot up 69,000 to 375,000, an addition of 19,000 to 320,000 had been forecast. The weekly claims numbers are subject to wide seasonal and periodic variation so it is impossible to draw any conclusions from a one week spike. Last year the initial claims number gained 41,000 in the same week. The number of claims had been trending down over the prior weeks. The total number is now at the top of the range of the 350,000 – 375,000 range that has been recorded for several months before every recession since 1980. However, the four week moving average is still 326,000 a level consistent with moderate job creation and below recessionary signals. Chicago Purchasers Index dropped to 51.5 in January from December’s 56.4; ‘prices paid’ rose to 81.7 from 67.4 and ‘new orders’ sank to 44.7 from 56.7. It was the worst of all possible worlds with slowing overall activity and new orders coupled with rising prices.
Friday: The expected decline in January’s ISM Survey did not materialize. The 50.7 reading was well above the median forecast of 47.2, above the revised December number of 48.4 (up from 47.7), and over the 50 demarcation between contraction and expansion. The ‘employment index’ was 47.1, and the December statistic was revised higher to 48.7 from 48.0. ‘New orders’ were 49.5 and December’s result was also revised up to 46.9 from 45.7. ‘Prices paid rose to 76.0 from 68.0. Non Farm payrolls at -17,000 was the first negative reading in four years since August 2003 and it shocked the market. But damage was somewhat ameliorated by the upward revision in December’s number to 82,000 from 18,000. However the November reading was demoted by 55,000 leaving a net gain of only 9,000 for the two months. The NFP numbers are revised twice, once in each of the subsequent months. When the initial statistic is so far from the average in a non random series the revisions will tend to bring the number closer to the average. A likely result for the January number will be an upward revision by 60,000 or so, much at December’s number was boosted 64,000 on adjustment. Net revisions to all of 2007 removed 191,000 from the job rolls. Construction jobs fell by 27,000, manufacturing by 28,000. Average Hourly earning rose by 0.2%, the smallest amount since last spring. The unemployment rate fell 0.1% to 4.9%. Construction spending sank 1.1% in December and November’s result dropped to -0.4% from +0.1% on revision. The final result University of Michigan Consumer Confidence number for January was 78.4, lower than the preliminary reading of 80.5; December was 75.5.
Eurozone – Monday: M3 money supply was 11.5% higher year on year in December. This is the first dip after two months at 12.3%, and is considerably less than the 12.1% that had been predicted. Loans to the private sector rose 11.1% in December and November’s figure was raised to 11.1% from 11.0%.
Thursday: the EMU Economic Sentiment Index dropped to its lowest level in two years in January at 101.7, 103.5 had been expected. The December result was revised to 103.4 from 104.7. All sectors fell led by consumer retails and services. The EMU Business Climate Indicator for January came in 0.78, below the revised December number of 0.89 itself down from 0.93. Flash HICP rose to 3.2% in January, over the 3.1% forecast and December’s result of the same. It was the highest reading since the monetary union began. For an ECB already on alert for secondary inflation effects there is no ease in this number. The union wide unemployment rate was stable at 7.2% in December as predicted. Though this is the lowest unemployment level since 1993 when record keeping began, it contrasts with an American rate of 4.9%% and 3.8% in Japan.
Friday: the final January manufacturing PMI result was 52.8, 0.2 higher than the preliminary result and matching the November reading.
Germany – Wednesday: wholesale sales lost 1.0% in December from November and were part of the generally disappointing holiday season for consumer goods. The November result was revised to -1.4% from -1.7% and the October to +2.2% from +2.1%.
Thursday: retail sales from the Federal Statistical Office (FSO) declined 0.1% in December on a seasonally adjusted basis, a gain of 1.7% had been hoped for. It was the third month in a row with very weak retail sales numbers. The year over year reading dropped 6.9% on an unadjusted basis, a drop of 5.1% had been predicted. Retails sales year to year fell in 10 of the 12 months of 2007. Flash (1st issue) of the Harmonized Index of Consumer Prices (HICP) lost 0.3% in January a yearly rate of +3.0%. The decline was less than the -0.5%, +2.8% predicted.. In December the changes were +0.7% and +3.1%. The ‘flash’ CPI also lost 0.3% in January for a +2.7% yearly rate, -0.4% and +2.6% had been forecast. In December the returns were +0.5% and +2.8%.
United Kingdom – Monday: the Hometrack House Price Survey fell 0.3% in January, limiting the year on year rise to 2.3%. It is the fourth consecutive monthly fall and the weakest reading since may 2006.
Tuesday: the Confederation of British Industry (CBI) distributive Trades Survey for January (reported volume of sales) registered 4% as expected, less than the 8% reading in December, indicating no recovery from that month’s sluggish holiday business. Land Registry House Prices fell 0.4% in January, leaving the elapsed year at +6.7%. In December they added 0.6%, yearly at +8.1%.
Wednesday: mortgage approvals in December sank to 73,000 their lowest number since the series began. November approvals had been 81,000.
Thursday: Nationwide House Prices fell 0.1% in January pushing the year on year gain down to 4.2%. It was the smallest yearly increase since 2005. A fall of 0.3% and a yearly rate of 4.1% had been forecast. GfK Consumer Confidence edged up to -13 in January from December’s -14.
Friday: the manufacturing Purchasing Mangers Index (PMI) for January was adjusted down to 50.6 from 52.4.
Japan – Tuesday: Retail Sales gained 0.2% in December over last year, substantially less than the 1.6% rise in November. For all of 2007 sales were off 0.1% from 2006. It was the first drop in overall volume in five years. In 2006 sales rose 0.1%. Real Household Spending added 2.2% year to year in December much better than the forecast 0.2% decrease and the November reading of -0.6%. The December unemployment rate was unchanged at 3.8% from November. It has now fallen for the fifth year in a row. For all of 2007 the average was 3.9%, for 2006 it was 4.1%.
Wednesday: Industrial Production in December rose 2/3 of expectations, +1.4% against +2.1% but was much improved over November’s 1.6% decline.
Thursday: housing starts were 19.2% lower year to year in December; in November they had lost 27.0% Construction orders gained 4.7% year to year in December; in November they had lost 3.8%.
The Week Ahead February 4 – February 8
United States – Tuesday : ISM Non Manufacturing Index for January at 10:00 ET; expected 53.0, December 54.4.
Wednesday: preliminary Non Farm Productivity for 4th quarter at 8:30 ET; expected +0.1%; 3rd quarter +6.3%. Preliminary Unit Labor Costs for 4th quarter at 8:30 ET; expected +3.7%, 3rd quarter -2.0%.
Thursday: jobless claims for the week of February 2nd at 8:30 Et; expected 340,000, prior week +69,000 to 375,000. NAR Pending Home Sales for December at 10:00 ET; November 87.6
Eurozone – Monday: industrial PPI for December at 10:00 GMT; expected +0.1%, m/m, +4.3% y/y, November +0.8% m/m, +4.1% y/y.
Tuesday: retail trade for December at 10:00 GMT; expected +0.2% m/m, -0.8% y/y, November -0.5% m/m, -1.4% y/y.
Thursday: ECB rate announcement, current rate 4.00%
Germany – Wednesday: total manufacturing orders for December at 11:00 GMT; expected -2.5% m/m, +9.9% y/y, November +3.4% m/m, + 13.6% y/y.
Thursday: trade balance (seasonally adjusted) for December at 7:00 GMT; expected +19.3 billion euro, November +19.8 billion euro. Industrial output for December at 11:00 GMT; expected +1.0% m/m, +4.2% y/y, November -0.9% m/m, 3.5% y/y.
United Kingdom – Monday: CIPS Construction PMI for January at 9:30 GMT; December 56.0.
Tuesday: CIPS Services PMI for January at 9:30 GMT; expected 52.0, December 52.4.
Wednesday: Nationwide Consumer Confidence for January at 00:01 GMT; December 85.
Thursday: manufacturing output for December at 9:30 GMT; expected +0.1% m/m, +0.3% y/y, November -0.1% m/m, +0.1% y/y. Industrial production for December at 9:30 GMT; expected +0.2%m/m, +1.0% y/y, November -0.1% m/m, +0.4% y/y. BOE rate announcement, current rate 5.50%.
Japan – Wednesday: preliminary leading index for December at 5:00 GMT; November 18.2. coincident index fro December at 5:00 GMT; November 30.0.
Friday: machinery orders for December at 23:50 GMT (prior day); November -2.8%.
Chief Market Analyst