Market Directions by Joseph Trevisani, FX Solutions

Market Directions Sunday, December 23, 2007

* The central bank cavalry
* Year end risks: Liquidity and P/L
* The new year economic outlook

The coordinated central bank action to supply whatever liquidity the credit markets required probably gave more support to the dollar than any other event this week. To the degree that the credit situation and its sub prime mortgage … Market Directions Sunday, December 23, 2007

* The central bank cavalry
* Year end risks: Liquidity and P/L
* The new year economic outlook

The coordinated central bank action to supply whatever liquidity the credit markets required probably gave more support to the dollar than any other event this week. To the degree that the credit situation and its sub prime mortgage basis are seen as a greater drag on the United States economy and the dollar, any palliation in the financial markets redounds to the dollar’s benefit. Positive American statistics, particularly consumer spending, also helped push the dollar to levels not seen since late October.

In the immediate future both the euro and the pound are vulnerable. The uncertain liquidity available in the remaining trading sessions this year will exaggerate any movement. The greatest problem for the euro and the pound is that there is still substantial unrealized profit in both currencies. The euro began the post August run at 1.3400, the pound started the year at 1.9200. Both currencies have broken the upward momentum which had been their greatest support.

The economic facts have been changing for several months. The growth prospects of Britain and the EMU are dimming and neither central bank will be able to raise rates in the coming months no matter what their view or the reality of inflation. The aggressive Federal Reserve rate reductions, which began in mid September, will produce economic growth in the US in the second and certainly the third quarter of 2008. The ECB has provided no economic stimulus and growth will continue to slip; when traders return to their desks in January the future for the EMU, the US and the UK will look very different from the past.

Central Banks

United States Federal Reserve

The Federal Reserve Treasury Auction Facility (TAF) first auction of $20 billion elicited $61.8 billion in bids for a bid to cover ration of 3.08. A second $20 billion auction was held on Thursday with demand of $57.7 billion for the $20 billion on offer. The average bid size rose to $790 million from the first auction’s $660 million. The consistent interest was taken as a sign that the funds are being sought by non money center banks. One of the main goals of this facility was to get funds out into the banking system beyond the normal money center banks that participate in the Fed’s open market operations. The number of bidders fell to 73 from 93 in the first auction. Credit market conditions had eased somewhat by week end.

Bank of England

The minutes of the December 6th Monetary Policy Committee (MPC) meeting revealed a 9-0 vote behind the 25 basis point rate cut and discussion of a larger reduction that was eventually rejected because of inflation concerns. Prior market sentiment had not expected a unanimous vote which put the condition of the British economy in a far starker light. Sterling immediately fell 50 points on the news. Credit conditions were the main reason for the cut according to MPC member Kate Barker.

European Central Bank

The ECB provided EUR348 billion in two week funding to ease the money markets over the year end. The average rate was 4.21%. The ECB approach is fundamentally different than that of the US Federal Reserve in that the European central bank provides as much funding as the market will accept, rather than auctioning a set amount as does the Fed. The results suggests that the majority of banks are relatively well funded and using the facility to store funds for use later in 2008.

Peoples Bank of China

The Chinese central bank raised one year deposit rates by 27 basis point to 4.14% and lending rates to 7.47%, or 18 basis points. It was the 6th hike this year. "The hike will help to prevent the economy from growing too quickly into overheating and structural inflation developing into overall inflation", stated the PBOC. However with inflation at 6.9% annually in November and up 4.6% for the year this increase still does not bring the deposit rates in positive territory. More rate increases can be expected in 2008 as the PBOC continues trying to cool rampant economic growth and inflation.

The Week in Review December 17 – 21

United States

Foreign investment in the US economy rebounded strongly in October with net long term securities purchases from overseas at $114.00 billion in the Treasury International Capital Report (TIC) from the Treasury Department. Private parties bought $96.2 billion and official sources amassed $21.8 billion; US entities purchased 4.1 billion in foreign securities. This report allayed fears that foreigners would be deterred from investing in the US by fear of an ever weakening dollar. It seems rather that the weak dollar has been seen as an opportunity for good value in US assets. With the purchase volume at more than 4 to 1 by private entities–individuals, companies and organizations–the flow was not a result of foreign central banks using their reserves to support the dollar and the US economy. The United States is still a favored investment destination for much of the world’s spare capital. The inflow was twice what is required to fund the monthly current account deficit.

Strong personal spending in November joined with last week’s retail sales figures has diminished somewhat the talk of pending recession. Most estimates of 4th quarter GDP, not due until January 31st, were raised to the 1% – 2% range. If December’s consumer spending results are comparable to November’s then anticipation of a serious slowdown will be put off until 2008.


Both manufacturing and service PMI predicted a gathering slowdown in production. The average fourth quarter composite PMI is equal to about +0.5% GDP growth quarter to quarter, but taken alone the December numbers drop to +0.45% per quarter.

Jean Claude Trichet ECB president acknowledged the escalating risk that EMU growth in 2008 will be below 2.0%, but he nevertheless defended the ECB focus on inflation. When asked why the ECB has not lowered rates he said, "Our first mandate which the treaty requires of us and our fellow citizens is to ensure medium term price stability is in line with our target that inflation is less than 2.0% and around 2.0%". There is nothing new in this opinion or its forceful expression but it will provide little comfort to European business planners contemplating 2008 business conditions. And since it seems the ECB is determined to wait out the recent inflation bump before contemplating a pro growth rate reduction, and a rate hike is not in the cards given the credit market turmoil, the ECB anti-inflation policy will not support the Euro even if the Fed cuts rates in January.

Gernot Nerb head of the German IFO Institute called the euro overvalued at current levels and stated that a further rise could prompt an ECB cut. "Everybody agrees that a fair rate is something around 1.2000", said Nerb in an interview with Market News International.

United Kingdom

When the Monetary Policy Committee is worried enough about economic growth to cut rates in the face of rising inflation there can be no help for the pound sterling from the central bank, though given the effect the pound has had on trade the fall may not be wholly unwelcome. The unpleasant shock of the record current account deficit added to the pressure on the sterling and eliminated the chance of any immediate recovery.

Economic Releases December 17 – 21

United States

Monday: net long term securities transactions from the Treasury International Capital Report (TIC) of the Federal Department of the Treasury recorded an inflow of $114.0 billion, of which $96.2 were private purchasers and $21.8 were from official sources. US entities bought $4.1 billion overseas. In September the net purchases had been $15.4 billion. The National Association of Home Builders (NAHB) Housing Market Index was unchanged in December at 19. This is the lowest this series has scored since its inception in 1985, but it also the third month in a row that the number has been stable.

Tuesday: Housing starts fell 3.7% in November to 1.187 million. This was slightly better than the median prediction of 1.180; October’s figure was revised a trifle higher to 1.232 from 1.229. The rate of decline has slowed from that in the third quarter but it is still down 24% from last November. Building permits also dropped to 1.152 reversing the October rise. Here too the October–November rate of decline has moderated somewhat; it is also 24% lower than last November. The International Council of Shopping Centers (ICSC) store sales for the second week of December were characterized as ‘reasonable’ by US retailers despite severe storms during the week in the middle part of the country.

Thursday: third quarter GDP was unchanged at 4.9% in it final issue. Core PCE prices in the third quarter were adjusted higher to +2.2% from +1.8%. The increase was 1.4% in the second quarter. The Fed target range is 1% – 2%.

Friday: Personal Income improved 0.4% in November a bit less than the anticipated +0.5%, but Personal Consumption Expenditures (PCE), at +1.1% were almost double the forecast of +0.6%. It was the largest jump in consumer spending in 2 ½ years and gave support to those who do not expect the economy to slip into recession. PCE core prices jumped 0.2% in November as they did in September and October but the year on year rate rose to 2.2% from 1.9% in October and 1.8% in September. This is the Fed’s favorite inflation gauge and November is the first month since May where the reading has been at or above the 2.0% target. The saving rate sank to -0.5%, the first negative reading since the summer of 2006. University of Michigan Consumer Sentiment for November edged up to 75.5 in the final release from 74.5. November had been 76.1. This series peaked at 96.9 in January of this year.


Monday: the flash (1st) manufacturing PMI at 52.5 was modestly better than forecast, 52.3, but still lower than the November result of 52.8, which itself was a surprise increase over October’s 51.5. Services PMI measured 53.2, below the 53.7 median prediction and November’s 54.1. It was the lowest services figure since June 2005.

Wednesday: Construction Production in October gained a much stronger than expected 0.6%, +2.4% on the elapsed year. The September figures were downgraded to -0.1% from 0.0% and to +0.9% from +1.5%.

Friday: Industrial new orders ran up 2.5% in October a surprisingly strong 10.9% yearly pace. A gain of 2.0% and +6.6% had been forecast. September was raised to -1.0% from -1.6%, August reduced to +0.7 from +0.8 and July revised up to -2.9% from -3.2%


Wednesday: the IFO Survey of business attitudes resumed its year long decline in December after a small up tick in November: business sentiment 103.0, expected 103.8, November 104.2; current assessment 108.1, expected 109.7, November 110.4; business expectations 98.2, expected 97.6, November 98.3. Business sentiment peaked in April at 108.6. The Producer Price Index shot up 0.8% in November, almost three times the +0.3% predicted, and an eight month high. The yearly rate gained 2.5% well more that the +2.0% forecast. The October rates were +0.4% and +1.7% respectively.

Thursday: GfK Consumer Confidence for January rose slightly to 4.5, December was 4.4 revised from 4.3 and 4.0 had been forecast. It was the first rise in six months. "The consumer climate has stabilized as the year draws to a close", said GfK.

United Kingdom

Monday: Rightmove House Prices as complied by the British real estate website fell 3.2% in December leaving them ahead only 4.8% for the year. It was the steepest fall since the survey began in 2002. However this survey is not seasonally adjusted and December is historically a slow month for home sales. The government reporting requirement on homes which begins in January may have also contributed to the price decline as owners of small homes rushed to complete sales before the year end reporting deadline. The Confederation of British Industry, a UK trade group, reduced its GDP forecast for 2008 to 2.0% from 2.2%. The group noted oil prices, credit market turmoil and sagging global demand as the chief determinants.

Tuesday: November CPI and core CPI arrived largely as predicted: CPI +0.3% m/m and +2.1% y/y, the same as forecast, October +0.5%, +2.1% y/y; core CPI +1.4% y/y, forecast +1.5%, October +1.5%. The Bank of England’s +1.9% inflation forecast for the fourth quarter is sure to be breached. With one month to go and October/November at an average of +2.1%, December inflation would have to be 1.5% or less to meet or better the inflation target.

Thursday: third quarter GDP was little changed on its third revision at 0.7%, the annual Rate was raised by 0.1 to 3.3%. The current account deficit for the third quarter set a record at £20.04 billion, far ahead of the second quarter deficit of £13.703 billion. At 5.7% of GDP and with much of the deterioration coming in the capital account, the surprising result put additional pressure on the pound sterling.

Friday: November retail sales climbed 0.4% up 4.4% over last year. The three months to November gained 1.1%, not as robust as the three months to October +1.3% but nowhere near the collapse that had been feared by many commentators. GfK Consumer Confidence fell in December to -14 the lowest reading since December 1995. November had been -10.

The Week Ahead December 24 – 28

United States

Tuesday: markets closed for Christmas

Wednesday: Case-Shiller Home price Index for October at 9:00 ET; September 195.62.

Thursday: Durable Goods Orders for November at 8:30 ET; October -0.4%. Conference Board Consumer Confidence for December at 10:00 ET; expected 86.0, November 87.3.

Friday: Chicago Purchasers Index for December at 9:45 ET; expected 52.0, November 52.9. New Home Sales for November at 10:00; expected 720,000, October 728,000.


No economic statistics released


Friday: preliminary CPI for December (release time undetermined; November +0.4% m/m, +3.0% y/y. Preliminary HICP for December (release time undetermined); November +0.5% m/m, +3.3% y/y.

United Kingdom

Monday: Hometrack House price Survey for December at 00:01 GMT: November +0.2% m/m, +3.6% y/y.

Friday: Nationwide House Prices at 7:00 GMT; expected -0.4% m/m, +5.3% y/y; November -0.8% m/m, +6.9% y/y.


Thursday: Housing Starts for November at 5:00 GMT; October -35.0% y/y.

Friday: National core CPI for November at 23:50 GMT (prior day); October +0.1% y/y. Central Tokyo Core CPI for December at 23:50 GMT (prior day; November +0.1% y/y. Unemployment rate for November at 23:50 GMT (prior day; October 4.0%. Retail sales for November at 23:50 GMT (prior day; October +0.8% y/y.


No economic statistics released

Joseph Trevisani
FX Solutions
Chief Market Analyst