Forex – The Wind of Change Market Directions

The question for the currency markets is what degree of American
economic weakness is priced into the current dollar level. It is not a
question that can yet be conclusively answered. But it will, over the
next two weeks be demonstrated, as figures for December on US Retails
Sales, Durable Goods, and inflation (CPI and PPI) are issued and the
market responds.



The Winds of Change

Market Directions Monday January 14, 2008

*Equity fears
*Central Bank prescriptions
*The ‘decoupled’ world economy?

The question for the currency markets is what degree of American
economic weakness is priced into the current dollar level. It is not a
question that can yet be conclusively answered. But it will, over the
next two weeks be demonstrated, as figures for December on US Retails
Sales, Durable Goods, and inflation (CPI and PPI) are issued and the
market responds.

US statistics have not yet confirmed the considerable worry over a
consumer led recession that has infected the equities market. If there
is one thing holding up–a relative term-the dollar it is the fear that
where the US economy leads the rest of the world is sure to follow. Some
amount of US economic pullback has been the operating assumption since
the sub-prime financial mess blew up this past August. If the US falls
to recession the restraint on the euro this week argues that a
sympathetic slowdown in the rest of the world is very much on the minds
of currency traders.

All of the world’s major central banks agree on the economic diagnosis,
but the prescriptions differ widely. Three major banks had their say
this week, the European Central Bank (ECB) and the Bank of England (BOE)
with their decisions to hold their current rate structure and the
Federal Reserve with Chairman Ben Bernanke promising substantial action
as needed. In the present economic context a 50 basis point cut at the
end of the month if not sooner is now the default Fed position.

The world economic situation is in flux. The basic assumptions of the
currency markets which have benefited the euro, the commodity currencies
and the pound sterling for six months are under strain. They will not
survive the prospective US slowdown or recession and it by no means
assured that the dollar will not be the ultimate beneficiary.

Central Banks


According to Jean Claude Trichet the president of the European Central
Bank, the board of governors debated a rate hike prior to their decision
to leave rates unchanged at 4.00% Thursday. He made no mention of
consideration of a rate cut. The omission was deliberate. If the bank’s
decision was fully expected, so was the attendant anti inflation
rhetoric. There is no reason to doubt the ECB governors’ concern about

In Germany the Verdi trade union is negotiating a wage package for more
than 2 million workers and asking for an 8.0% increase. These are the
second round effects the ECB has often mentioned. The ECB wants to
reassure workers and consumers that it will keep a rein on inflation to
help defray the pressure for large wage settlements. “I said on behalf
of the governing council that we were prepared to act preemptively so
that second round effects on upside risks to price stability would not
materialize and consequently that inflation expectations would remain
anchored”, said Mr. Trichet. He reaffirmed the tightening bias of the
bank, “We certainly are not neutral it a good interpretation of what I
said”. He also made a point of separating the problems in the money
markets and the bank’s response to them, “the risks as far as we see
them stemming from a numbers of factors including this [market]
correction are on the downside”. “We are seeing signals that are…very
mixed”. “Tensions in the interbank markets are probably unavoidable and
probably a necessary correction” “We make totally the difference between
what we have to decide to deliver price stability…to anchor solidly
inflationary expectations, and then that being decided, we have to care
for the money market behaving properly”. German workers particularly,
but European employees in general, have not pressed for large wage hikes
in the past few years, that may be about to change.

It is not necessary for the ECB to cite burgeoning economic worries.
With the frequency and stridency of its anti- inflation rhetoric, and
its constant waning that it can and might boost rates to ward off
inflation, the simple fact that the bank has not raised interest rates,
speaks volumes. Despite the rhetoric the ECB is not about to tighten
credit any time soon.

Federal Reserve

The last two lines in Federal Reserve Chairman Ben Bernanke’s speech
Thursday in Washington tell all one needs to know about Fed policy.
“Financial and economic conditions can change quickly. Consequently the
committee remains extremely alert and flexible, prepared to act in a
decisive and timely manner and in particular to counter any adverse
dynamics that might threaten economic or financial stability”. Does that
mean a 50 bps cut on January 30th? One would have to say yes,
particularly when that statement is combined with the earlier comment,
“In light of recent changes in the outlook for and the risks to growth,
additional policy easing may well be needed”. Those two statements are
about as close as you can come to a promise from the Chairman. The Fed
knows well that this speech will have cemented market expectations for
at least a 0.5% rate reduction at month end. Would the chairman and the
committee have excited that expectation and then not deliver. Very, very

Bank of England

The English central bank left its base rate unchanged at 5.5% on
Thursday. Sterling rose 60 points on the announcement but the move
dissipated quickly. The second thought being that the MPC will surely
cuts rates in February. The MPC did not issue a statement, as is their
usual procedure. Several factors lay behind the MPC decision: economic
deterioration though notable in some areas of the economy and of concern
in others, particularly housing, has not been marked enough in the face
of inflation pressures to force the banks hand. The quarterly inflation
report is due February 13th and the bank governors often prefer to have
the latest inflation data before acting. And finally, market pricing had
the decision rated even and perhaps the board members did not want to
risk alarming the market with a decision that would likely be
interpreted as a danger sign for the economy.

The Week in Review January 11 – 14

United States

Statistics did not provide much guidance to the state of the American
economy this week. Jobless claims fell when a rise had been expected and
the running claims number is still short of levels usually reached in a
recession. The trade deficit worsened and not only because of sky high
oil prices but because exports barely rose at all. With the dollar close
to record lows throughout the month such a small expansion in exported
goods speaks directly to foreign demand. Falling consumer demand is the
same worry besetting the US economy. The decoupling of the American and
world economies is beginning to look fanciful.


European consumers made it quite clear that they are at best distant
relations of their American cousins. November Retail sales fell as
dramatically in the EMU as they rose unexpectedly on the western side of
the Atlantic. The European consumer will not be prolonging the EMU
expansion. This is not a positive sign for the decoupling theory that
holds the EMU can continue to expand and avoid whatever economic ills
may appear in the Americas.

Christine Legarde the French Finance Minister was perfectly clear in her
assessment of the policy choices facing the ECB, ” If we have to choose
between high inflation and high growth or stable inflation and lower
growth I certainly have a preference for temporarily higher inflation
and higher growth”. The problem is that her conclusion is exactly
opposite from Mr. Trichet and his colleagues.

Economic Releases January 7 – 11

United States

Tuesday: the Pending Home Sale Index fell 2.6% in November to 87.6 but
the drop was countered by the +3.1% revision to October’s figure up to
89.9 from 87.2. This is the third consecutive month of relative
stability just above the August low of 85.5

Thursday: several large chain stores reported slow or negative sales
figures for December: Wal-Mart’s numbers were 2.4% ahead of last year
but Target’s sales shrank 5% and Macy’s, JC Penny and Kohl’s reported
declines. Initial Jobless Claims for the week of January 6th fell 15,000
to 322,000, a rise to 340,00 had been forecast. The four week moving
average fell 3,000 to 341,000.

Friday: the International Trade deficit widened almost 10% in November
to $63.1 billion from 57.9 in October. A modest increase to -59.0 had
been estimated. Rising oil prices and a decline in aircraft deliveries
by Boeing were largely responsible for the much wider than expected
shortfall. Imports rose by $6.0 billion, $4.8 billion for oil and
related products, exports gained $0.6 billion. The price of imported
crude jumped $7.16 almost 10% to $79.65 a barrel, but the volume of
imported crude fell only slightly hence the increase in the value of oil
imports. The average trade gap for October and November is higher than
the average in the third quarter so without a large reversal in December
exports will subtract from fourth quarter GDP. Most estimates for fourth
quarter GDP have been reduced to the 1.0% – 1.5% range. Import prices
rose 10.9% in 2007, the steepest increase since racking began in 1983;
non fuel prices rose 3.0% in the year. The deficit with OPEC nations was
as record $11.8 billion; it was $11.0 billion in October.


Monday: the EMU ‘economic sentiment’ index lost 0.1 in December to
104.7; the forecast had been 104.0. ‘Industry confidence’ dropped to 2
from November’s 3, ‘consumer confidence’ slid to -9 from -8 and the
‘business climate indicator ‘ skidded to 0.92 in December from 1.03 the
prior month, itself revised down 0.1. EMU unemployment continued at 7.2%
in November, the lowest reading since the series began in 1993. The
Industrial Producers Price Index (PPI) added 0.8% in December a 4.1%
yearly clip, +0.7% and +4.1% had been the forecasts; October had been
+0.6% and +3.3%. It was the largest monthly jump since April 2006. As
has been common with all inflation indices, energy prices were the
driver, followed by food. Without energy prices PPI rose 0.1% in
November, +3.2% on the year.

Tuesday: Retail Sales suffered a large deterioration in November falling
0.5% from October and settling at -1.4% on the year; +0.5% and +0.1% had
been forecast. The yearly number was the weakest in sales since 1996.
October’s monthly result was unrevised at -0.7% , the yearly figure was
adjusted up to +0.4% from +0.2%.

Wednesday: third quarter GDP added 0.1% on revision to +0.8% due to an
unexpected upward adjustment in investment activity; the year on year
number was unchanged at 2.7%.

Friday: the Organization for Economic Co-operation and Development
(OECD) leading economic indictors dropped to 98.1 in November from 98.3
the prior month. It was the 6th successive monthly drop.


Tuesday: Wholesale Sales declined 1.7% in November and were down 1.1% on
the year. The October results were revised to +2.1% m/m from +0.6% and
to +4.0% y/y from +1.8%. Manufacturing Orders jumped 3.4% in November;
expectation had been for a 2.0% decline after October’s+ 4.0% surge.

Wednesday: machinery orders slowed sharply in November to +7.0% year on
year from 20% in October as reported by the German Machinery
Manufacturers Association (VDMA). The three month span ending in
November was up 11% y/y; August – October gained 14% and July –
September rose 12%. Industrial Output faltered in November coming in at
-0.9% and +3.5% yearly; +0.4% and +4.4% were the forecasts. October was
revised up to +0.1% from -0.3%. All components fell in November. Retails
Sales as collected by the Federal Statistical Office (FSO) shrank 1.3%
in November and were 3.2% lower than November last; +1.1% and -1.6%
yearly had been predicted. It was the ninth month of negative result in

United Kingdom

Tuesday: British Retail consortium (BRC) like for like retail sales rose
0.3% month to month in December, far less than November’s 1.2% gain. It
was the lowest December reading since 2004 and the smallest for any
month since March 2006. Total sales at 2.3% were also well below the
November result of 3.1%.

Wednesday: nationwide consumer confidence registered 85 in December, the
weakest since February; November had been 86. In September this index
scored 102. This series began in 2004.

Friday: industrial production was lower than predictions in November,
-0.1% m/m and +0.4% y/y, versus +0.1% and +0.6%; October had been +0.4%
m/m and +1.0% y/y. Manufacturing output was also weaker than predictions
at -0.1% m/m, +0.1% y/y against +0.2% and +0.4%; October had been +0.3%
m/m and +0.3% y/y. These figures make it unlikely that manufacturing
will add to 4th quarter GDP.


Friday: employment fell 18,700 in December a far cry from the +10,000 –
+15,000 that the market had expected. The unemployment rate was stable
at 5.9%. The Bank of Canada is now expected to cut rates by 25 basis
points at its January 22nd meeting. The current rate is 4.25%.


Thursday: leading indicators registered 10 in November, the coincident
indicators 33. They were 18.2 and 70 respectively in October.

The Week Ahead January 14 – 18

United States

Tuesday: Retails Sales for December at 8:30 ET; expected +0.1%, November
+1.2%. Retail Sales ex auto for December at 8:30 ET; expected +0.2%,
November +1.8%. PPI for December at 8:30 ET; expected +0.1%, November
+3.2%. Core PPI for December at 8:30 ET; expected +0.2%, November +0.4%.

Wednesday: CPI for December at 8:30 ET; expected +0.2%, November +0.8%.
Core CPI for December at 8:30 ET; expected +0.2%, November +0.3%.
Treasury International Capital System (TICS, net long term securities
transactions) for December at 9:00 ET; November +$114 billion.
Industrial Production for December at 9:15 ET; expected 0.0%, November
+0.3%. Capacity Utilization for December at 9:15 ET; expected 81.4%,
November 81.5%. NAHB Housing Market Index for January at 13:00 ET;
December 19.

Thursday: Housing Starts for December at 8:30 ET; November 1.187
million. Building Permits for December at 8:30 ET; November 1.162

Friday: University of Michigan Consumer Sentiment (preliminary) for
January at 10:00 ET; December 75.5.


Monday: industrial production for November at 10:00 GMT; October +0.4%
m/m, +3.8% y/y.

Tuesday: ZEW Survey for January at 10:00 GMT; December ‘economic
expectations’ -35.7, ‘current conditions’ 59.6.

Wednesday: Final HICP for December at 10:00 GMT; preliminary +0.5% m/m,
+3.1% y/y.

Friday: Construction Production for November at 10:00 GMT; October +0.6%
m/m, +2.4% y/y.


Tuesday: ZEW Survey for January at 10:00 GMT; December ‘economic
expectations’ -37.2, ‘current conditions’ 63.5.

Wednesday: final CPI for December at 7:00 GMT; preliminary +0.5% m/m,
+3.1% y/y. Final HICP for December at 7:00 GMT; preliminary +0.5% m/m,
+3.3% y/y.

United Kingdom

Monday: Department of Communities and Local Government (DCLG) House
Price Index for November at 9:30 GMT; October +11.3% y/y. Producer
prices for December at 9:30 GMT; November output prices +0.5% m/m, +4.5%
y/y; input prices +1.7% m/m, +10.3% y/y.

Tuesday: CPI for December at 9:30 GMT; November +0.3% m/m, +2.1% y/y.
Core CPI for December at 9:30 GMT; November +1.4% y/y.

Wednesday: ILO Unemployment Rate for November at 9:30 GMT; October 5.3%.
Average Earnings (including bonus, three month moving average) for
November at 9:30 GMT; October +4.0%

Friday: Retail Sales for December at 930 GMT; November +0.4% m/m, +4.4%


Wednesday: Machinery Orders for November at 23:50 GMT (prior day);
October +12.7%.

Thursday: Revised Industrial Output for November at 4:30 GMT;
preliminary +1.7%.

Friday: Consumer Confidence for December at 5:00 GMT; November 39.8.

Joseph Trevisani
FX Solutions
Chief Market Analyst

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