The Week Ahead updated November 30, 2007
â€¢ The USD mounts a comeback
â€¢ Fed rate cut looks certain after weak Beige Book, dovish comments
â€¢ Multiple interest rate decisions next week: ECB, BOE, RBA, RBNZ, and BOC
â€¢ Risk aversion wanes even as money market conditions worsen
The USD managed to stage a rebound just one week after dropping to all-time lows in the US dollar index last Friday. Itâ€™s still too soon to indicate that the downside is over for the USD, but Fridayâ€™s price action generated a break of the primary daily trendline lower, which had been operative since the middle of August. EUR/USD is closing on key daily channel support at 1.4620/30, and a daily closing break below would serve as confirmation that the uptrend has ended.
What changed for the USD in such a short timeframe? Not very much, actually. The data that came in pointed to further weakness in the US economy, even suggesting a faster deterioration than before. Housing data, consumer confidence, durable goods orders, weekly jobless claims, and personal income and spending were all weaker than market expectations. Perhaps most worrisome was the sharp increase (+112K) in continuing jobless claims data, indicating that unemployed workers were finding it more difficult to obtains new jobs, suggesting labor market conditions have worsened recently. The Beige Book also stands out as another harbinger of further weakness down the road. Finally, dovish comments from Fed Vice Chair Kohn and Chair Bernanke noting a deterioration in financial market conditions and further erosion of the outlook for private consumption cemented expectations for a rate cut. But in logic that only seems workable in the financial markets, traders concluded that the weaker data would force the Fed to ease rates again at the Dec. 11 meeting, which would ultimately serve to support the US economy in the months ahead. With that logic, stocks rallied sharply and the USD caught a bid.
There were some notable developments in the financial sector that helped stabilize near-panic anxieties over the stability of US financial institutions. On Tuesday, a much-needed capital infusion to Citigroup from the Abu Dhabi Investment Authority suggested that ailing US financial firms could still obtain financing, even if it was at exorbitant rates. Equity markets loved the news and began to rebound in tandem. Wednesday saw the Fedâ€™s Kohn indicate the need to remain flexible and to react in the face of deteriorating conditions, later confirmed by the Beige Book, to forestall a deeper US slowdown. Fed Chair Bernanke echoed that sentiment in remarks later on Thursday evening, suggesting another rate cut is in store. In fact, the Beige Book was so downbeat that futures markets began pricing in the prospect of a 50 bp rate cut instead of only 25. The feeling is that more aggressive action now will prevent a deeper, longer slowdown in the future, raising the ultimate low-water mark for US interest rate expectations. Finally, efforts by US Treasury Sec. Paulson to get mortgage lenders/servicers to ease up on distressed home owners, potentially even freezing adjustable rate mortgage re-sets, one of the biggest looming obstacles to a re-bound in housing, allayed market fears further.
The news was not strictly US-based. Further signs of slowing emerged in Europe and the UK, further limiting expectations of higher rates in the Eurozone and accelerating expectations of rate cuts by the Bank of England (BOE). German consumer confidence weakened more than expected and German retail sales fell -3.3% MoM in Oct, bringing the YoY decline to -0.6%. ECB pres. Trichet also decried â€˜brutal movesâ€™ in FX rates, repeating language he has used before to express displeasure for the strength of the Euro. On Friday, newswires citing un-named ECB sources indicated that Eurozone interest rates are likely to remain on hold for the next several months, despite inflation higher inflation readings. UK housing prices continued to slide and mortgage lending dropped further, leading to a further decline in UK consumer confidence. BOE Gov. King also pointed out that persistently high short-term money market lending rates between banks was inhibiting credit flowing to consumers, exacerbating the housing slowdown.
Itâ€™s difficult to call the outlook â€˜improvedâ€™ for the US economy in general and the financial sector in particular, but the developments cited above generally led to a sense that the situation in the US is less dire, and that the Fed would respond proactively to forestall further slowing. That shift led to a return to risky assets, as stocks recovered and JPY-crosses (carry trades) moved higher yet again. USD/JPY led the dollarâ€™s recovery higher in that respect, and softer reports out of the Eurozone and UK late in the week caused longs in those currencies to exit.
The environment remains exceptionally fragile and if you look at the twisted logic by which carry trades and stocks staged a rebound (the situation is so bad, the Fed may have to cut rates more aggressively), it makes one wonder how long this bounce will last. I would note that price action in US equities on Thursday posted a doji and Fridayâ€™s attempt to extend the rally was rebuffed (S&P retreated from the 50% retracement of the entire decline), leaving a relatively long tail above, warranting further caution on the extent of further correction higher. We continue to remain one headline away from another meltdown in market confidence and the risks continue to favor more bad news over good news, leading me to favor another relapse lower in US stocks and carry trades.
Next week sees central bank interest rate decisions from nearly all the key currency countries, except for the US and Switzerland, which decide in the following week. Below is a summary of market expectations and my outlook for rate outcomes, in order of announcement:
â€¢ Bank of Canada: Tuesday morning EDT; headline consensus remains for steady 4.50% rates, but there has been a surge in those expecting a rate cuts to where itâ€™s nearly 50-50 between expected steady and a 25 bp cut. If youâ€™re on the BOC and see the deterioration to your south (US), you have to wonder what the virtue is of waiting for further data, which has turned down recently. A Â¼% cut would also weaken the CAD, providing some comfort to ailing exporters. I favor a 25 bp cut to 4.25%.
â€¢ Reserve Bank of Australia (RBA): Tuesday evening EDT; expectations are unanimously for a steady rate of 6.75%. Growth and inflation downunder remains persistently high, normally indicating a rate hike, but financial market conditions and deteriorating global growth favor waiting. I expect no change from the RBA.
â€¢ Reserve Bank of New Zealand (RBNZ): Wednesday evening EDT; expectations are also for a steady 8.25 official cash rate. Softening housing and confidence data put the risks to a rate cut, but I favor a steady decision at this meeting, as personal consumption reports remains solid.
â€¢ Bank of England (BOE): Thursday morning EDT; expectations are mostly 75% in favor of a steady 5.75%/25% favoring a Â¼% rate cut. BOE minutes showed two MPC members in favor of an easing at the Oct meeting. Data has only softened in the interim and with money markets in severe distress, a bit of relaxation in base rates appears needed. I favor a 25 bp rate cut to 5.50%, but itâ€™s a close call.
â€¢ European Central Bank (ECB): Thursday morning EDT; unanimously expected to hold rates steady. ECB officials have taken a tough line on inflation and generally expect the Eurozone economy to remain solid, despite ongoing financial market distress. The ECB would prefer to hike rates, but with the growth outlook dimming and money market rates well above their target, ECB officials can neither hike, nor ease. I expect them to stay on hold and ECB Pres. Trichet to take advantage of a downturn in the EUR direction to heap further negative rhetoric on it and give it another nudge down.
Looking at the key data reports coming out next week from the US, Monday kicks off with ISM-manufacturing for Nov, and itâ€™s expected to hold roughly steady. Tuesday sees only weekly ABC consumer confidence after the close. Wednesday sees ADP national employment report, which is forecast to show 50K jobs added, translating roughly to a 70-75K NFP increase. Wednesday also sees final 3Q non-farm productivity, unit labor costs, factory orders and the ISM non-manufacturing, also expected to remain roughly steady. Thursday sees weekly jobless claims and Nov. ICSC chain store sales. Friday sees Nov. NFP data and the forecast is for an increase of 75K jobs and a rise in the unemployment rate to 4.8%. Later, preliminary Dec. Univ. of Michigan consumer sentiment is expected to soften slightly further to 75.0 from 76.1.
Eurozone data begins on Monday with manufacturing sector PMIâ€™s for key countries and the Eurozone as a whole, along with the Oct. Eurozone unemployment rate. Tuesday sees only Eurozone Oct. PPI of note. Wednesday sees service-sector PMI for key countries and the Eurozone as a whole, followed by Oct. Eurozone retail sales. On Thursday, ECB and UK rate decisions are the key, but Oct. German factory orders are also out. Friday sees only Oct. German industrial production and Oct. OECD Eurozone leading indicator index.
UK data will see the HBOS house price change at some point during the week, but no fixed release is set. Monday sees only Nov. manufacturing sector PMI scheduled. Tuesday sees the BRC retail sales monitor and the Nov. construction-sector PMI. Wednesday sees Nationwide Building Societyâ€™s consumer confidence measure, service-sector PMI and Nov. BRC shop price index, a measure of retail inflation. Thursday will see the BOE rate decision after Oct. industrial and manufacturing production reports. Friday sees only the NIESR Nov. GDP estimate.
Japanese data begins on Monday morning with 3Q capital spending reports, followed by labor and overtime earnings in the afternoon. Tuesday sees only money supply data. Thursday afternoon sees the preliminary Oct. leading economic index and preliminary Nov. machine tool orders. Friday morning sees final 3Q GDP and GDP deflator.
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