Background The Employment Cost Index (ECI) is a quarterly report of compensation costs that is released in the final month of the quarter, with a cutoff date of payroll periods ending the twelfth of the month of the release. The ECI is an index-based indicator that presents the changes in wages, bonuses and benefits from the previous quarter, displayed on a per-hour basis. All non-farm industries are covered, with the exception of federal government employees (which only make up 2-3% of the work force).
The data is provided by the Bureau of Labor Statistics (BLS) and is broken down by industry group, occupation and union vs. non-union workers. The data is compiled through separate surveys of non-farm businesses (about 4,500 sampled) and state and local governments (about 1,000 sampled). The index has a base weighting of 100. The current base period is December 2005.
What it Means for Investors The ECI is watched primarily for its inflationary insights. Compensation costs represent the lion's share of the total cost for a company to produce a product or deliver a service in the marketplace (and can be computed per company by dividing cost of goods sold (COGS) by selling, general & administrative expense (SG&A) on the company's income statement). The relative percentages of COGS will vary by industry, making the data release valuable on an inter-industry level.
The ECI is used by the Federal Reserve to set monetary policy; as the Fed has publicly stated, it prefers the value of this release to the Employment SituationReport's hourly cost figures, which just include wages. Another benefit of the methodology used in the ECI is that wage changes that occur as a result of a shift in the occupational mix of workers can be captured here using a "basket of occupations" approach similar to that of the CPI. Results of the ECI are less likely to be affected by people shifting to lower or higher-paying jobs.
The ECI is a lagging indicator; rising costs at this level speak to economic overheating that has already been visible at earlier points in the economic food chain (commodity costs, retail sales, gross domestic product), and suggest that some rise in inflation is inevitable.
This indicator can move the markets if it shows marked differences from street estimates. Economists and Fed watchers are always on the lookout for surprise signs of inflation, and anything that changes the common perceptions on Wall Street as to the level of inflation will move the bond markets immediately, and stocks will react according to its recent performance relative to economic growth prospects. The deeper into the business cycle the economy is, the more likely it will be for stocks to sell off on fears of Fed rate cuts, and possibly the end of the growth phase within the current cycle.
Rising compensation costs are usually passed on to consumers because they are such a large corporate expense.
The ECI is used as part of the formula that calculates productivity. If productivity gains are less than proportional ECI gains, there won't be the necessary balance to keeping end prices to consumers down. Investors should always compare the ECI to total productivity figures, paying particular attention to relative rates within industries in which they have a stake.
Strengths:
The ECI calculates the total set of employee costs to businesses, not just wages. Health insurance, pensions and death-benefit plans, and bonuses are all calculated here and broken out separately from wages and salaries.
Data is provided with and without a seasonal adjustment.
Well respected by both the Fed and business leaders; company managers use the ECI to compare their own compensation costs relative to their industries
Rates of change are showed from the previous quarter and on a year-over-year basis.
Weaknesses:
The data is only released quarterly, and with a slight overlap, covering a mid-month period.
Hourly earnings shown in the monthly Employment SituationReport provide some headway into this release, taking some of the surprise value out of wages.
Can be volatile when periodic bonuses, commission payments and the like are taken into account (especially at year-end); economist interpretation is often needed to fully digest the report.
Background The Employment Situation Report, also known as the Labor Report, is an extremely broad-based indicator released by the Bureau of Labor Statistics (BLS). It is made up two separate and equally important surveys. The first, the "establishment survey", is a sampling of more than 400,000 businesses across the country. It is the most comprehensive labor report available, covering about one-third of all non-farm workers nationwide, and presents final statistics including non-farm payrolls, hours worked and hourly earnings. The data sample is both large and deep, with breakouts covering more than 500 industries and hundreds of metropolitan areas.
The second survey, referred to as the "household survey", measures results from more than 60,000 households and produces a figure representing the total number of individuals out of work, and from that the national unemployment rate. The data is compiled by the U.S. Census Bureau with assistance from the Bureau of Labor Statistics. This carries a census-like component, bringing demographic shifts into the mix, which gives the results a different perspective.
Both sets of survey results will show the change from the previous month, and also year-over-year, as trendlines are very important with this often volatile statistic.
What it Means for Investors The Employment Situation Report is a multi-layered release, with many links from the main page and following the headline discussion items. Because there is so much information provided, it's important to identify the numbers that will be most watched.
The non-farm payrolls figure is very important on Wall Street; it's the benchmark labor statistic out there used to determine the health of the job market because of its large sample size and historical significance in relation to accurately predicting business cycles. Economists have settled on the number of 150,000 jobs as the level that defines economic growth. Gains of roughly 150,000 jobs or more indicate expansion of the labor force, while anything below indicates a weak job market.
The payroll figures from the establishment report are considered a coincident indicator.
Each survey comes up with its own figures for total employed persons using very different tacks. The establishment report is larger, and theoretically more accurate, but excludes private households, the self-employed and the agricultural sector. The household report runs on a smaller sample and may be more subjective, but the inclusion of self-employed workers, for example, can make this figure more valuable in a time when many people are starting their own business (as often happens in the beginning of a new business cycle).
Average weekly hours for the manufacturing sector, as presented in the establishment report, is a leading indicator, and is represented in The Conference Board's U.S. Leading Index.
The unemployment figures from the household report (which is probably the most watched metric of the release after non-farm payrolls) are considered a lagging indicator, as people tend to be out of work when problems in the economy have already manifested themselves in falling economic output (less workers, less GDP).
Investors study the labor report to look for trends indisposable income, wage inflation and employment statistics, many studying industries of personal interest to them. Analysts will usually conclude that if payrolls are increasing and wages are rising, that personal consumption stats like retail sales will advance as well, as more money will be in the pockets of consumers.
The Fed watches this report intensely. Alan Greenspan used up good a deal of his allotted minutes during all those years of Senate briefings talking about the labor markets, specifically information contained in the benchmark Labor Report. The unemployment rate alone makes up more than 47% of the lagging index created by the Conference Board and used by the Federal Reserve Board.
In relation to the hourly employment costs, investors can be best served by using the figures here in conjunction with the Employment Cost Index, which comes out about a week after the Labor Report in the four months the ECI is released (ECI is a quarterly report). A key to look for is whether wages are keeping pace with inflation; if not, the real purchasing power of consumers will drop.
The household survey takes into account demographic changes to some degree, whereas the establishment survey only counts the total number of payrolls. In effect, the household survey acts as a mini-census, which is why the same employment report may show an increase in payrolls, while the unemployment rate simultaneously rises, a seeming contradiction in terms.
The number of hours worked data can shed light on where the economy is in the business cycle; companies will often stretch the hours of their current workforce before they decide to hire new workers. This conservative behavior likens to "testing the waters" of the economy before committing to hiring for future growth.
Investors can pore over the industry-specific numbers to get a good feel for labor trends within the industries investors have holdings in - there may be pockets of strength in an overall weak labor report.
Labor statistics can tell us a lot, but they do not necessarily define the economy. Many industries can be well positioned to remain profitable even during tough labor markets - financial services, for instance, can easily lay off workers and keep labor tight until conditions improve, while more capital-intensive industries such as manufacturing (with its higher fixed cost structure) may suffer bigger hits in profitability.
Strengths:
As one of the most widely watched reports, the Employment Situation Report gets a lot of press and can move the markets.
Summary analysis provided by the BLS (top link on the site) on the top-level release of an already detail-rich report
Relates to investors on a personal level; everyone understands having a job or looking for work.
Services industries are covered here - it is hard to find good indicator coverage of service-based businesses.
Weaknesses
Summer and other seasonal employment tends to skew the results.
Only measures whether people are working; it does not take into account whether these are jobs the people wish to have, or whether they are well-suited to workers' skills.
Volatile; revisions can be quite large, and updates should always be viewed in the most recent report.
Unemployment and payroll figures can seem to be out of alignment, as they are derived from two different surveys.
Compensation costs portion is considered inferior to the Employment Cost Index.
The Closing Line The Employment Situation Report is a very powerful indicator that is able to move the markets dramatically if the results surprise Wall Street. Heavily analyzed, the report is the single best way to understand the state of the labor force at any point in time.
Background
The Advance Report on Durable Goods Manufacturer's Shipments, Inventories and Orders, or the Durable Goods Report, provides data on new orders received from more than 4,000 manufacturers of durable goods, which are generally defined as higher-priced capital goods orders with a useful life of three years or more, such as cars, semiconductor equipment and turbines.More than 85 industries are represented in the sample, which covers the entire United States.
Figures are provided in current dollars along with percentage change from prior month and prior year for new orders, total shipments, total unfilled orders (orders that have been booked but not filled as of month-end) and inventories. Revisions are also included for the prior three months if they materially affect prior-released results.
The data compiled for consumer durable goods is one of the 10 components of the Conference Board's U.S. Leading Index, as growth at this level has typically occurred in advance of general economic expansion.
What it Means for Investors:
The headline figure will often leave out transportation and defense orders, as they can show higher volatility than the rest of the areas. In these industries, the ticket prices are sufficiently high that the sample error alone could swing the presented figure significantly.
It is useful for investors not only in the nominal terms of order levels, but as a sign of business demand as a whole. Capital goods represent the higher-cost capital upgrades a company can make, and signals confidence in business conditions, which could lead to increased sales further up the supply chain and gains in hours worked and non-farm payrolls.
Investors can play with the numbers here and look at things such as the rates of growth of inventories versus shipments; changes in the inventory/shipments ratio over time can point to either demand (falling ratio) or supply (rising ratio) imbalances in the economy.
Because capital goods take longer on average to manufacture than cyclical goods, new orders are often used by investors to gauge the likelihood of sales and earnings increases by the companies who make them. For instance, a company like Boeing could make revenue adjustments on the upside based on strong new order growth, signs of which could be gleaned from the Durable Goods Report. In addition, when production and capacity at U.S. manufacturers is rising, it helps to combat inflationary pressure, as more goods will be produced for consumer purchase.
Investors should be cautious to see through the high levels of volatility found in areas of the Durable Goods Report. Month-to-month changes should be compared with year-over-year figures and year-to-date estimates, looking for the overall trends that tend to define the business cycle.
Strengths:
Good industry breakdowns
Data provided raw and with seasonal adjustments
Provides forward-looking data such as inventory levels and new business, which count toward future earnings.
Weaknesses:
The survey sample does not carry a statistical standard deviation to measure error.
Highly volatile; moving averages should be used to identify long-term trends
The Closing Line The Durable Goods Report gives more insight into the supply chain than most indicators, and can be especially useful in helping investors get a feel for earnings potential in the most represented industries: machinery, technology manufacturing and transportation.
Background
The Consumer Price Index (CPI) is the benchmark inflation guide for the U.S. economy. It uses a "basket of goods" approach that aims to compare a consistent base of products from year to year, focusing on products that are bought and used by consumers on a daily basis. The price of your milk, eggs, toothpaste and hair cut are all captured in the CPI.
There are two presented CPI figures, the CPI for Urban Wage Earners and Clerical Workers (CPI-W), and the CPI for all Urban Consumers (CPI-U). The most watched metric, Core CPI (with food and energy prices removed) is the CPI-U, which will usually be presented with a seasonal adjustment, as consumer patterns vary widely depending on the time of year. The current base year for the CPI is 1982, so changes will typically be provided on a percentage basis to reflect only changes to prior index levels. Numbers will also be shown as an annual run rate of growth, to give investors a sense of the near-term inflationary outlook.
The Chain-Weighted CPI is also released along with the Core CPI, and is gaining momentum as a metric worth following, as Chain-Weighted CPI captures the effects of consumer choice. Chain-weighted CPI numbers are considered by many to be more reflective of actual consumer patterns than fixed CPI figures, as the chain-weighted index accounts for the substitution and new product bias that exists in the fixed CPI. If a consumer buys one product over another because of a price hike in the first product, chain-weighted figures will capture this buying shift, while Core CPI will not. Core CPI will continue measuring the price of the good as it rises, regardless of whether fewer people are purchasing the product.
The CPI is an extremely detailed release, with breakouts for most major consumer groups (such as food and beverage, apparel, recreation, etc.) and geographical regions, which are supplied by the "CPI U.S. City Averages".
What it Means for Investors The CPI is probably the single most important economic indicator available, if for no other reason than because it's very final. Many other indicators derive most of their value from the predictive ability of the CPI, so when this release arrives, many questions will be answered in the markets. This report will often move both equity and fixed-income markets, both the day of the release and on an ongoing basis. It may even set a new course in the markets for upcoming months. Analysts will be more sure of their convictions about what the Fed will do at the next Federal Open Market Committee meeting after digesting the Consumer Price Index.
The CPI is used to make adjustments to many cash flow mechanisms (pensions, Medicare, cost of living adjustments to insurance policies, etc.). As a result, most investors will find that the CPI affects them personally in some way. Fixed-income investors should always be aware of the rate of inflation against which they judge their investments; it is imperative to keep current yields ahead of inflation, or real wealth will fall.
Strengths:
Gives most insight into future Fed rate moves
Highly watched and analyzed in the media
Good regional and industry breakdowns for investor research
Weaknesses:
Volatile month to month
Fixed CPI has certain biases (new product, substitution), which can distort results
Exclusion of food and energy is only good for so long - these costs should be considered when assessing inflation
The Closing Line The CPI is one of the most important indicators in terms of moving the markets and setting monetary policy for the Fed. Consider looking at both the fixed and chain-weighted CPI.
Financial Markets Summary For The Week of September 8-12
The week of September 8-12 will see a heavy week of US macro data. Inflation will be at the forefront with import prices and producer prices released on Thursday and Friday, while the advance retail sales estimate for August to close out the week figures to be the primary market moving release of the week. The week will kick off with the Tuesday publication of the July pending home sales release. The majority of the data for the week will be published on Thursday, which will also see the release of the July trade balance, weekly jobless claims and US monthly budget statement. Friday will also see the publication of the University of Michigan’s preliminary estimate of consumer sentiment for September.
IFed Talk
The only Fed speaker scheduled for the week is FRB Dallas President Fisher, who will speak in Austin, Texas, topic and time TBA on Monday, September 8. The remainder of the week falls under the traditional blackout period on Fed talk ahead of the September 16 FOMC meeting. Pending Home Sales (July) Tuesday 10:00 AM
Pending home sales for July should fall -1.3% after a strong 5.3% uptick in June. The modest increase in sales activity during the summer months of 2008 has been fueled by purchases of foreclosed homes in the existing stock of houses. According to the National Realtors Association, up to 40% of all homes purchased in the existing home sales report fall under that category. This number will probably have to increase given the quantity of Alt-A and prime borrowers that are expected to see their homes enter into foreclosure over the coming months. Some cash buyers and other well positioned consumers may find good opportunities to re-enter the housing sector over the next several months, but we do not think in the short-term that this will be sufficient to clear the outsized level of inventories currently on the market. Trade Balance (July) Thursday 08:30 AM
The price of West Texas intermediate crude oil hit its recent peak on July 14 at $146.13 per barrel. This should provide a bit of a drag on the recent improvement in the trade deficit. We expect that deficit should increase modestly to -$58.5bln for the month. However, the real dollar goods balance should continue to see modest declines and the external sector should continue to provide support for overall economic activity during the third quarter of 2008. Import Prices (August) Thursday 08:30 AM
US inflation indicators should see their first sign of relief reflecting the decline in headline costs. We expect that import prices will fall -0.7% the month vs. the previous 1.7% increase in July. On an annual basis, import prices should show a 19.8% increase. The primary catalyst behind the August headline decline should be the fall in petroleum costs. Initial Jobless Claims (Week ending Sep 7) Thursday 08:30 AM
Initial claims should fall back slightly to 440K during the upcoming week. Over the next several weeks look for the weekly claims series to be quite volatile on the back of dislocation in the labor sector due to the series of hurricanes that look to hit the Southeast portion of the United States. US Budget Statement (August) Thursday 2:00 PM
The US budget statement should continue to spill red ink again in August, when our forecast suggests that the deficit should grow to -$107.1bln for the month. The combination of increased outlays, falling tax revenues that final rebate checks being cashed should push the deficit higher for the second straight month. Producer Price Index (August) Friday 08:30 AM
The market will focus on what we expect to be a decline of -0.4% m/m in headline costs for producers. This improvement, which should be driven by the fall in oil costs, has been widely priced in to expectations. However, we note that core prices can be expected to rise 0.3% m/m and 3.8% y/y in additional the 10.2% annual increase in headline prices. For the past several months we have pointed out the risk due to rising total intermediate costs, which are up 16.6% annually on a headline basis and 10.2% in the core. Fueling this rise has been the 23.9% increase in the cost of material for non-durable manufacturing, 36.4% cost of processed fuels and lubricants and 12.5% advance in the cost of materials for durable manufacturing. We do not think that these costs will be receding anytime soon and the risk of inflation into the core will continue for some time even as headline costs continue to abate. Most importantly, this is what led the Kansas City, Chicago and Dallas Fed regional banks to ask for a 25 basis point hike in the discount rate to 2.5%. According to the three Fed regional banks “higher input costs were being passed through to product prices and that inflation expectations had risen and judged that the upside risks to inflation were of greater concern than the downside risks to growth.” Advance Retail Sales (August) Friday 08:30 AM
The retail sales environment during the month of August should reflect the increasing strains that have become quite visible on the consumer. With the impact of the stimulus fading and a lackluster late summer sales season in the auto and back to school sales, we think that overall sales should see a tepid increase of 0.1% in the headline and a -0.2% in the core, with risk to the downside in both. Anecdotal reports from retailers do not bode well for the series and the typical later summer surge associated with the fall school season looks to have failed to materialize. Should the Redbook and retail chain reports come in below our modest expectations, we will revise down our forecast accordingly. University of Michigan Consumer Confidence (September) Friday 08:30 AM
The recent decline in the price of gasoline should continue to provide support to consumer confidence, which seems to have reached cyclical lows during June. The preliminary September estimate of consumer sentiment should rise to 63.9 as the recent fall in headline prices is passed through to consumers in the guise of cheaper prices for energy. We think that the modest outbreak in optimism is likely to be transitory once consumers, especially those in the Northeast and upper Midwest, turn their attention to the cost of heating oil and electricity costs during the upcoming winter months ahead.
Joseph Brusuelas
Chief Economist
Merk Investments http://www.merkfund.com/
The views in this article were those of Axel Merk as of the newsletter's publication date and may not reflect his views at any time thereafter. These views and opinions should not be construed as investment advice nor considered as an offer to sell or a solicitation of an offer to buy shares of any securities mentioned herein. Mr. Merk is the founder and president of Merk Investments LLC and is the portfolio manager for the Merk Hard Currency Fund. Foreside Fund Services, LLC, distributor.
US companies have reacted fast to the economic slowdown. They have managed to keep down stocks, the order books are very fat, and employee efficiency is improving. That is of importance for adjusting to the economic slowdown, for corporate earnings and for the inflationary pressure.
Companies traditionally run into various problems when sales slacken. Companies realise too late that the fall in sales is lasting, and since they do not adjust production/purchases in time, their stocks of unsold goods grow. The combination of a surfeit of unsold goods and flagging sales means that companies have to slash production/purchases to reduce stocks.
However, in the present slowdown, companies have foreseen the decline in sales and they are faster off the mark than usual. They reduced production as sales fell and thus avoided stockpiling. In fact, they have managed to reduce stocks in relation to sales, as evident from the chart.
There is another point on which we have seen a change in behaviour: the manufacturing companies have managed to build up large order books as mentioned earlier
Normally, employees turn less efficient at times of economic slowdown/ recession. That is because companies reduce production rather than the workforce. Also in that respect have companies deviated from normal practice. Production growth which is a measure of employee efficiency has risen sensibly over the past five quarters
What is the effect of this change in behaviour? First of all, it means better management of production and stocks when companies do not have to fire workers as they had to during earlier recessions. On the other hand, it may mean that employment does not rise fast when sales pick up again. The effect will therefore be that the economic swing will probably be smaller this time. The solid growth in productivity shows that companies are increasing employee efficiency, and that bodes well for corporate earnings in future. Finally, it also means that companies' costs per unit produced fall, and that may dampen inflation.
This week's other highlights
The US: pending home sales, producer prices and retail sales
China: consumer prices
Norway: consumer prices
Sweden: consumer prices
Monday
The UK: RICS - August
The survey from the Royal Institute of Chartered Surveyors has long indicated a softening housing market, and we expect this trend to have continued in August.
According to the RICS survey , the ratio between home sales and the stock of unsold homes fell further in July - particularly because of falling home sales and is now at the lowest level since 1995. This indicates further price falls to come.
The RICS house price index - which shows how many of the real estate agents who responded asses that housing prices to rise compared with those who expect them to fall - has risen marginally these past three months. That indicates some stabilisation, but the level is still very low and indicates that the fall in house prices has some way to go.
The low number of transactions indicates that the tighter borrowing conditions and expectations of further falls in house prices keep many potential buyers out of the housing market. The number of new mortgage loans is also very low.
Tuesday
The US: pending home sales - July
Pending home sales are a fairly good leading indicator of housing activity for the next two months although they cover only about 20% of total pending home sales. This is due to the fact that pending home sales are based on contracts signed before the transactions are closed.
Home sales have fallen by 33% since the autumn of 2005, but as appears from the chart below, home sales have been stable around 5m units (converted to sales in one year) over the past nine months. It is of course interesting whether home sales will remain stable.
The stabilisation is probably due to a combination of lower mortgage yields and falling house prices around the turn of the year, and this has been sufficient to neutralise the effect of the tighter credit standards in the mortgage market.
Mortgage yields have, however, risen since the spring. 30-year mortgage yields have risen from 5.5% in January to around 6.5%, and together with the tighter credit standards this may dampen home sales in the coming months. This is supported by a sharp fall in mortgage applications since the start of the year. But please note that part of the sale is due to compulsory sale of homes.
Sweden: consumer prices - August
The Swedish consumer prices are high and also significantly higher than what is to the liking of the Riksbank. The Riksbank is concerned whether the high rate of inflation - although it has risen due to temporary factors such as food and energy - will lead to second-round effects in the form of higher inflation expectations and acceleration of wage growth. But some indicators of inflation expectations have fallen a little just as wage growth has fallen slightly over the past months. Lower wage growth is, however, offset by a negative trend in productivity which means that labour costs will be higher.
In July, consumer prices rose by 4.4% y/y. We assess that August inflation will remain around this level since rising electricity prices offset some of the effect from the considerably lower oil and food prices. Moreover, the considerable weakening of SEK against USD means that the fall in oil prices in terms of SEK is less visible. However, for the slightly longer term we expect that the inflationary pressure will abate as the bleak growth picture materialises and the pressure on the resources of the economy is reduced, just as the basis effect from commodity prices will disappear.
Wednesday
Japan: machine orders - July
The development in machine orders has been better than expected over the past months. This indicates that private investment is more robust than earlier expected, and the level is still much higher than during earlier recessions.
However, we expect a much slower development in July since the growth picture is becoming increasingly gloomy just as the corporate profit margin is squeezed by high commodity prices. In June, it was notably foreign machine orders which had an adverse effect (fell by 12.1% m/m) while domestic orders - notably from manufacturing companies and the public sector - offset some of the fall.
China: consumer prices - August
Inflation has fallen some over the past months due to lower food prices, and we expect the falling trend to continue for the rest of the year. Consumer prices rose by 6.3% y/y in July against 8.7% in February (the sharpest rate of increase since 1996). Over the same period, inflation in food prices has fallen to 14.4% from 23.3%. It is notably prices on meat and vegetables which have driven down inflation over the past couple of months. These product groups have been affected by swine disease and the snow storm earlier in the year and are now normalising.
Inflation exclusive of food prices has, on the other hand, increased lately due to the government's increases of energy and fuel prices. In July, inflation exclusive of food prices was 2.1% y/y against 1.5% in January. Energy prices do not have a large share in the consumer price index - less than 5% - while food prices account for 1/3. The development in inflation will therefore still dominate headline inflation.
Norway: consumer prices - August
Since the turn of the year, inflation has been markedly above Norges Bank's inflation target, mainly driven by rises in food and energy prices but also the inflationary pressure from core inflation has increased. Domestically created inflation has increased, among other things due to a tight labour market and high wage increases, whereas imported inflation has long been negative. But imported inflation has turned and is now around zero.
In July, consumer prices rose by 4.3% y/y, and we expect inflation to remain around this level in August. Just as in July, there are prospects that electricity prices will drive up inflation whereas the falling oil prices pull in the other direction. For the slightly longer term, we expect that the inflationary pressure will abate as growth slows down and the pressure on the resources of the economy is reduced, just as the basis effect from commodity prices will disappear.
Thursday
The US: trade balance - July
The trade balance is interesting for a number of reasons. First and foremost because net exports have contributed significantly to GDP growth in recent quarters. In Q2 total growth was largely driven by net exports, and it is of course interesting to see whether this growth contribution continues. The trade balance may reveal how much the rest of the world will be affected by slower US growth. Finally there are indications of a falling deficit due to the fall in oil prices.
Since the end of 2006, the deficit has fluctuated around USD 60bn, and in June it declined to USD 56.8bn. The improvement of the deficit in June can be attributed to a very strong increase in exports driven by increasing deliveries to the manufacturing industry, capital goods and food. We doubt that export growth can be maintained at the very high level (13% y/y) in the light of the international slowdown in growth. Imports adjusted for price increases declined by 3% y/y and things are beginning to look like the development during the last recession.
However, if the effect of oil imports is removed, the deficit is only approx. USD 32bn and has fallen significantly since early 2007. Since oil prices have fallen considerably, a sharp fall in the deficit could be expected. But one should be aware that the oil price peaks in mid-July and the effect of it will therefore only be reflected in coming months. Furthermore, there is a tendency that the oil price is only reflected two months after. Our model for oil imports indicates an increase of approx. 2bn in the oil import.
Focus will also be on the import of capital goods, since this is an indicator of corporate investment. Traditionally corporate investment falls sharply during recessions, but this has not been the case so far. The import of capital goods adjusted for inflation shows a rise of 6%, which is rather solid.
Friday
The US: producer prices - August
The attention paid to producer prices has presumably fallen somewhat in line with the significant fall in oil prices. However, the financial markets will be interested in seeing whether companies raise prices of other goods. There has been a tendency that companies raise prices of semi-finished goods and commodities in particular – even exclusive of food and energy.
One should be particularly aware that producer prices are normally collected in the week containing the 13th day in the month. In fact, oil prices peaked around that time in July and fell by 20% until 13 August. Furthermore, food prices have fallen over the past two months. This will presumably pull down total producer prices.
On the other hand, there is a certain risk that companies have raised the prices of other goods (i.e. exclusive of food and energy). Thus, prices of semi-finished goods increased by 10.2% y/y and commodities by 37%. There is a certain risk that it will begin to be reflected in the prices of finished goods.
Thus there are prospects of a fall in total producer prices in August, while core producer prices may rise quite significantly.
The US: retail sales - August
Retail sales are one of the most important economic indicators this week. Retail sales account for approx. 40% of consumer spending and it is generally expected that consumer spending will pull the economy into recession.
Retail sales will be pulled down by petrol stations sales. Petrol prices declined by approx. 10% from July to August, and since retail sales are measured in terms of sales it will pull retail sales down. In the long term, the fall in oil prices may stimulate consumer spending and thus retail sales.
Overall, we expect a fall in retail sales. Jyske Markets - FX Researchhttp://www.jyskebank.dk/finansnyt
The analysis is based on information which Jyske Bank finds reliable, but Jyske Bank does not assume any responsibility for the correctness of the material nor for transactions made on the basis of the information or the estimates of the analysis. The estimates and recommendation of the analysis may be changed without notice.
The economy is experiencing an apparent calmness after a complicated year. Bad news is discounted in current prices and rates are steady for now. The positive momentum should go on until a new President will be elected in the U.S. However, growth is declining globally, unemployment is rising and inflation's long term trend remains on the upside. The U.S. dollar, in the meantime, is facing important resistance lines. The short/medium term trend stays bullish, although overbought conditions are surfacing.
Growth improving in the U.S., but for how long?
Growth was revised up for the second quarter in the United States and is now expected to be 3.3% from the 0.9% registered in the first quarter. The trade data contributed substantially to the increase. In fact, export numbers jumped to 13.2% from the originally estimated 9.2%, while imports declined to 7.6% from 6.6%. Housing continues to weigh on growth, while inflation's prospective stayed unchanged at 2.1% excluding food and energy. Consumer spending rose instead to 1.7% from 1.5% supported by the tax rebates. Americans are a bit more optimistic about their future, as commodity prices are softening from the highs and household revenues is mildly improving. In August, the Conference Board consumer confidence index rose to 56.9 (53.20 expected) from 51.9. The expectation index jumped to 52.8 from 42.7, the largest up move of the past three years. In effect, durable goods new orders climbed 1.4% in July, on the top of June's rise of 1.3%. Gains were solid with non-defense aircraft moving up 28% and core orders (non-defense capital goods excluding aircraft) rising 2.6% after increasing 1.3% in June. Will the positive momentum last? The international trade is trending, but not for long with the dollar rising and global growth declining. Then, there is personal consumption which is still benefiting from the stimulus package. As a result, numbers should be checked again, once money will not get into the mail anymore. Finally, jobless claims are strong and housing remains a drag the economy in the U.S.
Current trends to continue for the short term, as hope in mounting
We are experiencing an apparent calmness. Rates are steady across the Atlantic and bad news is already discounted in recent prices. Are we out the cyclone or just in its eye? Time will tell. U.S. Presidential elections will come to an end in November and hope is mounting. Consequently, current trends in commodities (down), interest rates (down) and the U.S. dollar (up) could go on until a new President will be elected. In the meantime, the Federal Reserve is watching events carefully since the economy is not out of troubles yet. The S&P/Case-Shiller price indicator for twenty major cities fell again 0.5% in June and it is 16% below the level of last year. Nonetheless, the housing market is showing some vitality, although it stays volatile and highly instable. Numbers are swinging from month to month and this pattern should continue until a bottom is reached. When? Trying to catch a falling knife could be painful, but various support lines are converging and they could meet between the end of this year and the first half of 2009.
In July, existing homes sales increased 3.1%, more than the expected +1.0%. Gains were distributed among single (+3.1%) and multiple homes (+3.4%) and only the Southern regions of the United States registered a decline. However, inventories of unsold homes are at record highs and rose to 11.2 months of supply from June's up move of 11.1 months. Consequently, prices continue to tumble. In July, they fell to 7.10% year on year from June's 6.1%. During the same month, new home sales moved up 2.4% to 515,000 units from the bottom of the past seventeen years touched in June's when only 503,000 new homes were sold. Here again, the Northern regions confirmed a good level of activity and increased almost 39%, while sales declined in the Central and Southern states by 8.2% and 2.5% respectively. Prices stay 6.3% below the level of last year, but inventories slid to 10.1 months of supply from June's 10.7 months.
Consumer confidence is tumbling in Europe
While Americans are experiencing the benefits of the tax rebates, Europeans are more pessimistic about the future. Consumer confidence is in a freefall in Germany, despite the unemployment rate declining to 7.6% from 7.8%. In August, the main IFO business sentiment fell to 94.8 from 97.5, the lowest level of the past three years. Both expectations and current conditions moved down. The German consumer confidence survey index from the GFK group declined instead to 1.5 points in September from August at 1.9 points. All the sub-indexes (propensity to buy, economic expectations and income expectations) remained extremely bearish. The European Central Bank (ECB) is still focusing on inflation, as Mr. Bini Smaghi confirmed last week, and only a strong downturn of the economy appears to motivate the central bank to change its policy. Nonetheless, current economic environment is ideal to touch rates to the downside, since commodity are receding for the highs and the bearish correction could go on for few more weeks/months. The Euro zone Consumer Price Index (CPI) preliminary estimate slid to 3.8% in August from 4.00% in July, while the M3 money supply eased to 9.3% (9.0% expected) from June's 9.5%.
The worst has yet to come
In effect, growth is fading globally and Europe is not immune to it. For the third month, the Bloomberg Purchasing Manager's Index (PMI), which surveys almost 1.200 executives, remained below the important benchmark of 50.0, despite moving up to 47.7 in August from 46.0 in July. German retail sales declined to 44.1 from 46.4, while both Italian and French sales rose. The former increasing to 44.8 from 38.2, while the latter rose to 53.7 from 51.3 respectively. All three countries make up about 80% of the total sales activity in the Euro zone. The decline of German growth is an indication that Europe is facing a tough period. The German's Gross Domestic Product (GDP) moved down to -0.5% quarter on quarter in the second quarter from the +1.3% shown in the first quarter. The fall of the construction business, as much as a shrinking household's wealth, could undermine growth further in the coming months as well.
USD short term trend up, but overbought conditions emerging
EUR/USD short/medium term trends point to the downside and the market could shortly reach 1.460/1.450, eventually 1.44 if 1.4470 is broken. Nevertheless, Euro/Usd seems to be oversold, a divergence between speculators and commercials is emerging from the COT data, and a breakout failure could take the price back to 1.50/1.52 without changing current downside pattern. A move blow 1.4320 will instead open the highway for a decline to 1.39. GBP/USD short term trend is down and price might decline further for the short/medium term. However, the market should stay below 1.8590 for 1.8000, 1.78.. A breakout failure could take the price back to 1.8690, 1.8750. USD/JPY failed to rise above the important resistance line at 111.00 and is again testing the support at 108.00, 107.20. The market is consolidating within a tight range. A swing above 111.65 is necessary for 112.60, eventually 113.50. A move below 106.75 would target 106.20. USD/CAD is consolidating from 1.07 to 1.04. A move above 1.0655 would target 1.07, 1.0750. Failure to breakout from the higher Bollinger band will take the price back to 1.04, eventually 1.03.
Angelo Airaghi MG Financial Group http://www.mgforex.com Angelo Airaghi is a Commodity Trading Advisor, registered with the National Futures Association and the Commodity Futures Trading Commission. He has been an active professional since 1990 working for major international financial companies. In the past 10 years, Angelo Airaghi has been an analyst and commentator for national and international media. Legal disclaimer and risk disclosure MG Financial Group, or any of its related companies, will not be held responsible for the reliability or accuracy of the information available on this site. The content provided is put forward in good faith and believed to be accurate, however, there are no implicit guarantees of accuracy or timeliness.
Background The Consumer Credit Report is a monthly release from the Federal Reserve Board that estimates changes in the dollar amounts of outstanding loans to individuals, funds which are mainly used to purchase consumer goods. Loans backed by real estate, such as home equity lines of credit (HELOCs), are not included in the survey. The two classes of credit covered are revolving and non-revolving credit; revolving credit can be increased by the consumer up to a limit without contacting the creditor (as in credit cards), while non-revolving terms are fixed at the time the loan (as with an auto loan).
Both classes are segmented into the categories below. The Consumer Credit Report shows the outstanding balances for each:
Commercial banks
Finance companies
Credit unions
Federal government & Sallie Mae
Savings institutions
Non-financial businesses
Securitized asset pools
Average interest rates are shown for many types of consumer debt, such as auto loans, credit cards and bank loans, collectively showing investors the overall "credit quality" of consumers and where the highest rates of growth are occurring.
Data is collected through surveys of banks, finance companies, retail sales outfits and credit unions, among others. Each release will show the three previous months' results, including any revisions to recent periods, if they have occurred.
What it Means for Investors Consumer credit is considered a good indicator of the potential future spending levels seen in the Personal Consumption and Retail Sales reports, and shows the extent to which benchmark interest rates such as the fed funds rate and prime rate have manifested themselves at the consumer level (it can take six months to a year for macro interest rates to work their way down to consumers).
The headline stats of this release will be total consumer debt (expressed in trillions and seasonally adjusted), the current annual run rate of growth or decline, and the total percentage of credit card delinquencies. The delinquencies are studied because sudden spikes may lead to fears that consumers are overextended in their debt levels. Some economists will try to compare the default percentages seen in the most recent recession as a breakpoint - if current default levels approach it, they will look for a recessionary trend to show itself in other economic indicators.
These factors are important when investors consider that consumers make up more than two-thirds of total GDP consumption. If consumers stop spending or face a credit crunch, GDP will not be able to grow much. Investors in consumer cyclical stocks should be keenly interested in consumers' ability to spend more in the future.
Consumer credit figures have a lot of seasonal and inherent volatility, so investors should always review the current report for adjustments to prior periods, paying particular attention to revisions to year-over-year growth. Long-term trends are the most studied portion of the report, both in the total outstanding balances as well as the change in overall interest rates being charged.
The Conference Board has tapped consumer credit as a lagging indicator, and uses a ratio of consumer credit to personal income as a component of its Index of Lagging Indicators. The Fed operates on the theory that consumers will not significantly increase their borrowing levels until their personal incomes increases enough to justify the higher debt load. As such, borrowing may show the largest increases when the economy is already coming out of a recession, rather than during the worst of it.
Strengths:
Contains detailed breakdown of auto loan figures, such as average maturity and prevailing interest rates
Data is provided with and without seasonal adjustments.
Release shows comparisons against previous month, previous year, and also against results from the last five years
Weaknesses:
Only total growth in outstanding loans is shown; there is no way of knowing if consumer payments have fallen off or if new loan growth has slowed based on a falling consumer credit number (and vice versa).
Absence of home-equity debt provides for an incomplete picture.
Because it comes out after the consumer confidence report and retail sales reports for the month, some analysts will not look as intently at the consumer credit figures month to month, instead reviewing multi-period trends once or twice a year
The Closing Line The Consumer Credit Report will not be a big catalyst in the markets because of earlier-released indicators, but it remains a good lagging indicator, especially when examined in conjunction with personal wage growth and interest rates. If prevailing rates are moderate and incomes are rising, consumer credit can grow in step without causing elevated fears in the market.
Financial Markets Summary For The Week of September 1-5
The week of September 1-5 will see a holiday induced four day trading week that will be light on data, but will see the return of heavy volume to the equities market and feature the publication of the August non-farm payrolls report on Friday. The week will kick off with the release of the ISM manufacturing report and the total vehicle sales report, both for August. Wednesday will see the factory orders estimate for July and the Fed beige book for the July –August period. Weekly jobless claims, the ISM non-manufacturing composite and the Q2 estimate of non-farm productivity will be released on Thursday. Fed Talk
The week ahead will see a number of Fed speakers on the schedule. Monday will see Atlanta Fed President Hoenig speak on inflation and inflationary pressures in the US economy at 08:30 AM EDT on 1 September. Dallas President Fisher will speak on the US economy at 1:40 EDT on 4 September. San Francisco Fed President Janet Yellen will speak twice during the upcoming week. On 4 September she will speak on the US economic outlook at 2:30 EDT. The following day Ms. Yellen will again address the economic outlook at 3:55 EDT. Boston Fed President Rosengren will speak on September 3 at 12:30 EDT topic TBA.
ISM Manufacturing (August) Tuesday 10:00 AM
The Institute for Supply Management's estimate of activity in the industrial sector for the month of August should see a slight decline on the back of modest economic activity at home and abroad. Although, purchasing managers should see a glimmer of hope on the back of what we think will be a very sharp decline in the prices paid component, the shoddy state of new orders and a second straight decline in new export orders should feature what will be a fall back to 49.3 in the headline for the month. Total Vehicle Sales (August) Tuesday: Throughout The Day
The ongoing adjustment in domestic motor vehicle industry should continue in August when we expect that domestic vehicle sales will arrive at 9.4mln and total vehicle sales will come in at 13.0mln. The combination of lack of demand for the fuel inefficient vehicles still on the market and the substitution of private transportation for mass transport in large metropolitan areas is subtly reshaping the domestic auto market. Within the context of tight credit, a weak labor market and falling home prices the auto industry is poised for further problems throughout the remainder of 2008. Factory Orders (July) Wednesday 10:00 AM
The solid environment for external demand should underlie a mild factory orders report for July. We anticipate that factor orders will increase 1.0% for the month. The second straight above expectations print in durable goods orders for July and the fifth straight above market expectations posting does give some hope that the spillover of financial stress into the real economy will be limited. The market will focus beyond the headline on shipments of non-defense capital good ex-aircraft that is a forward-looking indicator of growth. We expect to observe a solid 0.6% advance in that category. Fed Beige Book Wednesday 2:00 PM
The market will be focused on the condition of the consumer and the lingering deadweight that is the housing sector on economic activity midyear. The beige book should report modest economic activity with demand still seeing some of the impact from the fiscal stimulus package that arrived in the second quarter of 2008. What might prove more interesting will be the pricing situation during the report. The previous beige book imparted that there were anecdotal reports of demands for wage increases linked to surging headline prices. Should that gain steam, the markets current rosy outlook on future inflation may be slightly altered. Initial Jobless Claims (Week ending Aug 30) Thursday 08:30 AM
Initial claims over the past two weeks has surged well above the critical threshold of 400K and the less volatile four week moving average has increased to 442K. The strong move to the upside may partially be a function of legislative changes that have enabled continuing files to be identified and initial filers. This implies that the market should see the headline moderate over the coming weeks. Thus we expect a 435K print for the upcoming week. ISM Non-Manufacturing Thursday 08:30 AM
The service sector reflects the stress of higher headline costs and mixed prospects in the labor market that have defined the condition of the consumer over the past several months. We expect that the headline for the ISM non-manufacturing activity estimate will modestly ease to 49.3. Q2 Non-Farm Productivity Thursday 08:30 AM
Amidst a very difficult economic environment over the past year, productivity continues to hold up quite well. Firms that did not over indulge themselves during the expansion have maintained worker output per hour though 2007-08. During energy shocks, one would normally expect to productivity to weaken, but the lagged impact of past investment in technology appears to have provided a cushion for firms to weather the storm. We expect productivity in the second quarter to increase 3.0% primarily on the back of firms reducing payrolls to hedge against further economic downturns ahead. Non-Farm Payrolls (August) Friday 08:30 AM
The rise in initial jobless claims throughout the sampling period may be a bit ripe due to a policy change in how first time claimants are accounted for. However, the smoothed four-week moving average has moved above the 400K level. The carnage in the goods producing sector, construction and manufacturing will continue. In July, other than the health care, education and hospitality sectors all other major categories of private sector hiring went negative or were flat for the month. We expect the headline to see a net subtraction of -75K for August and the unemployment rate to rise to 5.7% for the month.
Joseph Brusuelas
Chief Economist
Merk Investments http://www.merkfund.com/
The views in this article were those of Axel Merk as of the newsletter's publication date and may not reflect his views at any time thereafter. These views and opinions should not be construed as investment advice nor considered as an offer to sell or a solicitation of an offer to buy shares of any securities mentioned herein. Mr. Merk is the founder and president of Merk Investments LLC and is the portfolio manager for the Merk Hard Currency Fund. Foreside Fund Services, LLC, distributor.
The mild mid summer bounce in sales activity inside the housing sector has stimulated broad market discussion around whether a bottom is forming in the market. Price declines in some major markets have turned around over the past two months and in other major markets they are falling at a slower pace. Combined with the starts data, which we believe is close to finding a bottom; this is the first glimpse of positive news in the sector for quite some time. Although, these developments provide a potential turning point we believe that conditions for stabilization in the housing sector are not ripe at this time.
The major issue looming over the housing market is the continuing problems at Fannie Mae and Freddie Mac. The twin GSE's guarantee over 70% of all mortgages currently originated in the financial sector and to be blunt, at this time the financial system cannot properly function without them.
We have consistently since the start of the crisis around Fannie and Freddie made known our preference for the orderly privatization of the two government behemoths after the credit crisis abates. But, without the government either providing cash as a backstop to them or nationalization at this point the probability of stabilization of the housing sector in the near term is low.
Second, the inventory levels in stock of new homes and existing homes stands at 10.1 and 11.2 months respectively. While prices have adjusted, it has not been sufficient to begin clearing inventories. To make matters worse, foreclosure rates in the Alt-A and prime categories is beginning to pick up. Our forecast is that home prices in the aggregate will have to fall another 10% to begin to move back toward stable equilibrium levels between 4-6 months.
Moreover, when one looks at the spread between the ten year treasury and the thirty year fixed mortgage rate one notices a 248 basis point gap, which is far between the 170-180 basis point spread typical during the last stable era in the housing market during the late 1990's. With rates actually higher than they were one year ago when the meltdown in the mortgage market began we believe that there is more room to the downside in the housing market ahead.
Perhaps, more interesting is the behavior shift among potential buyers. During the height of the mania the expectations of many homeowners were shaped to believe that 20% returns per annum was the norm. This led to the unsustainable extraction of home equity and is one of the primary reasons so many individual find themselves under water on their mortgages.
Today the pendulum has swung back in the other direction. The mean reversion occurring in the pricing of real estate assets is on its way to overshooting a bit, and now many potential homeowners that remain on the sidelines have expectations of potential losses should they enter the market prematurely.
Housing sales have picked up midyear, as one would normally expect during the summer months. Yet, we think that the market may be making a bit too much out of the slight improvement in the data. The housing market will eventually turn. But that is unlikely to occur in 2008 and we do not expect to observe it until prices fall another ten percent. Until the problems at Fannie and Freddie are resolved and prices adjust further to being clearing the outsized inventory on the books and that on the way due to the coming wave of foreclosures in the Alt-A and prime categories, the discussion regarding a bottom forming in the housing sector is all but prologue. Joseph Brusuelas
Merk Hard Currency Fund http://www.merkfund.com/
The views in this article were those of Axel Merk as of the newsletter's publication date and may not reflect his views at any time thereafter. These views and opinions should not be construed as investment advice nor considered as an offer to sell or a solicitation of an offer to buy shares of any securities mentioned herein. Mr. Merk is the founder and president of Merk Investments LLC and is the portfolio manager for the Merk Hard Currency Fund. Foreside Fund Services, LLC, distributor.
The USD largely consolidated its recent gains this week, but not before making marginal new highs against the most beleaguered currencies (EUR, GBP, and AUD). Data continued to come in showing further deterioration in both current conditions and future outlooks in the UK and Europe. In contrast, US data continued to come in mostly better than expected (existing homes sales, consumer confidence, durable goods, 2Q GDP, and Chicago PMI all beat expectations). This is a theme we have been following for several months now, and it finally seems to have taken hold among analysts in the broader market. In contrarian thinking, that would suggest the bulk of the USD's moves are done for the time being. But I'll argue later that this is most likely simply a period of consolidation that will be followed by further USD gains. In the meantime, traders need to be prepared for more consolidation and relatively choppy conditions, subject to key levels I'll outline next.
In EUR/USD, the intra-week low at 1.4570 effectively achieved the 'measured move' target indicated by the double-top pattern from just above 1.6000. Depending how one measures the distance between the neckline and the double top, as well as the level of the neckline itself, the pattern indicated a 'measured move' objective of about 750 points, making 1.4540 the target. Last week's low effectively hit that target and subsequently prices began to correct. The 1.4500/50 area is an obvious 'round number', psychological source of support and it's not surprising that EUR/USD should hesitate on its first attempt down there. Weakness below 1.4500 will signal further declines to the 1.4300/50 area initially, and then target 1.4000 next. The 1.4850-1.4950 area remains the level to establish new short positions.
In GBP/USD, what looks to be unfolding is the fallout from a rather gnarly looking 'head and shoulders' top. The neckline was broken with the drop under 1.9400 and targets a 'measured move' objective of 1,870 points to 1.7530. Cable is currently probing daily closing low support at 1.8160/70 from June of 2006, and once that level is broken, I would expect losses to quickly extend to 1.8000, which looks likely to fall like a house of cards, opening the way to the 1.7500/50 target area. The 1.85-1.86 area is the dream level to re-sell on any correction.
AUD/USD has also reached a significant support level that is likely to lead to a period of consolidation. The past week's intra-day low was just below 0.8500, another 'round number' source of psychological support. 0.8508 is also the 61.8% Fibonacci retracement level for the move up from the 0.7676 spike low just over a year ago to the all-time high at 0.9850. A daily close below 0.8500/08 should signal further weakness initially to the 0.8280/0.8320 area, marked by a major low from Sept. 2007, but ultimately weakness toward 0.8000 is expected. 0.87/88 remains the best levels to consider selling on bounces.
The USD will continue to strengthen
Recent data has painted a very clear picture of deteriorating growth prospects in G7 economies outside of the US, while US data has shown increasing signs of stabilization. Still, nagging concerns remain about the US outlook. It's as if we're paddling down an uncharted river and we're not sure if the rocks we see up ahead are just shallow rapids or the edge of large waterfall. This uncertainty is the most likely driver of the current period of consolidation, and with major US data out next week (Beige Book and Aug. NFP, in particular) there are plenty of near-term risks to contend with. The data will eventually reveal itself to us, but as we have argued in recent weeks, US consumers have retrenched and look able to weather the storm, as long as it doesn't last too long. This view, contrasted with eroding outlooks elsewhere, keep us fundamentally biased toward further USD gains.
The other major USD support going forward stems not from currencies as a barometer of national outlooks, but rather from currencies as an asset class. Over the last five years as the USD weakened, US investors increasingly sent investments abroad. With stumbling economic outlooks in Europe/UK/Japan and fresh signs of slowing in Asia ex-Japan, US investors will increasingly be repatriating assets back to the US. The sudden rebound in the USD has likely caught many investors flat-footed, meaning the bulk of USD asset repatriation has yet to hit the market. These flows will be an ongoing source of USD support over the next several months, regardless of what the US data suggests for the here and now. (And we're not talking a few billion here, but rather trillions of dollars in off-shored investments.) Next Friday's Aug. NFP will likely be a case in point. We will be watching closely to see if the USD is able to shrug off another expected job loss, which would be another indication of the long-term nature of the current USD recovery. Should the USD react more negatively, we'll take it as an indication that consolidation is ongoing.
RBA, BOC, ECB and BOE rate decisions next week
It is a busy week for central banks with the RBA, BOC, ECB and BOE all due to decide on interest rates. Below we offer a summary of what to expect from each meeting and the likely reaction in currencies. Reserve Bank of Australia
The Reserve Bank of Australia is set to announce on Tuesday at 0430GMT and the broad consensus is that the bank will reduce the current 7.25% target rate by 25 basis points. Economic activity has slowed in recent months with retail sales slipping to an annual growth rate of 3.2% in June -- the weakest run-rate since October 2005. Meanwhile, slowing global growth will continue to put pressure on red-hot commodity prices which will impact the Australian economy's terms of trade notably. We have seen this first and foremost in the US with weakening gasoline demand driving oil prices down more than $30 from the all-time highs. The key for this event will be what the RBA says or hints about the future path of rates. If they allude to further rate cuts from here we would expect sharp selling in AUD/USD with the 0.8500 zone vulnerable. On the flipside, no rate cut should see Aussie back up towards the 0.8700 mark. Bank of Canada
The Bank of Canada's rates confab is scheduled for 1300GMT on Wednesday and the consensus is unanimous in calling for no change to the 3.00% policy rate. Inflation, at an annual rate of 3.4%, is running well above the bank's target of 2.0% while economic data have been mixed. In the latest month the unemployment rate fell to 6.1% in July from 6.2%, June building permits were crushed -5.1% from 2.0%, while core retail sales jumped 1.4% for June after a 0.6% result -- to name a few. The uncertainty over the economic outlook coupled with uncomfortably high inflation augurs for a BOC on hold. That said an unexpected rate cut would probably see USD/CAD test daily trendline resistance near the 1.0720/30 area, which goes back to the 1.1880 highs in February 2007. European Central Bank
The European Central Bank is up on Thursday at 1145GMT with the usual press statement following at 1230GMT. The consensus is for the bank to leave rates on hold at the current 4.25% level. As such, the press statement will once again be in focus. Recent comments from ECB member Axel Weber that a rate cut is currently premature are likely to resonate in Trichet's post rate decision comments. That said Trichet will also have to acknowledge that economic growth has clearly slowed with 2Q GDP printing negative and recent business surveys like the German IFO -- which plunged to 94.8 in August from a prior 97.5 -- suggesting no speedy recovery in 3Q. While likely to be similar to the prior press statement which harped on inflation worries and downgraded growth slightly, we would expect a potential bounce in EUR/USD if Trichet suggests rate cuts are out of the question. In this case we would look to sell post-Trichet EUR bounces as reality sinks in that the Euro-zone economy remains on shaky ground. Bank of England
Last but not least, the Bank of England will decide on rates on Thursday at 1100GMT. The consensus here is unanimous that the bank will leave rates at the current 5.00% level. If this happens, the release will turn out to be a non-event as the BOE does not provide a press statement unless they make a change to rates. The meeting will likely prove to be contentious as per the latest musings from BOE member David Blanchflower who noted the very real risk of the UK plunging into a recession. Indeed he said that he expects "negative growth" for "several further quarters.'' While the risk of a rate cut is an extremely low probability event, this would be the only thing to shake up GBP/USD in a big way. On such a surprise we would expect Sterling to see a sharp leg-down towards the 1.8000 area.
Key data and events to watch next week
There are a plethora of top-tier US indicators due up in the week ahead. ISM manufacturing and construction spending kick things off on Tuesday. Factory orders and the Fed's Beige Book are due up on Wednesday. We will provide a detailed report on what to expect from the Beige Book next week. ADP employment, productivity and the usual weekly jobless claims data are due on Thursday while Friday closes out the week with the all-important NFP employment report. There are also a number of Fed speakers on tap next week with Kroszner and Hoenig up on Monday, Rosengren on Wednesday, and Fisher and Yellen scheduled for Thursday.
The Euro-zone also sees a very busy week which starts on Monday with German retail sales and Euro-zone PMI revisions. Tuesday has Euro-zone PPI on deck while Euro-zone retail sales are up on Wednesday. French employment and German Factory orders are due on Thursday. The highlight on Thursday, however, will be the ECB rate decision (see write-up above for details). German industrial production rounds out the week of data on Friday.
The action in the UK is on the light side but is important nonetheless. Consumer lending data kicks off the week on Monday with consumer confidence following on Tuesday. The all-important BOE rate decision closes out the week on Thursday. The market expects no change to rates which would mean a non-event here (more details above).
It is extra light in Japan next week with labor earnings data due up on Monday and capital spending on Thursday the only noteworthy reports. Bank of Japan Governor Shirakawa is due to speak on Tuesday as well.
Canada has limited economic events also, with the BOC rate decision the highlight on Wednesday. Friday closes out the week with the top-tier employment report and Ivey PMI index.
It's modestly busy down under but it is all Australia as New Zealand sees no noteworthy data releases. The week kicks off on Sunday with the AiG manufacturing index followed by the current account balance on Monday. Tuesday has building approvals and the all-important RBA rate decision on tap. Data for the week ends with 2Q GDP on Wednesday and the trade balance on Thursday.
Brian Dolan, Chief Currency Strategist
Jacob Oubina, Currency Strategist Forex.com http://www.forex.com
DISCLAIMER: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase of sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
This past week's economic calendar provided some key insights into how much economic growth will moderate in the third and fourth quarters. The biggest headline was generated by Thursday's larger-than-expected upward revision to second quarter real GDP growth. Other key reports include a larger- than-expected rise in July durable goods orders and a much weaker- than-expected report on July personal income and spending. On balance, these reports point to second half real GDP growth around the 1 percent range, which is slightly below our previous projection.
Second quarter real GDP was revised up by 1.4 percentage points to a 3.3 percent pace. The larger-than-expected increase results from a large improvement in net exports and less of a drawdown in business inventories. Consumer spending also rose a bit more than expected.
How Much More Can Trade Improve?
The trade deficit narrowed by just over $85 billion in the second quarter, which accounted for 3.1 points of the second quarter's 3.3 percent growth. Exports surged at a 13.2 percent pace, while imports fell at a 7.6 percent pace the second quarter's huge drop in the trade deficit will make it much more difficult to get a big gain from trade in the current quarter. Exports are still expected to make a positive contribution to growth during the current quarter but we are only looking for a positive contribution of 0.3 percentage points, or about one-tenth the contribution seen in the second quarter.
Consumer spending will also contribute less to growth in coming quarters. Our most recent forecast has personal consumption expenditures declining at a 0.7 percent annual rate in both the third and fourth quarters. The latest personal income and consumption data suggest spending could drop a bit more than that in the current quarter. Personal income fell 0.7 percent in July and real consumer spending fell at a 0.4 percent pace. If spending is unchanged in both August and September, then real personal consumption expenditures would fall at a 1.4 percent pace in the third quarter. We doubt conditions will be that dire. Gasoline prices plummeted in August and that should free up a little more discretionary income. In addition, incentives on new motor vehicles were increased late in the month and that should provide at least a slight boost to sales in September.
While consumer spending is set to slow, business fixed investment looks like it will be a little more resilient during the second half of the year. Advance orders for durable goods rose 1.3 percent in July, following a similar-sized gain the previous month. Orders for non-defense capital goods, ex aircraft, which is the key component that tends to track business fixed investment, rose 2.6 percent and is up at a 13.5 percent annual rate over the past three months. Capital goods orders are likely benefiting from the bonus depreciation provisions of the Economic Stimulus Act.
Shipments of capital goods rose 0.6 percent in July and are up at a 6.7 percent pace over the past three months. With orders running twice that level, business fixed investment should remain solidly positive in both the second and third quarter.
Two other pieces of encouraging news were a much larger than expected increase in the Chicago Purchasing Managers' index and a solid bounce back in the University of Michigan Index of Consumer Sentiment. The Chicago PMI rose 7.1 points to 57.9, with solid gains in production, new orders and order backlogs. The Prices Paid index dipped by about 10 points but remains high at around 80.6. The employment series tumbled 6.7 points, however, to a relatively low 39.2.
U.S. Outlook
ISM Manufacturing Index • Tuesday
The Institute for Supply Management's purchasing managers' index for manufacturers slipped to the expansion/contraction line of 50.0 in July. The forward looking new orders index fell 4.6 points to 45.0 - marking the lowest level since right after the September 11th attack and suggesting continued weakness in the manufacturing sector in the coming months.
Regional purchasing managers' indices have been mixed this month (Chicago & NY up, Philly down) and suggest little change to the national ISM index in August. Limiting any improvement in the headline index will be a significant pullback in the employment index which showed a strong 8.2 point jump in July - an increase that was likely more seasonal than fundamental. In general, commodity prices have been coming off historical highs and should lead to some slippage in the prices paid index. Higher prices, however, should remain problematic for manufacturers and non-manufacturers.
Previous: 50.0 Wachovia: 50.2
Consensus: 49.5
Total Vehicle Sales • Wednesday
Falling to a sixteen year low, total light motor vehicle sales fell to a 12.5 million unit annualized pace in July as consumers continue to avoid major durable goods purchases. Year-to-date, total light motor vehicle sales have averaged 14.3 million units - compared to 16.2 million units for all of 2007.
It appears, however, that increased incentive activity may have led to some improvement in the light motor vehicle sales pace in August. Even with a potential increase this month, motor vehicle sales remain very depressed as consumers continue to fret about their job and personal finance prospects.
Previous: 12.5M Wachovia: 12.9M
Consensus: 13.0M
Employment Report • Friday
Falling for the seventh consecutive month, nonfarm payrolls declined 51 thousand in July. The household survey reported a 72K decline in employment and coupled with a 213K increase in the labor force raised the unemployment rate 0.2 percentage points to 5.7 percent - the highest level since March 2004.
Given the distortion caused by the extension of unemployment benefits it is almost impossible to get a clear reading of the underlying picture regarding initial claims. Since the correlation of claims to changes in nonfarm payrolls is strong, we are likely to see a wide range of payroll estimates this month as economists look at other metrics to help forecast this particular month's payroll figure. We expect to see further deterioration in August with our call of -97K. The unemployment rate will likely drift higher in coming months but should remain steady at 5.7 percent in August.
Previous: -51K Wachovia: -97K
Consensus: -70K
Global Review
Taiwanese Economy Slows Further
As shown in the graph at the left, real GDP growth in Taiwan slowed from a year-over-year rate of 6.3 percent in the first quarter to 4.3 percent in the second quarter. Output declined 2.4 percent on a non-seasonally adjusted basis in the second quarter relative to the previous quarter. (A seasonally adjusted series of real GDP is not readily available.) This decline is larger than the average drop in real GDP that has been registered in the second quarter over the past few years, which suggests that output may have contracted a bit on a seasonally adjusted basis in second quarter of this year.
Why is the Taiwanese economy decelerating? Slower growth in the rest of the world appears to be playing a role. As shown in the top chart on page 4, export growth has clearly slowed this year. This slowdown in export growth is consistent with deceleration in industrial production this year. Industrial production, which rose more than 12 percent (year-over-year) in the first quarter grew less than 7 percent in the second quarter and it was up only 1.1% in July, indicating the third quarter has gotten off to a sluggish start.
Taiwan experienced a “bubble” in credit card borrowing earlier this decade, which has kept growth in consumer spending rather tepid over the past few years. Therefore, exports have played a large role in driving GDP growth, and deceleration in exports has had a significant effect on the overall economy. That said, there is more to the recent Taiwanese growth slowdown than simply exports.
The top chart also makes it clear that import growth has weakened significantly, which is often symptomatic of slower growth in domestic spending. Indeed, domestic demand declined at a year-over-year rate of 1.3 percent in the second quarter due in part to the 7.7 percent drop in investment spending. As noted above, growth in consumer spending has been lackluster, and real consumer expenditures, which rose only 1.9 percent over the course of last year, were up just 1.1 percent in the second quarter. The sharp increase in energy prices earlier this year has likely exerted a slowing effect on real consumer spending in Taiwan.
Speaking of energy prices, the middle chart shows that CPI inflation has risen to nearly 6 percent, the highest year-over-year inflation rate since the early 1990s. However, the chart makes it clear that most of the rise in the overall rate of CPI inflation is attributable to food and energy prices. With the subsequent decline in these commodities prices, the overall rate of CPI inflation should recede in the months ahead. That said, the central bank has been gradually lifting its discount rate to insure that previous increases in food and energy prices do not feed through into “core” prices. With the economy slowing and wage growth showing very few signs of acceleration, a significant increase in core CPI inflation does not seem likely.
The Taiwanese dollar, which rose to an 11-year high versus the U.S. dollar earlier this year, has given up some of its gains over the past month due largely to signs that growth in Taiwan, not to mention most other economies, is slowing. The Taiwanese dollar could experience further losses, at least in the near term, if investors continue to have doubts about the Taiwanese economic outlook.
Global Outlook
U.K. Purchasing Managers' Indices
The U.K. purchasing managers' indices are widely followed because they offer insights into the current state of the U.K. economy. The construction PMI, which will be released on Tuesday, has essentially collapsed, which is consistent with weakness in construction spending this year. And the manufacturing (Monday) and service sector (Wednesday) PMIs have each dropped below “50”, suggesting that these sectors are struggling. Data on mortgage approvals and consumer confidence will offer further insights into the present state of the economy.
In our view, the U.K. economy has slipped into recession and we look for GDP to contract over the next few quarters. That said, we do not expect the Bank of England to cut rates soon (see below for discussion) due to lingering concerns about inflation.
Previous Man PMI: 44.3 Consensus Man PMI: 44.5
Previous Services PMI: 47.4 Consensus Services PMI: 47.0
Central Bank Meetings
Four foreign central banks hold policy meetings next week. The Reserve Bank of Australia kicks off the schedule early on Tuesday morning (U.S. time), and many investors look for the first rate cut since 2001. Growth down-under appears to be slowing quickly, and the RBA adopted a “bias” to ease last month.
Elsewhere, major central banks likely will keep rates on hold. The Bank of Canada, which meets on Wednesday, has cut rates by 150 basis points since December. Like the Federal Reserve, the BoC likely will remain on hold for the foreseeable future. The Bank of England and the European Central Bank, which both hold policy meetings on Thursday, will likely refrain from cutting rates for the next few months because inflation in both economies are well above rates that each bank considers to be acceptable.
Current RBA Rate: 7.25% Current BoC Rate: 3.00%
Current BoE Rate: 5.00% Current ECB Rate: 4.25
German Industrial Production • Friday
The German economy appears to be slowing quickly. Real GDP declined at an annualized rate of 2.0 percent in the second quarter, which partially reflects statistical payback for the very strong 5.2 percent rate registered in the first quarter. However, more recent indicators suggest that growth in the third quarter likely will be weak. The Ifo index of German business sentiment, which is highly correlated with growth in industrial production, has plunged to its lowest level since mid-2005. “Hard” data on industrial production in July likely will confirm other signs of slowing growth.
Data on German retail sales in July are expected to be released at some point next week, and data on factory orders will give some clues to the outlook for industrial production in the next few months.
Previous: 0.2% (month-on-month change)
Consensus: -0.5%
Point of View
Interest Rate Watch
Real GDP-Inflation Data Keeps Fed on Hold
This week's release of second quarter GDP revealed strong exports but a weak domestic economy. Consumer spending was boosted by the rebates but the outlook remains uncertain. As a result, the downside risks to the economy remain in place. Our outlook remains for below par growth in the second half of the year. Meanwhile, core inflation remains just above the Fed's perceived target ceiling. Therefore, short-term rates are likely to remain steady as the Federal Reserve faces the dual imbalance of below-trend economic growth and above-target inflation.
For the long end of the Treasury curve, we expect inflation stability will keep the ten-year rate in a tight 3.8 - 4.0 percent range. We remain cautious on the recent dollar improvement and we are concerned that the federal deficit outlook has deteriorated faster than expected. The U.S. reliance on capital inflows in a weak economy/higher inflation period is a perilous balance. Credit Spreads: Width Defines Risk
There is no easy out for creditors or debtors in our outlook. A difficult workout remains ahead. Credit spreads are not expected to tighten in the near term. Negative financial news reminds creditors of the event risk in company announcements.
Capital markets continue to search for a new risk/reward tradeoff. At present, credit spreads suggest that credit remains limited relative to a neutral position. The financial markets continue to search for a new equilibrium spread. Our expectation is any new equilibrium will be higher than what it was during the 2004-2006 period. Risk is being more fairly priced—we just haven't seen what the new equilibrium price is quite yet.
Topic of the Week
A Long Slog Remains Ahead For Housing
The mid-year data on home sales, home construction and housing prices all suggest there is still more work to be done before housing finds a definitive bottom. Sales are probably closest to bottoming. Sales of both new and existing homes have more or less fluctuated around recent levels for the past three or four months and price declines appear to be moderating. New home construction remains in free fall, however, particularly single-family starts. While some of the more recent numbers on the housing industry have come in a little better than expected, we caution against drawing too many conclusions. Much of the recent improvement in existing home sales has come from foreclosure sales, particularly in hard-hit markets like California, Florida, Arizona, and Nevada.
Given how tight credit conditions are today and how much mortgage rates have backed up, even the modest amount of stability we are seeing in home sales is encouraging. A renewed slide cannot be ruled out, however, with overall economic growth poised to slow during the second half of the year, continued challenges in the secondary mortgage market and caution by mortgage providers.
Against this backdrop, forecasts of the housing market are fraught with trepidation. We are sticking with the forecast we have had for much of this year. Sales of both new and existing homes are expected to bottom in the next nine months and home construction is expected to bottom by the middle of next year. Home prices are expected to find a bottom sometime between the middle of 2009 and the middle of 2010, with the most challenged markets seeing prices bottom near the end of that period. Wachovia Corporation http://www.wachovia.com
Disclaimer: The information and opinions herein are for general information use only. Wachovia Corporation and its affiliates, including Wachovia Bank, N.A., do not guarantee their accuracy or completeness, nor does Wachovia Corporation or any of its affiliates, including Wachovia Bank, N.A., assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or any foreign exchange transaction, or as personalized investment advice. Securities and foreign exchange transactions are not FDIC-insured, are not bank-guaranteed, and may lose value.
