NEWS / Foreign Exchange

Bernanke??™s JEC Testimony ??“ Fed Still Worried Most About Inflation, However ??¦

Am I missing something? Has not the FOMC marginally moved toward ??“ not all the way to ??“ an agnostic position with regard to its next likely directional change in the federal funds rate? That??™s what I took away from Fed Chairman Bernanke??™s JEC testimony and Q & A today. Yes, the FOMC still sees higher inflation as the ???predominant policy concern ??¦[h]owever, the uncertainties around the outlook have increased somewhat in recent weeks.??? One of those uncertainties has to do with business capital spending. To wit, ???the magnitude of the slowdown [in business equipment and software expenditures] has been somewhat greater than would be expected given the normal evolution of the business cycle.??? And today??™s anemic report on February durable goods orders and shipments reinforced the notion that the slowdown is greater than the Fed expected. Any other downside risks? ???[T]he correction in the housing market could turn out to be more severe ??¦ perhaps exacerbated by problems in the subprime sector.??? And perhaps by problems in the Alt ??“A market, too. ???Moreover, we could see greater spillover from the weakness in housing to employment and consumer spending than has occurred thus far. Ask the folks in Irvine, California, the headquarters of New Century Financial about the spillover from housing into employment and consumer spending ("Subprime Mortgage Collapse Eviscerates California Headquarters", Bloomberg, March 28, 2007). My reading of all this is that the FOMC, although still concerned that inflation might not moderate into its comfort zone, is also is now worried more than it was on January 31 that real economic growth will not stabilize in the range of 2% to 2-1/4%, but rather will head toward zero or below. That worry is well placed if the FOMC takes into consideration the behavior of the index of Leading Economic Indicators (see The Econtrarian, March 22, 2007, "Recession Imminent? Both the LEI and the KRWI are Flashing Warning").

January-February Durable Goods Orders/Shipments Bode Poorly For Capex

New orders for durable goods rebounded a pathetic 2.5% in February after a downwardly revised 9.3% January decline. New orders for core nondefense capital goods ??“ nondefense capital goods excluding civilian aircraft ??“ fell 1.2% further in February after their January decline of 7.4%. Adjusting for prices, the January-February average of new core capex orders is down at an annualized rate of 23.5% vs. the Q4:2006 average. New orders have more to do with future capital goods expenditures in future quarters. So this whopping contraction in January-February new orders will likely have economists revising down their Q2 real GDP forecasts. With regard to current-quarter capex, shipments are more relevant. The news there is not better qualitatively speaking. The January-February average of real core capex shipments is down an annualized 12.0% vs. the Q4:2006 average. So, economists also may be revising down, yet again, their Q1 real GDP forecasts as these shipments data are pointing toward the second consecutive quarterly contraction in real expenditures for business equipment and software. If so, then indeed, ???the magnitude of the slowdown [in capex] has been somewhat greater than would be expected given the normal evolution of the business cycle.???

South Africa: Slowing Inflation Should Put Rate Hikes on Hold, But Other Tightening Is Still Possible

There was some concern that if today??™s CPI report for February showed the slightest hint of higher prices, it would all but guarantee that the Monetary Policy Committee (MPC) of the South African Reserve Bank (SARB) would increase the repo rate at its April 11-12 meeting. But now that the markets have been surprised by some very tame data, analysts are rethinking their forecasts for interest rates in the near-term, and what the MPC might do next.

Every major measure of consumer inflation in South Africa stepped down a notch in February, and the year-over-year figures became that much more appealing. The headline CPIX figure (inflation less food and interest payments ??“ the favorite statistic of the MPC) declined to a 4.9% increase on the year in February from 5.3% in the previous month, while inflation as measured by overall CPI slowed to 5.7% from 6.0%. These figures are both within the SARB??™s comfort zone of 3-6%, and while the Reserve Bank believes that inflation could tick up slightly from energyrelated prices, such an increase now appears to be less threatening. But while this apparently gives the MPC a free opportunity to hold the repo rate at 9.00% during its next meeting, some statements from Committee members are keeping the market guessing.

SARB Governor Tito Mboweni offered up a particularly choice statement on Tuesday during a iscussion of the country??™s sustained run of economic growth. He expressed concern that the current 5.0%+ rate of expansion may be inflationary if such growth was exceeding potential GDP expansion, and if so, alternative means may have to be explored to rein in credit growth that has been expanding at a 25% clip over the past few months. Such alternative measures are presumed to include higher bank reserve requirements in the near-term. This tool of monetary policy, while less precise than higher interest rates, would allow the MPC to maintain its tightening bias and keep an anti-inflationary posture, but not administer any further rate hikes in the near-term.

Our forecast is for steady interest rates during the April meeting and possibly after the June 6-7 meeting, but the MPC will take alternative steps to curb credit expansion. We expect a mild tightening of reserve requirements in April, along with stronger statements about controlling growth in credit and the inflationary potential of the current expansion. Barring a startling spike in prices, however, we expect a steady repo rate into Q3.