NEWS / Foreign Exchange

Weekly Forex Column

Market Directions    March 26 ??“ 30, 2007

The Week in Review

Not even Ben Bernanke can move a market whose mind is settled. That is the lesson we can take from the Federal Reserve Chairman??™s testimony before Congress this week.  Despite his repeated assertions that the Fed is mindful of inflation, that it has not changed its anti inflation bias and that he is not about to lower rates any time soon, the Euro continued in strength against the Usd throughout the week. Only the renewed pull of Yen based carry trades at the end of the week gave a temporary elevation to the dollar.

With the Fed on the sidelines and the ECB aiming for at least one more 0.25% increase to 4.0%, the United States economy is the sole source of Dollar support. But even there the picture is ambivalent and worries are not scarce. The week??™s statistics (covered in detail below) were evidence either of an economy treading water despite heavy seas and poised for a recovery later in the year, or of weakness presaging a fall and maybe a recession. The numbers could be read positively or negatively, the difference in interpretation depended largely on prior assumptions independent of the data.

The sub prime loan collapse which has received so much press does not appear to be generated by overall economic decline. Job growth remains strong and the number of 4th quarter credit card delinquencies was steady.  The chorus of housing detractors, last heard in the fall off 2006 promising a recession once the inflated housing equity was withdrawn from the consumer spending pool, has however, resumed prognostication. 

Iran, sensitive to even the mild UN pressure applied recently, kidnapped British sailors in the Persian Gulf, sending oil prices above $66 a barrel on Friday.  The currency markets current extreme touchiness to international events was demonstrated by its reaction to several headlines, also on Friday, stating that the US Commerce Department had ???opened the door??™ to trade retaliation against China for its ???subsidies??™.  The Euro was sent racing higher an hour before the London close on the news. No doubt thin liquidity at the end of week and month contributed to the move but the specter of higher oil prices and increased tension with Iran and in the Persian Gulf lurked behind the China trade angle. The item had already been reported in several newspaper articles earlier in the day.

Though protectionism is inherently inimical to trade and is a clear threat to a free market currency like the Dollar whose Chinese trading partner manipulates its own currency, there is more at immediate play in this story than simple trade warfare. The past two UN resolutions against Iran have been passed with Chinese assent. Whatever the balance of threats in the Persian Gulf the economic danger from a disruption in oil supplies is far more pressing to Europe and the United States than to the China.  A prolonged bout of consumer discontent with high gasoline prices can only harm economic growth in the west.  Any action that undermines Chinese cooperation with the US against Iran is a potentially grave problem for the world economy.  The US Commerce Department press release was the culmination of a long bureaucratic process; it could not have reached its conclusion at a worse time.

In France Central Bank bashing seems to have become an election year event. Both Nicholas Sarkozy, the ruling party candidate for president, and Segolene Royal, the Socialist Party choice, criticized the European Central Bank (ECB).  Mr. Sarkozy blamed the ECB for the problems of Airbus, the European aircraft consortium, and Ms Royal complained of the bank??™s autism and called for a revision of its charter. While populism in French elections has become far more prevalent since Jean Marie Le Pen??™s showing in the last election, it still must be disconcerting for ECB officials to be so routinely chastised by the politicians of one of its founding members.  Jean Claude Trichet??™s statement that we are doing what was mandated by the European people was perhaps a return to the French politicians as well as an explanation for its interest rate policy.

Economic Releases March 26 - 30

United States

New Home Sales for February came in on Monday down 3.9% at 848,000, well below the forecast of 980,000. January was revised lower as well to 882,000 from 937,000.  This result negated last Friday??™s Existing Home Sales of 6.69 million which was up 3.9% and left the market unsure if the housing crunch is again accelerating.  Euro rose 40 points on the news (1.3295 -1.3335) and the Dollar fell 50 points against the Yen from 118.30 to 117.70.   The inventory of unsold houses which had been falling rose to 546,000 from 538,000 in January; the supply awaiting sale increased to 8.1 months from 7.3.   The Conference Board Consumer Confidence reading for March arrived at 107.2, slightly under the February number of 111.2 which had been revised down from 112.5.  The February figure had been the highest since 2001. All weakness in the March number was in the future expectations component, job prospects and current conditions remained moderately strong.  Durable Goods Orders for February were up 2.5% recovering from January??™s precipitate fall, -8.7% (revised).  But with the ex-transport component at -0.1% and lower four of the last five months the downtrend is worrying for large industrial orders. 

Bernanke's Congressional testimony on Wednesday was the key market shaper of the week. He characterized the sub-prime lending problem as contained and not spreading to the overall economy but requiring a careful watch.   He said the Fed is not inclined to lower rates despite some signs of below par growth, especially with underlying inflation ???uncomfortably high???.  ???Employment continues to expand, job losses in manufacturing and residential construction have been more than offset by gains in other sectors???.  In his view ???the continuing increases in employment??¦ have helped sustain consumer spending???.   Once again it is the outlook of the consumer, whose expenditures represent more than 70 percent of the American economy, which propels the US machine. As long as workers can find jobs Mr. Bernanke appears willing to remain sanguine about US economic prospects. He stated that inflation has ???slowed somewhat but recently has been elevated, [with] core CPI in the 12 months to February at 2.7% up from 2.1% a year earlier???. In spite of this rise he thinks that ???inflation expectations appear to be contained??? with the primary risk to be the ???tightness of labor markets???.  

The Fed Chairman's point on consumer consumption was seconded by the final revision to US 4th Quarter GDP. The first iteration in January was 3.6%, which was revised a few weeks later to 2.2%, and finally corrected Thursday to 2.5%, a bit higher than the prediction of 2.2%. The entire revised gain was due to ???gains in consumption", that is, retail consumer spending.

Friday??™s data revived hopes that the US economy will return to trend growth of 3-3.5% growth later in the year. The Chicago Purchasing Mangers index for March came in at 61.7 far in advance of the forecast of 49 and February??™s 47.9.  Perhaps more importantly the new orders component was 72.2, dramatically better than the 48.7 reading from February. The good news continued with February??™s Personal Income rising 0.6%, well over the expectation of 0.3%, with Personal expenditures up 0.6% as well.  Construction Spending climbed in February 0.3%, predictions had hovered at -1.0%. The January result was revised upward to -0.5% from -0.8%.  Considering that the Eastern half of the country experienced cold snowy weather in February the outcome was doubly a surprise.  The core Personal Consumption Expenditure (PCE) Chain Weight Price Index moved up 0.3% in February with the year to year number at 2.4%.  This is the number that presumably keeps Chairman Bernanke awake at night.

Eurozone

German IFO Sentiment numbers for March at 107.7 were much better than expected, 106.6, and were supportive of Trichet??™s view of a strengthening European economy.  Euro rose on the issue. Wednesday??™s M3 money supply numbers at 10% for January were likewise much stronger than expected, 9.8%, with the three months moving average reaching 9.9% well over December??™s 9.7%. Though the currency market did not stir on the release it was the highest pace of money supply growth in seven years. The ECB will certainly be quoting these figures in the weeks ahead.  The fall in the German unemployment rate for March, from 9.3% to 9.2% was cause for some congratulation among continental politicians and officials.  There was, however, no market reaction to ECB governing Board member Mitja Gaspari??™s dovish comments on ECB rate policy and the need for further rate increases. He is leaving the council on March 31st and has been know for his mild take on rate policy.

The Week Ahead

United States

The American economy receives a critical look this week. Will the results support the unexpectedly positive numbers that hit the market Friday? The Institute for Supply Management (ISM) Manufacturing Index due on Monday will provide a good idea if the March Chicago Purchasers Index was a fluke. As a nationwide compilation it carries more weight with traders and economists than the Chicago number; 51.5 is expected, in February it was 52.3.  The ISM Non-Manufacturing Index for March is issued on Tuesday. It outlines conditions in the larger (service) sector of the economy but it is not as widely watched as the manufacturing ISM, though that view may be changing. January was 54.3, December was 59.0.  Factory Orders for March are released concurrently; February??™s figure was -5.6%.  Whatever the results of the statistics earlier in the week Friday??™s Non-Farm payrolls will confirm or deny all.  This number has consistently defied negative predictions.  It was here that the dollar received its last large boost in early January. Current median expectation is for 135,000 jobs to have been added to the nation??™s payroll in March. Estimates range from 110,000 to 195,000, with rumors reported in the market of a judgment as high as 240,000 by a major American bank.  The unemployment rate is anticipated to rise back to 4.6% from its current 4.5%.

Eurozone

The Eurozone economy is not under as much scrutiny as its counterpart in the States. Consequently the limited data to be released this week will not affect the currency markets greatly, even if dramatically out of line with predictions.   Monday is the issuance of the Reuters Purchasing Managers Index, seasonally adjusted, for March.  The median forecast is 55.8, February was 55.6. On Wednesday we receive the Services version of the same report, 57.6 is predicted, February was 57.5.  Retail Sales, also on Wednesday is the most watched result for the European week. Consumer spending is not as large a component of continental economies as in the US but it has become increasingly important in recent years. The February forecast is for a 0.6% rise month to month; January fell 1.0%.  The year on year number is anticipated at 1.1%; January dropped 0.1%.  As the January results were ascribed largely to the impact of the German VAT tax increase, the February figures will be considered more telling for consumer spending growth in the months ahead.