NEWS / Foreign Exchange

Weekly Forex Column

Market Directions April 2 ??“ 6, 2007

The Week in Review

Currency markets celebrated the Euro this week. The united currency climbed to a six year high on Thursday, but US Non Farm Payrolls (NFP) ended the party on Friday with an unexpectedly strong view of American employment. March payrolls were 180,000 fully 1/3 higher than median pre release estimate of 135,000. In fact the result was even stronger than indicated by the 45,000 difference. Weak ISM, Factory and other statistics had caused many market commentators to lower their estimates for NFP, these lowered judgments did not factor into the 135,000 number which had been collected before this week??™s results were known. January and February numbers were also revised higher by a total of 32,000. Most European banks and the New York Stock Exchange were closed on Friday for the Good Friday Holiday and the market response to the NFP was relatively muted. The Euro fell 50 points against the Dollar and the USD gained 60 points against the Yen. The only clear gainer was the Euro/Yen which closed within 20 point of the all-time high of 159.69, reached earlier in the day. The Yen carry trade has lost none of its popularity.

The NFP number came at the end of a string of mediocre or negative US statistics, (details below) earlier in the week. By itself the NFP number is not enough to change the general market assumption of a slowing American economy or the perception of Federal Reserve rate inaction for the foreseeable future.

Half the market was surprised by the Monetary Policy Committee (MPC) of the Bank of England (BOE) decision not to raise the repo rate beyond 5.25% on Thursday and half was not. Prior sentiment had been split 50% -50%. Cable initially dropped 40 points on the report to 1.9675 with sterling longs vacating their positions. But calmer reflection soon brought sterling back to 1.9715. The market is likely to go into the May meeting heavily favoring a 0.25% rate hike. Though the March MPC vote was 8-1 in favor of a hold, with David Blanchflower voting for a cut, the February BOE inflation report seemed to imply the need for at least one more 0.25% hike. Recent British data has been mixed with weak manufacturing results but PMI and housing data strong. The bias will grow for a May hike as the decision approaches. March CPI data will be crucial to the MPC decision.

In other central bank news the Reserve Bank of Australia decided not to raise rates beyond the current 6.25% and two of the Yen carry trade favorites, the Aud/Yen and the Nzd/Yen suffered immediate profit taking declines.

New York Mercantile Crude Oil Futures closed at $64.28 a barrel on Thursday. The Iranian release of 15 British Sailors and Marines, announced Wednesday, calmed the immediate oil market jitters. Iranian claims to have captured the sailors in their own territorial waters were widely discounted in western capitals. Britain denied any trespass and she and her allies had deplored the action and demanded their release without conditions. Crude oil had jumped to $69.20 March 27th just a few days after the initial capture and largely as a result of the dispute. Though Britain said the release was unconditional, the return of a detained Iranian diplomat to Iran brought that assertion into question. Iran has clearly demonstrated its ability and willingness to provoke international crises for its own purpose and at its own timing. Iran is a direct beneficiary of any rise in oil prices and its economy is almost wholly dependant on its oil export earnings. This flagrant demonstration of its power to affect the price of oil and western economies is bound to have a lasting effect on crude oil futures. The very ease with which Iran accomplished its goal of kidnapping the servicemen without any interference from the British or American military underlines its power to set and control the content and timetable of political events in the Persian Gulf. With American and Iraqi security operations in Iraq proceeding, the potential for confrontation in the Gulf remains very high. Underneath all surface disputes lies the Iranian pursuit of nuclear energy and weaponry. Without some sign of accommodation on this basic issue from Iran, the Middle East and the Persian Gulf will remain the fulcrum of international politics and economic concerns, overshadowing everything else with its potential for immediate, serious and debilitating crises. We have not heard the last of this problem.

Before excessive gloom sets in about the US economy it is wise to remember that though manufacturing has slowed considerably both of the ISM numbers are consonant with a moderately growing economy and GDP increase in the first quarter of 2007 between 2% and 3%. While this is not a spectacular performance for the US, it is very credible for a mature industrialized economy and is, in fact, as good as or better than the numbers from any other major economy. There is nothing in these results to prompt the Fed to contemplate a rate cut or even yet ending its now conditional tightening bias. This is the scenario that Mr. Bernanke has been promising since late last summer. And while the decrease in inflation has not satisfied the Fed, the GDP side is at fruition. The one caveat to this story is a falling dollar. A strong dollar and surging imports have helped keep a lid on inflation, especially consumer inflation. It is difficult for American manufacturers to raise prices if overseas competitors are present in the market with lower priced goods. As the dollar falls not only do the foreign manufactured goods rise in price from the gain in the exchange rate, but it permits American manufacturers to charge higher prices as well. A Fed rate hike to defend the Dollar is even farther off than a rate cut to defend the economy. A currency trader should never discount the Federal Reserve but current economic results do not add up to either an increase or a decrease in the Fed Funds rate for many months.

Market assumptions on central bank policies will have changed not a whit from this week??™s statistics. And, with the exception of the NFP number the same could be said of the economic judgment underlying the Euro??™s recent rise. However, the NFP exception is about as big an exception as you can have for the American economy. The weeks ahead will tell if the economists have once again underestimated the resilient US economy.

Economic Releases April 2-6 2007

United States

Initially nothing went right for the USD this week. Last Friday saw a flurry of positive reading from the US economy. Personal Income, Construction Spending and the Chicago Purchasers Index all arrived better than predicted and this had opened the possibility of more upbeat reading from the general economy. However, this week a series of numbers came in not only lower than in previous months but also smaller than the market expectations. Monday??™s March ISM Manufacturing Index at 50.9 slipped from the February result of 52.3 and disappointed market hopes of 51.5. March ISM New Orders at 51.6 was even further below Februarys 54.9 than the overall reading. There was little market reaction to the release. Last week??™s Chicago Purchasers Index of 61.7, which elicited hopes for an upturn, did not carry over into the national numbers and seems to have been a local anomaly. February Factory Orders were likewise anemic at 1.7% barely recovering from January??™s fall of 5.7%, which itself was a downward revision of the original -5.6% number. Perhaps the biggest disappointment was the March ISN Non Manufacturing Index. As recently as January the reading was 59.0, well over the long term average of 57.0 and giving promise that the consumer and service sector could carry the economy through the evident manufacturing slump. The February number had fallen to 54.3 but the median expectation for March was 55.0. The result of 52.4 denied even this modest hope. The ISM Manufacturing Index has had a 67% correlation with GDP over the past 17 years and the numbers would indicate a moderately growing economy of perhaps 2.5%. Pending Home Sales Index for February was the one positive surprising with a 0.7% rise to 109.3 from 108.5 in January and seeming to depict an underlying stabilization in the housing market.

The details of the NFP numbers were as impressive as the headline figure of +180,000. All large categories of employment gained: construction added 56,000 jobs, rebounding smartly from February??™s loss of 61,000 jobs and raising the possibility that the drop in February was due to the uncommonly severe winter weather. Retail employment fell a modest 16,000 but health care, food service, federal and local government and education all added workers. The unemployment rate fell 0.1% to 4.4%; the actual rate was 4.395% Predictions had been for an equal rise to 4.6%. This rate matches the previous low in October 2006. The unemployment rate was last lower in May of 2001.

The March NFP figures combined with the revisions to January and February raised the monthly average for the first quarter from 138,000 to 152,000. This compares favorably with the fourth quarter of 2006 which averaged 155,000, though less than the third quarter average of 185,000. These are not numbers that would spur the Fed to adopt a rate loosening bias.

Eurozone

The March Reuters PMI Manufacturing Index at 55.4 came in a bit under the 55.8 forecast and slightly less than the 55.6 reading in February. The Producers Price Index for February was released almost as expected at +0.3% month on month (m/m) and +2.9% years on year (y/y). The median prediction had been +0.3% m/m and 2.8% y/y. January numbers were revised marginally higher the monthly number to +0.2% from +0.1% and the yearly to +3.1% from +2.9%. Retails Sales for the countries of the united currency were likewise a bit slower than forecasts, +0.3 m/m and +1.2% y/y as opposed to +0.6% m/m and 1.1% y/y. January results were also marked down from -1.0% to -0.8% m/m and from -0.1% to -1.1% y/y.

German manufacturing was much stronger than anticipated in February, expanding at 3.9% against the 0.5% expectation. This was the strongest result for German industry since 2004.

The Week Ahead

United States

It is an unusually sparse week for American economic releases. Wednesday brings the FOMC meeting minutes and though this generates interest it never brings forth a surprise. The crucial point to remember is that these are edited minutes not a transcript. The International Trade Balance for February is released on Friday. It is expected to widen slightly to -60.3 billion from -59.1 billion in January. The Produce Price Index for March is also out on the last day of the week, the core number is expected to be +0.2%; February was +0.4%. The last statistic of note is the University of Michigan Consumer Sentiment number for April, 87.5 is forecast; March was 88.4.

Eurozone

Industrial Production figures for February are issued on Friday, the m/m number is thought to be +0.2%, the yearly number +4.0%; January??™s statistics were -0.2 m/m and +3.7% y/y. EU commission forecasts for GDP growth in 2007 are a Wednesday release. The prediction for the 1st quarter is between 0.4% and 0.8%; the 2nd quarter between 0.5% and 0.9%; the 3rd quarter between 0.3% and 0.9%.