NEWS / Foreign Exchange

Market Directions April 16 ??“ 20, 2007

The Week in Review

The G 7 has tacitly acknowledged it is powerlessness to affect the world??™s currency markets. The communiqu?© released after last week??™s meeting in Washington DC did not mention Japanese Yen or Chinese Yuan trading rates, previous recipients of G7 censure.  The paragraph on currencies was lifted verbatim from the February statement in Essen Germany.  The assembled finance ministers and central bank presidents also declined to address currency issues in their pubic statements.  This silence by the representatives of the industrialized world??™s foremost economic powers is an acceptance of the far greater efficiency of market forces in determining exchange rates than the occasional rhetorical and interventionist endeavors of the central bankers. This does not mean that the world??™s central bankers are helpless before the market. The Bank of Japan could end the carry trade in an afternoon if it desired, by raising Japanese rates, the European Central Bank (ECB) could achieve the same by cutting theirs.  The Federal Reserve might go a long way toward eliminating the US Trade Deficit by lowering the Fed funds rate and China could greatly reduce its trading surplus by raising rates and letting its currency float. But the world??™s central bankers will not do these any of things. They may talk about exchange rates but their economic and interest rate policies are determined by the needs of their domestic economy and politics not by international currency considerations.  As recently as last April the G7 had a different view as it singled out the Chinese Yuan as a culprit in the skewed international trade balances.  The market duly responded by sending the Dollar into a month long swoon. But after the shock of the communiqu?© and the profit taking it engendered wore off the dollar stabilized and even resumed its climb against the Yen.  Rhetoric and jawboning cannot change the underlying economic and political realities of the world??™s trading countries.

In the sudden silence since last Friday the market could be heard working.  On Thursday the carry trade, seemingly given a green light by the G7 statement, was slammed, or as the market jargon goes, suffered a bout of ???risk reduction??™,  that is profit taking, brought on by much stronger than expected growth and inflation statistics of the Chinese  economy.   Though the yen crosses recovered much of their losses on Friday the point was clear. Even with respect to a controlled currency like the Chinese Yuan, market forces are effective in pressing adjustments.   In retrospect the G7 forbearance looks both wise and circumspect. 

It is debatable whether the recent Euro surge is due primarily to the strength of the European economies or the perceived gathering weakness in the United States. The American moderation is the newer factor and it was reinforced by the week??™s economic results, (details below).  The consumer sector experienced medium growth in spending and housing showed steady. In the most welcome news, for the equities, if not the dollar, inflation beat a retreat, as the core CPI number fell to 2.5% in the year to year statistic. With every moderation of inflation and growth in the United States, speculation about a Fed increase recedes further into 2007 and the dollar suffers. 

In Europe ECB officials repeated their concerns about inflation, but the market has long since factored in the next 0.25% hike.  Opinion is divided about the chances for a move beyond 4.0% but with the many recent comments on the surprising vivacity of the European economies and their ability to withstand a high and climbing Euro, sentiment will surely begin to price in a hike to 4.25%. Nicholas Garganas ECB Governing Council member said that ???we should be satisfied that the Euro is strong???. A comment that has an interesting parallel to the oft voiced American refrain that a ???strong dollar is in the US interest??™.  On the western side of the Atlantic the Fed has been largely removed from the rate equation with a prolonged hold the base market assumption

For the first time in fifteen years the British Pound closed above 2.0000 and for the first time since the requirement was formulated in 1997 the Governor of the Bank of England (BOE) was obliged to write the Chancellor of the Exchequer and explain why CPI was more than 1% from its target. The government inflation goal is 2.0% and the March Consumer Price Index was 3.1%. In his letter to Chancellor Gordon Brown, Mervyn King said that he expects inflation to fall back to within the target range in  ???a matter of months???.  Market expectations for at least a 0.25%  hike at the next Monetary policy Committee (MPC) meeting on May 10th,  heightened after the CPI release, were then sealed by the  minutes  of the April 4 -5 meeting of the MPC, issued on Wednesday.  Sterling rose to a 26 year high, 2.0130, on the news that the vote to hold rates was 7-2 in favor.  Sentiment had expected a repeat of the last tally of 8-1.  The new BOE inflation forecast is due in May before the MPC meeting and it will surely be above the 2% target.

The  11.1% expansion of the Chinese economy in the 1st quarter  sparked a rapid sell off in the Yen crosses on Thursday as  markets feared both further Bank of China (PBOC) rate adjustments and a drop in the central parity rate the of Yuan against the USD. The PBOC set the parity at 7.7199 a new high for the Yuan on Thursday.  Friday the parity moved slightly lower to 7.7230. As China has become ever more important and integrated to the world economy traders have begun to note statistical developments in the Chinese economy and respond to them as they would to numbers released in Washington, London, Brussels or Tokyo.   In February a dramatic fall in the Shanghai stock index sparked a month long decline in stock indexes around the world.  China is clearly coming of economic age.

Economic Releases April 16 - 20

United States

The American economy kept a measured pace this week with consumer sales expanding moderately and inflation shifting lower; neither outcome provided support for the Dollar.  Retail Sales figures for March issued on Monday were up 0.7%; the core number, the reading without Food and Motor Vehicles Sales, rose 0.8%.  Both numbers bested expectations of 0.4% and 0.6%; February??™s statistic was revised up to 0.5% from 0.1%.  The annualized rate of core Retail Sales growth in the first quarter was 4.7% not far behind the 5.2% growth in the fourth quarter of 2006 and likely to give a 3.5% to 3.75% boot in real consumer spending in the first quarter.

The Consumer Price Index (CPI) for March released on Tuesday expanded 0.6% as forecast, but the core number, without food and energy prices, rose only 0.1%, half the 0.2% forecast.  The actual March reading was 0.06%, having been rounded up for release. The annualized core rate dropped to 2.5% two tenths below the same figure in February.  These benign results both ratified the Fed??™s inflation analysis and put paid to any lingering promise for an increase of the Fed Funds rate.  Traders immediately drove the Euro up 50 points, the by Yen half that and the Euro/Yen vaulted 40 points.

The US home market showed further signs of stabilization this week. Housing Starts  Increased 0.8% in March to 1.518 million units from February??™s 1.5039 and better than the anticipated 1.490 million.  Building Permits lifted 0.8% as well reaching 1.544 million. The February result had been 1.532.  Housing Starts have now risen four of the last five months and while this is by no means a return to strong growth it will limit the drag from the housing sector on national employment and GDP numbers. 

Industrial Production for March slipped 0.2%, 0.1% had been expected and the February number was revised lower as well to 0.8% from 1.0%.  Capacity Utilization for March fell to 81.4%, below the expected 82%, which had been the February figure as well. But the drop disguised the weather driven shift from February to March.  Because of the unusually cold weather in the second month of the year  utility generation  rose that month 7.6%, as March returned to more seasonally temperature levels  utility generation fell 7.0%,  largely a wash: January 81.2%, February 82.0%, March 81.4% 

Foreign investment kept easy step with the merchandise trade gap.   The Treasury International Capital System (TICs) reported net foreign purchases of long term securities at $77.9 billion and overall purchases at $94.5 billion.  Both are more than adequate to fund the monthly American trade deficit of about $60 billion.

Eurozone

Final HICP inflation  figures for March were 0.7% for the month and 1.9% year to year, just below the ECB 2% goal and now so  for the  fifth month in a row.  Construction activity in February climbed 0.9% month to month and 10.4% year to year over the January reading of 0.3% and 9.1%.  The January statistics were revised down from 0.6% for the monthly and from 10.4% for the yearly.

United Kingdom

March CPI rose 0.5% month to month and 3.1% year to year. Average earnings including bonuses shot up 4.6% in February above the 4.2% forecast and the 4.2% January reading. The March consume Price Index came in at 0.5% month to month and 3.1% year to year, forecast had been for 0.3% and 2.8%; this is the statistic that prompted the BOE letter.

Germany

The April ZEW survey registered an all time high in the ???current conditions??™ section at 76.9, March had been 69.2 and 68.8 had been the median forecast.  The ???economic expectations' also gained at 16.8 bettering the March issue of 5.8 and the median prediction of 10. March PPI at 0.3% month to month and 2.5% year to year was good news as well, substantially improving on the forecast of 0.4% and 2.0%. and the March result of 0.3% and 2.8%.  The March reading was lowest PPI since 2.3% in September of 2003.

China

The Chinese economy expanded at 11.1% in the 1st quarter, considerably more than the anticipated 10.4%.  The return to above 11% growth surprised the market as the Chinese government has undertaken financial and currency measures to restrain growth and has stated that this is one of their chief concerns. Since 2006 the Chinese economy has grown above 10% every quarter: Q1 2006 10.4%, Q2 2006 11.5%, Q3 2006 10.6%, Q4 2006 10.4%, Q1 2007 11.1%   Export growth boomed to $46.5bilion in the first quarter, more than doubling  the first quarter of 2006 at $23.1 billion.

The Week Ahead

Economic Releases April 23 ??“ 27

United States

The best is last this week with 1st quarter GDP released on Friday at 8:30 am ET.  Median expectation is for 2.0% growth but the range of forecasts is 1.3% to 2.7%.  Most of the latest economic results in the US have exhibited moderate growth; an outlier has been the Non Farm Payrolls report of job creation, which has continued strong. The March reading was 180,000 well above the forecast of 135,000, with 32,000 added to prior months.  As long as American consumers have felt confident about job prospects consumer sentiment and spending have held up fueling the US economy.  Despite the mediocre results of the many secondary statistics a better than expected result for the GDP will combine with the recent NFP report to provide substantial dollar support.   The housing sector receives a careful perusal this week with Existing Home Sales for March on Tuesday, February sales were 6.69 million units. New Homes Sales for March is issued on Wednesday, February was a disappointing 848,000.  February is historically a weak month for home sales; in addition the weather in much of the country was cold.  Traders will be looking to see if spring has indeed returned to the housing market.  Durable Goods Orders for March are out on Wednesday. The headline number was 1.7% in February, ex Defense was 1.6% and ex Transport was -1.0%.  Two consumer sentiment numbers for April are also issued this week, The Conference Board number on Tuesday, March was 107.2, and the University of Michigan release on Friday, March was 85.3.

Eurozone

Limited issuances this week.  Industrial New Orders for February are reported on Tuesday, a 0.5% expansion is expected in the monthly number and 7.8% in the yearly.  The January figures were -0.2% and 12% respectively.  The Current Account seasonally adjusted reading for February is reported on Friday.  The median forecast is for a surplus of E1.0 billion, January??™s number was E2.7 billion.

Germany

The IFO Survey for April arrives on Wednesday, the various components are forecast as follows: Business Sentiment, expected 107.9, prior month 107.7; Business Expectations, expected 103.7, prior month 103.2; Current Assessment, expected 112.6, prior 112.4.  This survey has been consistently strong and has tabulated well with the success of the German economy.  Preliminary reading for the April German CPI and HICP will be released on Friday. Predictions for CPI are 0.2% in the month to month and 1.7% yearly. March numbers were 0.3% and 1.9%.  HICP expectations are 0.2% and 1.8%. March numbers were 0.2% and 2.0%.  HICP is the uniform inflation statistic for all the Eurozone countries.