special reports

Talking Points

$ Dollar The Indomitable
€ Euro Remains in Track
¥ Deflation Defeats Yen
₤ Cable Mildly Higher on CBI
₣ Carry Trade Weakens Swissie

Dollar The Indomitable

Last week we concluded our note with the following observation, “For now, positioning remains dollar bulls best friend. With  IMM specs so heavily long euros the pair remains grossly overbought.” This week despite a sea of red data on the economic front the greenback managed to gain ground rising 57 basis points against the euro, on – you guessed it –positioning. The economic data was dismal at best with both Existing and New Home Sales plunging to year lows while Durable Goods contracted –2.4% versus 0.5% expected.

Granted, the Durable Goods number was not nearly as weak as the headline suggested. Without the volatile transport sector, Durables increased by 0.5% vs. 02% expected indicating that the US manufacturing sector remains relatively strong and this underlying strength provided some fundamental boost to the dollar. Nevertheless,  overall, the picture of the US economy painted by last week’s data was not pretty. Housing is clearly in the midst of a sharp correction that may accelerate as winter approaches.  Speculative bubbles never end in a soft landing and with most housing prices still levitating near record highs, the prospect for further declines appears high, especially if oil refuses to recede from the $70/bbl level and gasoline prices take a progressively bigger bite out of consumer spending.

Next week the path for dollar bulls may become  decidedly more difficult to hoe as if the FOMC minutes due to be released on Tuesday reveal that the Fed has effectively stopped rather than merely paused in its rate hike campaign. On the economic front, traders will zero in on the NFP data due next Friday. Employment remains the absolute key to the dollar bulls argument that the US economy is in the midst of  slowdown rather than on the cusp of  a recession.  If payrolls cannot expand at the market anticipated 120K, new consumer demand, so critical to the future growth of US GDP will not materialize most likely precipitating a sell off in the greenback.




Euro Remains on Track

The euro went on a roller coaster ride this week first plunging after markedly worse then expected news for the ZEW survey only to recover its composure a few days later when IFO demonstrated continued strength in the regions largest industrial economy. The ZEW results released on Monday, truly shocked the currency market printing at –5.6 versus 11.4 expected. The negative number was the first such reading in over 5 years and send the unit sharply lower on concerns that EZ economy may be in danger or reverting back to stagnation. A few days later however, the much more respected IFO – a survey of businessmen rather than business analysts - produced much healthier readings printing at 105.0 versus 104.8 projected. The IFO remained near record highs and as we wrote on Thursday, ”put to rest, for the time being, any worries that ECB may be forced halt its rate hike campaign for fears of snuffing out the recovery.  Barring any rapid deterioration  in fundamentals the ECB should be on track to raise rates by another 25bp in its October 5th meeting.”

Next week the European calendar will be dominated by the ECB press conference on Tuesday and PMI surveys at the end of the week. The central bank is expected to leave rates on hold and reaffirm its cautious but steady approach to further rate hikes. However, should ECB President Trichet signal any equivocation vis a vis future rate hikes, the euro could suffer further damage as interest rates have been the primary driver behind its rally over the past several months.  The end of the week will bring the Manufacturing surveys which are expected to slip slightly from prior months highs, but still remain well above the 50 boom/bust level.

Soft inflation data destroyed the yen this week with the currency the biggest loser against the greenback amongst the majors. The new, recalibrated gauge of Japanese consumer price data registered a gain of only 0.2% on a year over year basis versus 0.5% projected.  As we noted on Friday, “The news revealed that pricing power in Japan remains severely limited as the last vestiges of deflation stubbornly refuse to leave the system. Traders sold the yen hard in reaction to the data speculating that the BOJ will most likely remain neutral for the rest of the year and will therefore present no threat to the newly laid carry trades  by hiking rates further.” However we also stated that “Despite the disappointing headline data, the underlying price trends continued to point upward.  If Japans’ export driven growth  abetted by the weaker yen, continues to maintain pace, inflationary pressures will begin to seep into the Japanese economy sooner rather than later. Furthermore if oil continues to ratchet higher, the lower yen will only exacerbate Japan’s already massive costs for energy imports. Therefore, the BOJ may choose to take pre-emptive action focusing instead on inflationary expectations rather than actual price levels to tighten monetary policy sooner than the market anticipates.  However, until such time that Japanese monetary officials actually begin to articulate these concerns to the market, the yen appears to be destined for further weakness.”

Next week Japanese employment data should continue to report strength in the Japanese job sector with job-to-applicant ratio remaining well above 1.0 level. However, traders will focus will be on the Overall Household Spending data and on the Retail Trade numbers. With deep seated deflationary habits still resident in the economy, the change in Japanese consumption habits  is extremely slow in the making. Until such time that Japanese consumer spending picks up pace, the monetary officials will continue to maintain a very cautious policy posture providing little reason for speculators to bid up the currency.




Cable Mildly Higher on CBI

Following a choppy week of trading, Cable managed to wrap Friday up at 1.8868, higher than the previous week’s close of 1.8810. Economic data was mixed, but the CBI Industrial Trends figure was the highlight of the week, as the headline index improved to a 20 month high of –8 from –11 in July. A breakdown of the survey data showed that domestic price expectations jumped to a reading of +13 from +6, subsequently fueling inflation concerns after CPI data released last week showed a decline of –0.1% in July. While varying inflation figures only blur the picture for the BOE, the central bank will also have to consider early signs of a slowing house market as the Rightmove survey for August slipped –1.6% from 2.9% the month prior. At the same time, Q2 GDP posted in line with consensus figures at 0.8% QoQ and 2.6% YoY.  Additionally, domestic demand provided an unexpected boost to the GDP reading as private consumption rose 1.0% from 0.3% in Q1 and raises the prospects for sustainable economic growth throughout the rest of 2006.

The outlook for this week is grim compared to the past week with almost every piece of economic data expected to highlight the fact that UK growth could be fragile at best. As we mentioned above, CBI Industrial Trends were impressive in August, but the CBI Distributive Trades report could be disappointing as retail sales could prove far less resilient than the manufacturing sector. The housing sector could see another blow to its growth, with Nationwide House Prices anticipated to slow in August. Furthermore, GfK Consumer Confidence should show a slip in sentiment as households were faced with uncertainty from the UK – US airline bomb plot and ever increasing outlooks for higher energy prices. Given the possibility of a whole week of relentlessly negative economic releases, sterling bulls may have much harder time pushing the unit higher.




Carry Trade Weakens Swissie

If ever there was doubt about the power of the carry trade effect in the currency market,  it was confirmed this week in the Swissie. Despite ever improving Swiss economic data and weakening US fundamentals, the dollar’s 375 basis point advantage has allowed dollar bulls to dominate as the USDCHF has managed to rise to 1.2400 this week.  The Swiss economy maintained strong labor figures in Q2 as the Employment Level rose to 3.651M.  Furthermore, the trade balance jumped to an even greater surplus of 1.42B in July versus an expected rise of 0.92B. The increase was a result of buoyant exports, which benefited from a weaker Swissie. On the flip side, Producer and Import Prices for July posted in line with expectations at 0.2%, bringing the annual rate down to 2.9% from 3.1% in June. While the economy appears to be economically sound, traders seem to be looking for more significant signs of further SNB rate hikes, and Producer and Import Prices did not do the trick this past week.

While Tuesday’s US FOMC minutes are likely to be the priority event for traders, the economic calendar for the coming week should theoretically lend strength to the Swiss franc, as one of the most important indicators for the country is likely to improve once again. The KOF leading indicator is anticipated to rise for the twelfth consecutive month to a reading of 2.64 as the SNB remains optimistic and predicts growth of 2.5% this year. The UBS Consumption Indicator may create some downside risk for the Swissie, however, as the figure has the potential to slip from June’s 2.111, the highest reading since April 2002. While household spending was encouraged by low unemployment numbers and mounting consumer sentiment last month, July saw higher energy costs that weighed on producers and gasoline prices which tightened the purse strings for the average consumer.  SVME PMI should reiterate the dilemma of producers as the figure is predicted to dip to 64.5 from 65.1 in July.

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