Whenever we look at economic data, we use the information to extrapolate what the Federal Reserve will do with interest rates. However in recent weeks, the extrapolation has become far more difficult since US data has been telling us one thing while the Federal Reserve has been telling us another. So far, there have been signs that the US economy is weakening and that the odds are building against the dollar while at the same time the Federal Reserve has been telling us that inflation has become so problematic that they have to keep on raising interest rates. Today’s batch of economic data makes figuring out whom to believe even more difficult. Jobless claims and the Empire State manufacturing survey both came out strongly, but the report on net foreign purchases of US securities (also known as the TIC report), industrial production and Philly Fed surveys all showed weakness. Since the TIC report was the day’s most important release, the market tried to send the dollar lower, but traders were fearful of shorting the dollar too significantly in an environment where the Fed fund probability for a June rate hike is at 100 percent. The Treasury International capital report was extremely disappointing today, coming out at $46.7 billion compared to a forecast of $60 billion. The report indicated that foreign investors did not buy enough US dollar denominated investments to plug the April trade deficit of $63.4 billion. The weakness of the dollar and central bank reserve diversification into Euros has played a big role in the weaker demand. The biggest selling was from the UK which is frequently thought to include investments from the Middle East. For now, this may be written off as a one off phenomenon, but if weak demand persists for another month, it will become a far more pressing concern. The market currently has its focus centered on what the Fed will do at the end of the month, but once that passes and we see the next TIC report the following month, then another weak number will be met by a larger reaction in the US dollar. Aside from the TIC report, the other bad news today was the 0.1 percent drop in industrial production as well as the decline in the Philly Fed survey from 14.4 to 13.1. Although the Philly Fed was stronger than the market’s forecast, after seeing the jump from 12.9 to 29.0 in the Empire State manufacturing survey, traders were looking for a stronger number to validate the strength in the more volatile NY index. Overall, the performance in the manufacturing sector has been lackluster at best with the Philly Fed survey remaining at the low double digit level for the fifth consecutive month. The big upside surprise was the jobless claims report which dipped below 300k to 295k. This is certainly an encouraging number and is a good sign for the labor market. However, with only 75k jobs created last month, this is only a recovery from the worst rather than a confirmation of a continued boom.
The Euro is slightly stronger than the dollar today as Eurozone inflation numbers come out right in line with expectations. Consumer prices rose 0.3 percent last month, bringing the annualized pace of growth up from 2.4 percent to 2.5 percent. The year over year rate is above the central bank’s 2 percent target and confirms the need for the ECB to continue to raise interest rates later this year. Although they are in no rush to raise rates at the moment, ECB President Trichet and many Eurozone officials have often said that rates remain accommodative. Their current stance is best summed up by the comments from ECB Bini Smaghi who said that the future decisions on interest rates will depend on “growth and inflation.” The central bank will continue to assess economic data and the move in commodity prices to see if they need to raise rates again in August. Remember, even though the ECB meets twice a month to discuss monetary policy, they usually alter rates only when there is an accompanying press conference. The next one will not be until August 31st, which means that there will be plenty of economic data that will be released by then for them to make a better judgment.
The British pound continued to steadily recoup some of last week’s hefty declines, as improving yet unsurprising economic data kept up the momentum. Retail sales for May was the first indicator to hit the wires with solidly optimistic figures. Sales matched estimates for a 0.5% rise over April to mark the fourth consecutive increase for the improving sector. Oddly enough, the retail data was one more indicator that resulted from the now familiar World Cup effect. As game time approached, purchases of clothes and electronics spiked by 0.7 and 1.5 percent respectively. The real question however is whether the event’s affect on the economy will amplify growth enough as to finally bring a rate hike back onto the table for the Bank of England. As it is, consumer spending accounts for two-thirds of the economy. The other data sets for the day fell to the releases of the Leading and Coincident Indicator Indexes for April. The aggregate leading index rose 0.6% for the period paced by the strength in the benchmark FTSE equities index. Performing equally well, the coincident indicator bumped 0.2% higher for the third straight month helped along by strong disposable income growth and retail sales for the month.
There were no surprises from the Bank of Japan who left monetary policy unchanged last night. The decision was unanimous and according to the central bank’s monthly report, they stand behind their upbeat assessment on the country’s economic recovery. Last night’s numbers support their stance with the leading economic index bumping up from 50 percent to 54.5 percent. As far as the BoJ goes, the timing of their eventual rate hike is still unclear and will depend on how inflation and growth holds up. Fukui did say that the excess liquidity in the banking sector has already been drained, which means that the next step will be to raise interest rates. We still think that they will delay their decision until the fourth quarter after Prime Minister Koizumi steps down from office.