The Week Ahead
Monday, September 17, 2007 -Friday, September 21, 2007
What to look for in the week ahead
The Week Ahead updated September 17, 2007
� Fed set to cut rates only 25 bps; issue relatively stern statement
� Fallout is likely equity and risky trade negative
� GBP under pressure from Northern Rock, overextended housing market
� Eurozone sentiment set to take a hit with lower ZEW
The US dollar finished last week modestly lower on the close, but up from its intra-week low at 79.30 in the USD index. The market remains heavily focused on USD bearish themes, but I think the real story remains the ongoing credit crunch and the uncertainty it poses for financial markets. Late last week we got another dose of bad news in the form of Northern Rock, the fourth largest UK mortgage lender, seeking emergency funding from the Bank of England (BOE). Northern Rock may be the tip of the iceberg in the UK, with home price indexes starting to show declines for the first time since 2001. In past weeks I have repeatedly cautioned about the risk of negative news surprises in general and on the risk facing the UK housing market in particular. These events appear to be in play at the moment and are very likely to keep the GBP under pressure, both against the EUR and the USD.
I continue to view the market overall in terms of risk-averse/risk-seeking behavior, with the weak-USD theme playing a background accompaniment to the primary risk melody. The clearest barometer of shifts in investor sentiment continues to be major stock market indexes, with carry-trades and other speculative trades (long precious metals and commodities) following the stock market�s lead.
On Tuesday of this week, the FOMC will be holding a regularly scheduled rate setting meeting at which the Fed is expected to cut rates by 25 bps. Just last week, markets had been pricing in a 20-30% chance of a 50 bp rate cut, but as of Monday morning those expectations had been priced out, and Fed Fund futures are now showing only a 100% chance of 25 bps rate cut. In recent reports I had argued that a Fed rate cut was not guaranteed without accompanying signs of slower consumer spending or rising unemployment. The combination of the negative August NFP and last Friday�s negative August core retail sales report now provides the fundamental cover, or justification, for the Fed to ease rates without jeopardizing its credibility. But for those anticipating further rate cuts in coming months, I would maintain that the case for additional rapid Fed easing is far from certain.
Despite cataclysmic predictions from many market analysts, the US economy does not appear to be in danger of imminent collapse. On the labor market front, weekly initial jobless claims data are still not showing signs of any major shift in the employment outlook, with last week�s report of 319K remaining around the average for the past 12 months of 317K. Yes, continuing claims have risen in recent weeks, suggesting unemployed individuals are taking longer to find new jobs, but the latest level of 2.585 mio is only slightly above the average of 2.550 mio since the beginning of 2007. The retails sales report was on its face a negative, but the core-core (ex-autos, ex-gasoline, and ex-building materials) registered a 0.1% gain. So, yes, consumer spending has pulled back somewhat, but it does not appear to be collapsing. US sentiment gauges, despite dire warnings on the economy, have largely stabilized and in some cases improved. Weekly ABC consumer sentiment held steady at -17 in the week ending Sept. 9 and is above its recent lows of -20. September IBD/TIPP economic optimism fell less than expected and preliminary September Univ. of Michigan sentiment improved to 83.8 from August�s final 83.4. In short, the US consumer and economy have slowed somewhat in recent months, but do not appear to signaling anything more than a minor pullback. In GDP terms, we might be looking at a drop from earlier projections of 2.6% in 3Q to something on the order of 2.3%.
In short, the US consumer is still weathering the storm roiling financial markets and the Fed is still intent on demonstrating it will not bail out investors and firms who engaged in excessive or irresponsible risk-taking. In this light, I expect the Fed statement for the future outlook to be more upbeat and less accommodative than many in the market still expect. With oil prices now up near $80/bbl, recently benign inflation readings are likely to be a thing of the past, and this will keep the Fed on guard. Incoming data will remain the key to any additional Fed easing.
The market�s reaction to a less-accommodative Fed statement is likely to be equity negative, with consequent negative implications for carry trades (long JPY-crosses). As I�m writing this, high yielding currencies like AUD and NZD appear to be correcting lower as futures markets have signaled no chance of a 50 bp rate cut and increasingly embrace a likely stern Fed statement. Equity markets are so far not falling precipitously, but I anticipate additional weakness if my expectations are fulfilled.
Looking ahead to the data calendar this week in the US, Tuesday sees August PPI, expected to remain benign, July TIC data, and the September NAHB housing market index, followed by the FOMC rate decision in the afternoon. Wednesday sees August CPI, also forecast to remain steady and benign, along with August housing starts and building permits, which are expected to decline slightly, but that is nothing new. Thursday see weekly initial jobless claims, August LEI, which are forecast to turn negative for the first time since June, and the Philadelphia Fed index. Additionally, Fed Chair Bernanke will follow-up the Tuesday meeting with an appearance before the House Financial Services Committee, where he can be expected to elaborate further on the Fed�s thinking beyond the Fed�s statement.
Eurozone data is light with only the September ZEW investor sentiment index for Germany and the Eurozone due out on Tuesday and the Eurozone PMI�s for services and manufacturing on Friday holding significance. The ZEW sentiment gauges are expected to drop sharply, from about -6.5 to -16, highlighting the erosion in sentiment and likely reduced growth outlooks in Europe. The Eurozone PMI�s are also forecast to decline, but not as sharply as ZEW investor sentiment. Still, the market has yet to accept the notion that Eurozone growth has likely peaked, as have ECB rates. That day is still to come.
In Japan, the BOJ is meeting and expected to hold rates steady on Wednesday in light of recent weak data and adverse financial market conditions. On Tuesday morning Tokyo time, the July Tertiary Industry index is expected to fall -0.5% MoM after a 0.1% gain in June. Thursday sees the BSI Large All Industry and Manufacturing gauges for the 3Q and weekly stock and bond flow data from the MOF. Friday sees only the July All-Industry Activity index, which is also expected to register negative.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.