Market Updates | Written by CEP News | Jul 11 08 21:44 GMT |
(CEP News) - Swings in financial stocks overshadowed economic data on Friday. Press reports that Fannie Mae and Freddie Mac might require rescue from the U.S. government dominated trade - even overshadowing a new record high in oil and a surprising Canadian jobs report.
Fannie Mae and Freddie Mac closed down 45% and 47% on the week. The two U.S. government-sponsored companies own or guarantee about half of the $12 trillion U.S. mortgage industry.
There were conflicting reports about whether the Federal Reserve would allow Fannie and Freddie to borrow from the discount window. Equity markets bounced off their lows when a newswire initially reported that Fed Chairman Ben Bernanke said the government-sponsored enterprises could use the discount window. After most markets closed, except foreign exchange, Federal Reserve spokesperson Michelle Smith told reporters there have been no official discussions with Fannie and Freddie about the discount window. That sent the U.S. dollar toward session lows.
The Dow Jones industrial average closed down 128 points to 11101 and the S&P 500 closed down 14 points to 1239. On the week, the Dow lost 1.9% while the S&P 500 fell 1.7%.
Financial companies with ties to the U.S. housing industry were also punished. Lehman Brothers, the fourth-largest investment bank in the U.S., fell nearly 40% during the week.
The Canadian banking industry also took a hit. The S&P/TSX Capped Financials Index fell to its lowest level since the March 17 collapse of Bear Stearns.
In the broader market, shares lost ground for the fifth straight week. Since closing at a record high on June 18, the Toronto Stock Exchange has declined by 9%. On Friday, Toronto's S&P/TSX composite index closed down 35 points to 13709.
Canadian markets were once again boosted by commodity markets as oil showed its resilience, rallying to a record high $147.27. It was an extremely volatile week for crude as prices fell nearly $10 to begin the week, which prompted a number of analysts to say a major price correction was imminent. However, continued tensions between Iran and Israel and an unexpected U.S. supply drop later pushed up prices.
WTI crude oil closed up $3.43 to $145.08. The front month gold contract at the Chicago Board of Trade was up $18.50 to $960.40 per ounce.
In currency markets, the loonie came under pressure after a Statistics Canada report showed the economy shed 5,000 jobs in June and the unemployment rate ticked up to 6.2%.
"The Canadian economy has lost full-time jobs for two months in a row. That's not the job creation that sustains economic growth," said Adam Fazio, currency strategist at CIBC World Markets.
Nonetheless, the loonie closed up 0.0010 to 0.9906 against the U.S. dollar (1.0094 USD/CAD) and gained 0.0089 on the week. The Canadian dollar remains well within its three-cent range on either side of parity, and Fazio doesn't see a near-term catalyst for a breakout.
"It's like a spring that coils tighter and tighter but when it goes, look out," Fazio said.
The U.S. dollar was under broad pressure on speculation the U.S. government will be forced to guarantee $5 trillion in Fannie Mae and Freddie Mac obligations.
The U.S. dollar was down 0.8100 to 106.2700 against the yen and the Dollar Index was down 0.570 to 71.923. During the Friday session, the Dollar Index fell to its lowest since April 23.
The euro was up 0.0149 to 1.5937 against the U.S. dollar, up 0.0161 to 1.6085 against the Canadian dollar, up 0.0032 to 0.8013 against the pound sterling and was higher by 0.37 to 169.42 against the yen.
The pound sterling was up 0.0107 to 1.9887 against the U.S. dollar and up 0.0126 to 2.0074 against the Canadian dollar.
U.S. fixed income also sold off on worries Fannie and Freddie debt could increase the supply of outstanding U.S. government debt. The decline in Canadian employment helped the CGB market withstand the sell off.
U.S. two-year yields are up 19.4 bps to 2.60%, with five-year yields up 20.4 bps to 3.28%, 10-year yields up 16.2 bps to 3.96% and 30-year yields up 12.6 bps to 4.54%. The Eurodollar September 08 contract is down 2.0 ticks to 97.07. The yield curve is flatter, with the 10/2-year spread down 3.3 bps to 136.13 bps.
Yields on two-year Canadian government bonds are up 2.3 bps to 3.18%, with five-year yields up 3.3 bps to 3.41%, 10-year yields up 3.0 bps to 3.78% and 30-year yields up 2.8 bps to 4.09%. The Canadian 10-year note is yielding 18.16 bps less than the U.S. 10-year note.
In Germany, returns on two-year German bonds are up 1.5 bps to 4.41%, with five-year yields up 4.0 bps to 4.43%, 10-year yields up 2.8 bps to 4.43% and 30-year yields up 1.6 bps to 4.74%.
Yields on UK two-year bonds are up 1.5 bps to 4.88%, with five-year yields up 1.9 bps to 4.86%, 10-year yields up 2.5 bps to 4.89% and 30-year yields up 2.6 bps to 4.57%.
The week starts out quietly as there are no notable economic data points on Monday. Traders will be looking for weekend news on Fannie Mae and Freddie Mac before turning their focus to Bernanke's semi-annual testimony to U.S. lawmakers. Canada's central bankers will meet on Tuesday to decide what to do with the 3.00% overnight target rate. Economists see virtually no chance the bank will change rates, and futures markets are pricing the hold as a certainty.
All data taken at 5:10 p.m. EDT.
By Adam Button, abutton@economicnews.caThis email address is being protected from spam bots, you need Javascript enabled to view it , edited by Nancy Girgis, ngirgis@economicnews.caThis email address is being protected from spam bots, you need Javascript enabled to view it
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Saturday, July 12, 2008
Friday's News Recap: Canadian Employment Falls, U.S. Consumer Sentiment Rebounds
News Recap | Written by CEP News | Jul 11 08 20:26 GMT |
(CEP News) - North American economic releases were characterized by elements of surprise Friday with Canadian employment unexpectedly shedding jobs in June, the University of Michigan consumer sentiment index surprising to the upside and speculation about Fannie Mae and Freddie Mac rocking markets.
For the first time since December, Canadian employment shed 5,000 jobs in June against forecasts for a modest increase of 8k. In May, 8.4k jobs were added. Meanwhile, Canada's unemployment rate ticked up to 6.2% from the previous month's 6.1%. Economists were expecting the rate to remain unchanged from May. However, in the last 12 months, employment has grown 1.7% or 290,000 jobs.
"Reality may finally be catching up with the Canadian job market," said BMO deputy chief economist Doug Porter. "We wouldn't make too much of a one-month dip in employment - that can happen even in the middle of a boom."
On the housing front, Canadian home price increases slowed to 4.1% on an annual basis in May, the slowest pace recorded in almost six years as housing markets in Alberta and British Columbia cool, Statistics Canada said. May's price increase was the slowest since July 2002 when year-over-year prices increased 4%. On a monthly basis, prices were unchanged between April and May.
Strong exports to the U.S. and record exporting to other countries drove Canada's trade surplus with the rest of the world up to $5.5 billion in May from a revised April surplus figure of $4.8 billion. Canadian exports rose for a fifth consecutive month, jumping 5.4% to $42.1 billion as both volumes and prices increased, Statistics Canada reported.
Following the collapse of Fannie Mae and Freddie Mac share prices over the last two days and speculation of a government bailout, U.S. Treasury Secretary Henry Paulson released a statement saying the Treasury Department is continuing its dialogue with regulators and firms. He also said the focus is to back Fannie Mae and Freddie Mac "in their current form".
Later, there were conflicting reports about whether the Federal Reserve would allow Fannie and Freddie to borrow from the discount window. A newswire initially cited sources that Fed Chairman Ben Bernanke said the government-sponsored enterprises could use the discount window. Later, Federal Reserve spokesperson Michelle Smith told reporters there have been no official discussions with Fannie and Freddie about the discount window.
In data releases, the preliminary consumer sentiment survey from Reuters and the University of Michigan rebounded for the first time since January, reaching a score of 56.6 in July from June's reading of 56.4. The consensus was expecting a further decline to 55.5. According to the report, 90% of respondents said they thought the U.S. economy was in recession, with the downturn expected to deepen further.
The outlook continues to look grim with the consumer outlook index falling to 48.3 in July from 49.2 in the prior report. The current conditions index rebounded to 69.5 from 67.6 in last month's final report.
In another surprising result, the U.S. monthly trade deficit unexpectedly shrank in May to -$59.8 billion, with April's deficit figure downwardly revised to -$60.5 billion from a previously reported -$60.9 billion, the U.S. Census Bureau reported. Economists had been expecting a deficit of $62.5 billion, with expectations ranging from -$65.0 billion to -$59.5 billion. A sharp decline in oil imports was responsible for the decline.
According to the U.S. Treasury, monthly receipts totalled $259.912 billion and spending came in at $209.188 billion, resulting in a deficit of $50.725 billion for June, a 145.1% increase from the prior year.
U.S. import prices continued to rise in June, according to data released from the U.S. Bureau of Labor Statistics (BLS) on Friday, which showed a 0.9% month-over-month increase in import prices excluding petroleum products and a 6.6% annual gain. In May, the import price index excluding petroleum rose 0.7% month-over-month and 6.6% year-over-year.
In overnight releases, the Federal Statistics Office of Germany (Destatis) said that German wholesale price inflation reached 8.9% year-over-year in June, the highest annualized increase recorded since January 1982 and in line with forecasts. May's rate was 8.1%. Month-over-month, the wholesale price index grew 0.9% in June, also as expected and down from the 1.4% growth rate observed in May.
WTI crude oil surged more than four dollars to $145.92 in overnight trading due to rising tensions in the Middle East and prospects of further violence in Nigeria.
Japanese consumer confidence waned further in June, falling to a reading of 32.9 despite expectations for a fall from 34.1 in May to 33.0. Household consumer confidence did slightly better than the consensus of 32.5, declining to 32.6 from 33.9.
Final figures for Japanese industrial production for May showed some small unexpected downward revisions with production expanding by 2.8% month-over-month despite the preliminary 2.9% seen earlier, and an annual 1.1% rise compared to the preliminary 1.2% rate.
Speaking at a conference in Yalta, Ukraine on Friday, International Monetary Fund Managing Director Dominique Strauss-Kahn stressed that the global economy, caught between "the ice of a recession and the fire of inflation", would not recover before next year. Strauss-Kahn also emphasized that the economic consequences of the current financial crisis is still "in front of us" but that the worst of the rout is over.
By Stephen Huebl, shuebl@economicnews.caThis email address is being protected from spam bots, you need Javascript enabled to view it , with contributions from Erik Kevin Franco, efranco@economicnews.caThis email address is being protected from spam bots, you need Javascript enabled to view it , Sean McKibbon, smckibbon@economicnews.caThis email address is being protected from spam bots, you need Javascript enabled to view it and Todd Wailoo, twailoo@economicnews.caThis email address is being protected from spam bots, you need Javascript enabled to view it , edited by Nancy Girgis, ngirgis@economicnews.caThis email address is being protected from spam bots, you need Javascript enabled to view it
CEP Newswires - CEP News © 2008. All Rights Reserved. www.economicnews.ca
The Copying, Broadcast, Republication or Redistribution of CEP News Content is Expressly Prohibited Without the Prior Written Consent of CEP News.
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(CEP News) - North American economic releases were characterized by elements of surprise Friday with Canadian employment unexpectedly shedding jobs in June, the University of Michigan consumer sentiment index surprising to the upside and speculation about Fannie Mae and Freddie Mac rocking markets.
For the first time since December, Canadian employment shed 5,000 jobs in June against forecasts for a modest increase of 8k. In May, 8.4k jobs were added. Meanwhile, Canada's unemployment rate ticked up to 6.2% from the previous month's 6.1%. Economists were expecting the rate to remain unchanged from May. However, in the last 12 months, employment has grown 1.7% or 290,000 jobs.
"Reality may finally be catching up with the Canadian job market," said BMO deputy chief economist Doug Porter. "We wouldn't make too much of a one-month dip in employment - that can happen even in the middle of a boom."
On the housing front, Canadian home price increases slowed to 4.1% on an annual basis in May, the slowest pace recorded in almost six years as housing markets in Alberta and British Columbia cool, Statistics Canada said. May's price increase was the slowest since July 2002 when year-over-year prices increased 4%. On a monthly basis, prices were unchanged between April and May.
Strong exports to the U.S. and record exporting to other countries drove Canada's trade surplus with the rest of the world up to $5.5 billion in May from a revised April surplus figure of $4.8 billion. Canadian exports rose for a fifth consecutive month, jumping 5.4% to $42.1 billion as both volumes and prices increased, Statistics Canada reported.
Following the collapse of Fannie Mae and Freddie Mac share prices over the last two days and speculation of a government bailout, U.S. Treasury Secretary Henry Paulson released a statement saying the Treasury Department is continuing its dialogue with regulators and firms. He also said the focus is to back Fannie Mae and Freddie Mac "in their current form".
Later, there were conflicting reports about whether the Federal Reserve would allow Fannie and Freddie to borrow from the discount window. A newswire initially cited sources that Fed Chairman Ben Bernanke said the government-sponsored enterprises could use the discount window. Later, Federal Reserve spokesperson Michelle Smith told reporters there have been no official discussions with Fannie and Freddie about the discount window.
In data releases, the preliminary consumer sentiment survey from Reuters and the University of Michigan rebounded for the first time since January, reaching a score of 56.6 in July from June's reading of 56.4. The consensus was expecting a further decline to 55.5. According to the report, 90% of respondents said they thought the U.S. economy was in recession, with the downturn expected to deepen further.
The outlook continues to look grim with the consumer outlook index falling to 48.3 in July from 49.2 in the prior report. The current conditions index rebounded to 69.5 from 67.6 in last month's final report.
In another surprising result, the U.S. monthly trade deficit unexpectedly shrank in May to -$59.8 billion, with April's deficit figure downwardly revised to -$60.5 billion from a previously reported -$60.9 billion, the U.S. Census Bureau reported. Economists had been expecting a deficit of $62.5 billion, with expectations ranging from -$65.0 billion to -$59.5 billion. A sharp decline in oil imports was responsible for the decline.
According to the U.S. Treasury, monthly receipts totalled $259.912 billion and spending came in at $209.188 billion, resulting in a deficit of $50.725 billion for June, a 145.1% increase from the prior year.
U.S. import prices continued to rise in June, according to data released from the U.S. Bureau of Labor Statistics (BLS) on Friday, which showed a 0.9% month-over-month increase in import prices excluding petroleum products and a 6.6% annual gain. In May, the import price index excluding petroleum rose 0.7% month-over-month and 6.6% year-over-year.
In overnight releases, the Federal Statistics Office of Germany (Destatis) said that German wholesale price inflation reached 8.9% year-over-year in June, the highest annualized increase recorded since January 1982 and in line with forecasts. May's rate was 8.1%. Month-over-month, the wholesale price index grew 0.9% in June, also as expected and down from the 1.4% growth rate observed in May.
WTI crude oil surged more than four dollars to $145.92 in overnight trading due to rising tensions in the Middle East and prospects of further violence in Nigeria.
Japanese consumer confidence waned further in June, falling to a reading of 32.9 despite expectations for a fall from 34.1 in May to 33.0. Household consumer confidence did slightly better than the consensus of 32.5, declining to 32.6 from 33.9.
Final figures for Japanese industrial production for May showed some small unexpected downward revisions with production expanding by 2.8% month-over-month despite the preliminary 2.9% seen earlier, and an annual 1.1% rise compared to the preliminary 1.2% rate.
Speaking at a conference in Yalta, Ukraine on Friday, International Monetary Fund Managing Director Dominique Strauss-Kahn stressed that the global economy, caught between "the ice of a recession and the fire of inflation", would not recover before next year. Strauss-Kahn also emphasized that the economic consequences of the current financial crisis is still "in front of us" but that the worst of the rout is over.
By Stephen Huebl, shuebl@economicnews.caThis email address is being protected from spam bots, you need Javascript enabled to view it , with contributions from Erik Kevin Franco, efranco@economicnews.caThis email address is being protected from spam bots, you need Javascript enabled to view it , Sean McKibbon, smckibbon@economicnews.caThis email address is being protected from spam bots, you need Javascript enabled to view it and Todd Wailoo, twailoo@economicnews.caThis email address is being protected from spam bots, you need Javascript enabled to view it , edited by Nancy Girgis, ngirgis@economicnews.caThis email address is being protected from spam bots, you need Javascript enabled to view it
CEP Newswires - CEP News © 2008. All Rights Reserved. www.economicnews.ca
The Copying, Broadcast, Republication or Redistribution of CEP News Content is Expressly Prohibited Without the Prior Written Consent of CEP News.
A copy of CEP News disclaimer can be found at http://www.economicnews.ca/cepnews/wire/disclaimer.
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Lehman shares plunge amid market distress
By Dan Wilchins and Jennifer Ablan
NEW YORK (Reuters) - Shares of Lehman Brothers plunged to nine-year lows and stock in other Wall Street firms declined as new signs of distress in financial markets spooked investors.
Lehman fell as much as 23 percent, before recovering to close down 16.6 percent on Friday, far outpacing the drop in rivals such as Merrill Lynch & Co , which lost 3.8 percent and Goldman Sachs Group Inc , which declined 4.5 percent.
In the last two weeks, Lehman has lost about a third of its market value, and the company's shares now trade at less than half their book value, or the net accounting value of its assets, which typically signals extreme distress.
The investment bank has been the subject of false rumors in the past, and the U.S. Securities and Exchange Commission is investigating whether investors have looked to profit by spreading rumors to push down the company's shares.
On Thursday, its shares were battered by rumors -- later discredited -- that some key customers, Pimco and SAC Capital, had pulled business away from it. Pimco, the world's biggest bond fund, said on Thursday it continued to trade normally with Lehman as did SAC, a prominent hedge fund.
Standard & Poor's on Friday refuted negative speculation, saying Lehman appears to have "sound credit fundamentals."
"The persistent and ongoing pressure on Lehman's stock price in recent days has not had negative effects on Lehman's liquidity, funding or client business," said S&P, affirming its "A/Negative/A-1" rating on the stock.
On June 30, Lehman's shares dropped on rumors that it was going to be bought out at a price below its then market price. Again, the rumors could not in any way be substantiated.
The U.S. stock market fell on Friday, largely because of fears that the U.S. housing crisis would drag down the nation's major mortgage finance agencies, Freddie Mac and Fannie Mae , and because the government offered no hint that it would step in swiftly to help.
Around the time Bear Stearns collapsed, the Federal Reserve opened backup financing lines for Wall Street, which should prevent a major investment bank from failing overnight.
But even with the ability to borrow against assets at the Federal Reserve, Lehman could run into trouble, said James Ellman, president at hedge fund Seacliff Capital in San Francisco, which has about $200 million under management. He said Seacliff does not have a position in Lehman.
"They can walk all the assets they want to the Fed, but clients can still take funds elsewhere, and if enough clients decide to remove their business, that brokerage likely does not survive long-term," Ellman said.
Bear Stearns, once the fifth-largest U.S. investment bank, faced a run on the bank in March, and was forced to sell itself.
"People think Lehman will be acquired by someone at below its current share price. Just look at what happened with Bear Stearns," said Jim Huguet, co-chief executive at fund manager Great Companies, which manages $300 million. Great Companies does not have a position in Lehman.
It is extremely difficult to know the market value of the mortgages, real estate, and related securities that are valued on Lehman's books at around $60 billion, experts said.
Huguet said that it was difficult for Lehman given the ferociousness of short sellers.
"Everybody is totally negative on financial stocks, and until housing prices stabilize, and people feel like there is liquidity for these firms, the market will continue to take them down. It's interesting the way the shorts have gotten -- it's almost like a group of piranhas. Something in the water is hurt, and all of the sudden it has 10,000 piranhas on it."
Lehman spokeswoman Kerrie Cohen declined to comment.
Lehman's shares closed down $2.87, or 16.6 percent, at $14.43 on Friday. Earlier, they touched a low of $13.29, their lowest level since 1999.
(Reporting by Dan Wilchins; Editing by Toni Reinhold and Carol Bishopric)
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NEW YORK (Reuters) - Shares of Lehman Brothers plunged to nine-year lows and stock in other Wall Street firms declined as new signs of distress in financial markets spooked investors.
Lehman fell as much as 23 percent, before recovering to close down 16.6 percent on Friday, far outpacing the drop in rivals such as Merrill Lynch & Co , which lost 3.8 percent and Goldman Sachs Group Inc , which declined 4.5 percent.
In the last two weeks, Lehman has lost about a third of its market value, and the company's shares now trade at less than half their book value, or the net accounting value of its assets, which typically signals extreme distress.
The investment bank has been the subject of false rumors in the past, and the U.S. Securities and Exchange Commission is investigating whether investors have looked to profit by spreading rumors to push down the company's shares.
On Thursday, its shares were battered by rumors -- later discredited -- that some key customers, Pimco and SAC Capital, had pulled business away from it. Pimco, the world's biggest bond fund, said on Thursday it continued to trade normally with Lehman as did SAC, a prominent hedge fund.
Standard & Poor's on Friday refuted negative speculation, saying Lehman appears to have "sound credit fundamentals."
"The persistent and ongoing pressure on Lehman's stock price in recent days has not had negative effects on Lehman's liquidity, funding or client business," said S&P, affirming its "A/Negative/A-1" rating on the stock.
On June 30, Lehman's shares dropped on rumors that it was going to be bought out at a price below its then market price. Again, the rumors could not in any way be substantiated.
The U.S. stock market fell on Friday, largely because of fears that the U.S. housing crisis would drag down the nation's major mortgage finance agencies, Freddie Mac and Fannie Mae , and because the government offered no hint that it would step in swiftly to help.
Around the time Bear Stearns collapsed, the Federal Reserve opened backup financing lines for Wall Street, which should prevent a major investment bank from failing overnight.
But even with the ability to borrow against assets at the Federal Reserve, Lehman could run into trouble, said James Ellman, president at hedge fund Seacliff Capital in San Francisco, which has about $200 million under management. He said Seacliff does not have a position in Lehman.
"They can walk all the assets they want to the Fed, but clients can still take funds elsewhere, and if enough clients decide to remove their business, that brokerage likely does not survive long-term," Ellman said.
Bear Stearns, once the fifth-largest U.S. investment bank, faced a run on the bank in March, and was forced to sell itself.
"People think Lehman will be acquired by someone at below its current share price. Just look at what happened with Bear Stearns," said Jim Huguet, co-chief executive at fund manager Great Companies, which manages $300 million. Great Companies does not have a position in Lehman.
It is extremely difficult to know the market value of the mortgages, real estate, and related securities that are valued on Lehman's books at around $60 billion, experts said.
Huguet said that it was difficult for Lehman given the ferociousness of short sellers.
"Everybody is totally negative on financial stocks, and until housing prices stabilize, and people feel like there is liquidity for these firms, the market will continue to take them down. It's interesting the way the shorts have gotten -- it's almost like a group of piranhas. Something in the water is hurt, and all of the sudden it has 10,000 piranhas on it."
Lehman spokeswoman Kerrie Cohen declined to comment.
Lehman's shares closed down $2.87, or 16.6 percent, at $14.43 on Friday. Earlier, they touched a low of $13.29, their lowest level since 1999.
(Reporting by Dan Wilchins; Editing by Toni Reinhold and Carol Bishopric)
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Fannie and Freddie's Troubles are a Lose-Lose for the US Dollar
Daily Forex Fundamentals | Written by DailyFX | Jul 11 08 21:30 GMT |
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- Euro Within 1 Penny of its Record Highs
- British Pound: Time for Some Action
Fannie and Freddie's Troubles are a Lose-Lose for the US Dollar
Calling the financial markets active today is practically an understatement. The combination of soaring oil prices and problems with Fannie Mae and Freddie Mac triggered sharp volatility in the equity and currency market. At one point during the US trading session, the Dow jumped 200 points within minutes, driving EUR/JPY to a record high. The market was initially very disappointed by US Treasury Secretary Paulson's reluctance to bailout Fannie Mae and Freddie Mac, but they were pleasantly surprised by Bernanke's offer to access the discount window (The ABCs of Fannie Mae and Freddie Mac's Problems).However their optimism was short-lived as stocks resumed their slide. The biggest question in the financial markets right now is whether or not Fannie and Freddie are too big to fail? If the government stepped in to prevent the Bear Stearns meltdown from crushing the market, they will undoubtedly step in to prevent a collapse in Fannie Mae or Freddie Mac because if either GSE fails, Americans will have to shoulder the burden. Fed Chairman Ben Bernanke has already announced that the GSEs can have access to the discount window, which would allow them to borrow money directly from the Federal Reserve rather than the markets. If Fannie and Freddie's problems are not solved and they still have difficulties borrowing, this means that they will have difficulties lending, which is something that the US government can not risk at this moment. For the currency market, it is a lose-lose situation for the US dollar. Further problems at Fannie and Freddie would push stocks lower once again, which would trigger another flight to safety out of US dollars. A bailout would essentially double the public debt, risking a downgrade in the US credit rating. Expect Friday's volatility to continue into the new trading week. We have a very busy US economic calendar that includes retail sales, producer prices, consumer prices, the Empire State and Philly Fed manufacturing surveys, industrial production, the Treasury International Capital flow report, housing starts and the minutes from the last FOMC meeting. Meanwhile the trade balance was stronger than the market expected thanks to a rebound in exports. Consumer confidence also improved modestly but it still remains near a 30 year low.
Euro Within 1 Penny of its Record Highs
The Euro traded within 1 penny of its record highs on fresh fears that another major financial crisis may be around the corner. If it wasn't for the potential repeat of the Bear Stearns debacle in March, we would have a quiet summer. However US stocks fell to a new 23 month low today triggering another flight to safety into anything but US dollars. Whether the EUR/USD manages to hit a new record high will be less dependent on economic data and more dependent on how much better or worse the market feels about the health of Fannie Mae and Freddie Mac. The latest rally in the Euro helps Eurozone nations deal with the rise in oil prices but it also raises the risk of sharply weaker growth for countries other than Spain and Ireland. Like the US, there are a number of pieces of economic data on the Eurozone calendar that are worth watching. This includes the German ZEW survey of analyst sentiment, consumer and producer prices.
British Pound: Time for Some Action
The British pound strengthened against the US dollar due entirely to dollar weakness. Although the problems with Fannie Mae and Freddie Mac affect the US the most, the UK will not escape unscarred. Bond yields have started to trickle higher while the FTSE has plunged alongside the Dow. In some ways, the UK economy is in as much trouble as the US. According to the latest data from mortgage lender Halifax, house prices dropped for the fourth month in a row to the lowest level on record. More housing market data will be released next week and we do not expect the current trend to change. The UK will be reporting consumer and producer price growth along with their employment numbers for the month of June. Inflationary pressures are expected to grow, but the outlook for the unemployment numbers are mixed. Even though the labor conditions in the service sector improved last month, conditions in the manufacturing sector deteriorated.
Big Week Ahead for the Canadian and New Zealand Dollars
Of the three commodity producing currencies, the Australian dollar was the market's biggest focus this past week. Not only were employment numbers released, but currency pair soared to a new 25 year high this morning. A move above the August 1982 high of 0.9905 would mark a 26 year high for the currency. Next week, the currency market's focus will shift to the Canadian and New Zealand dollars. The Bank of Canada has a monetary policy decision. Although they are not expected to alter interest rates, watch out for any market moving comments from the BoC Governor. New Zealand on the other hand has retail sales, service sector PMI, and consumer prices due for release. Given the sharp drop in consumer and business confidence, we expect the data to be kiwi bearish. The divergence in economic activity between Australia and New Zealand has driven the exchange rate of AUD/NZD to a new 7 year high.
EUR/JPY Hits Record High
Japanese Yen crosses have had a varied reaction to the volatility in the Dow today. USD/JPY and CAD/JPY came under aggressive selling pressure, while EUR/JPY and CHF/JPY are higher. This tells us that traders are just selling US dollars and not all risky assets. Depending on which Yen crosses that you buy, the carry trade could still be working. EUR/JPY hit a new record high, which is a trend that we have seen often. When the Dow first broke the Bear Stearns low in late June, EUR/JPY also rallied to a new high. Looking ahead, the Bank of Japan is expected to leave interest rates unchanged at 0.5 percent as the economy continues to suffer.
Disclaimer
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Bank of Canada Monetary Policy Monitor
Daily Forex Fundamentals | Written by TD Bank Financial Group | Jul 11 08 21:04 GMT |
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HIGHLIGHTS
- Economic conditions and Bank rhetoric prompt us to think that the Bank will remain on the sidelines on July 15, leaving rates at 3%.
- The Bank of Canada has previously stated they have a neutral bias, and we expect a similar bias to come out of this meeting as well.
- Governor Carney has stated some concern about inflation as a result of the massive commodity rally. We expect commodity price movements to remain a key variable on the Bank's radar.
- Though there is no compelling case for making a move on rates this time around, there are brewing inflation risks which suggest that the Bank's next move may be a hike.
The market has undergone a profound shift in expectations since the June 10th Bank of Canada Fixed Announcement Date. Though the decision to keep rates on hold at 3% surprised the markets, the accompanying statement indicated that the bias is now neutral. Subsequent comments by Governor Carney reinforced that view very clearly when he stated that “going forward, there remain important downside and upside risks to inflation, but these risks are now judged to be evenly balanced.”
With a clear neutral bias, market expectations have shifted accordingly. It is now clear that the Bank is comfortable with the overnight rate at 3%, but it will be keeping a close watch on inflation. On that front, there is some cause for concern. Nonetheless, a careful assessment of both economic conditions and Bank rhetoric prompt us to think that the Bank will take an opportunity for a breather on the sidelines leaving rates at 3% on July 15. Down the road, the Bank will be compelled to begin a tightening cycle in 2009.
Slower Economic Growth Will Tame Inflation
The economic data have shown signs of modest improvement after a dismal first quarter in which the Canadian economy contracted by 0.3% (q/q, annualized), due primarily to weakness in inventories and residential structures.
In April, GDP posted a robust 0.4% M/M gain, which made a nice kick off to the second quarter. The domestic side of the economy is holding up reasonably well, thanks to the income gains derived in large part from the commodity boom. In Governor Carney's Calgary address, he noted that “since 2002, rising commodity prices have fuelled a 25% improvement in our terms of trade, which alone has been responsible for roughly two-thirds of the 15 per cent gain in real per capita disposable income.” Such income gains have supported retailing activity, which is still up over 4% on a year ago basis. The real question is how the slowdown in the U.S. will impact Canada's export sector. And on that front, the storm clouds remain ominous and suggest trade will continue to be a net drag on GDP until early 2009. This means the Canadian economy should remain weak and we expect growth of 1.9% in Q3 and just 0.8% in Q4.
A slowing Canadian economy means the output gap, which is now closed, may move moderately into excess supply in the summer months. That will take some of the pressure off inflation, which reduces the need for any immediate rate increases. As such, the best recipe in this situation is to stay on the sidelines.
Inflation is Percolating
While not an immediate problem, inflation risks are turning more problematic. Thus, there is scope for keeping rates on hold now, but keeping a watchful eye on inflation going forward. Canadian core CPI remained well contained at just 1.5% Y/Y in May and has not crossed the 2% threshold which is the Bank of Canada's operational target since September 2007. However, core CPI on a three month annualized trend was 2.2% in May, and several other alternative core measures also point to inflation a little above the 2% target.
Further up the pipeline, wage pressures remain strong, and are trending well above historical averages. In May, the average hourly wages of permanent employees rose 4.6% Y/Y as a still tight labour market allowed workers to bid wages higher. Unit labor costs, or wages adjusted for productivity, have been on the rise since mid-2007 and are now nearly 4% on a year ago basis. But the likelihood of a true wage-price spiral seems small, and the risk that workers will try to negotiate higher wages to offset the erosion of purchasing power is unlikely to be as big of a threat as commodity prices. On the flip-side, capacity utilization measures have recently plummeted, and a recent change in the mortgage industry could crimp home inflation. Moreover, growing economic slack should keep the reins on inflation.
In addition, expectations for headline inflation have been creeping higher, which is no doubt concerning to the Bank. In the Bank of Canada's Summer Business Outlook Survey 35.6% of the respondents expected inflation to be above 3%, which is the highest level since the survey began. Expectations for higher prices along the production chain suggest that inflation is becoming well entrenched. Not only do businesses expect higher input prices, but they also expect to pass on those higher prices by raising output prices. Note however, that the Bank of Canada would have had a peek at this information going into the last meeting and so the neutral bias already reflects this view.
Headline inflation, however, is already a little too hot. Rising food and energy prices have pushed inflation back above the 2% rate. In May, all-items CPI was up 2.2% Y/Y. Looking ahead, inflation appears to be on an upward trend. Since the June 10th FAD, a barrel of crude oil has gained nearly $15/barrel to trade at a new all-time high of $145.29. Oil is just one of many commodities that continue to post strong gains. The Bank of Canada's commodity price index is up 48% Y/Y in June and the energy sub component is up a whopping 89% Y/Y. The steady rise in oil prices will surely push headline inflation higher in the near term.
Other commodities such as food are also poised to push headline inflation higher for a number of reasons. First, the trend appreciation in the Canadian dollar was an important factor in pushing prices lower in 2007. The media attention on the issue was an important catalyst for the downward pressure on prices. That now appears to be over. Since the beginning of the year, the loonie has stabilized around parity with the U.S. dollar, and going forward, we expect the Canadian dollar to give up some ground against the U.S. dollar. As such, the currency is no longer playing a prominent role in holding down prices and retailers are under less scrutiny to keep prices low.
Secondly, in the past couple years, food prices have been contained by the intensifying competition between Canadian grocers trying to preserve their market share, as companies like Wal-Mart are trying move into Canada. This is likely a one-time effect which is unlikely to be repeated.
Third, because of the way the Canadian CPI is constructed, food prices play a more prominent role not only in headline CPI, which includes 17% food (as compared to 13.8% in the U.S. definition), but also there are some food items like bread and meat which are included in the core CPI definition. Thus, with expected increases in food prices in the near term, there may be some follow through to headline and core inflation readings. All told, we forecast Canadian CPI to breach the 3% threshold by year end, while core should hit 2%.
The disconnect between headline and core CPI poses something of a dilemma for the Bank of Canada. The Bank of Canada normally uses core inflation as its operational guide. But the forces pushing headline inflation, particularly commodity prices, cannot be completely ignored. When Governor Carney addressed an audience in Calgary shortly after the last meeting, he acknowledged that, “the Bank needs to be mindful of the possibility that rising commodity prices may affect the relationship between total and core CPI” and added that “the Bank will also continue to look at a range of measures to assess the underlying trend of inflation.” However, the Bank has also reiterated its focus on core CPI recently, and we do not expect any sharp changes in methodology in the near term.
Credit Conditions Still on the Mend
Also arguing for steady rates in the near term is that the impact that the credit crunch has had on the Canadian economy.
The three month CDOR versus the three month OIS spread narrowed to 27 basis points over the past few months, and is well below the highs recorded last August when the credit crunch first hit or during the Bear Stearns bailout. In fact, the narrowing in the three month CDOR-OIS spread has been sufficient enough to cause the Bank of Canada to discontinue its Term PRA program of liquidity injections because “conditions in Canadian markets have improved since the end of April.”
Other positive signs of improvement in the credit market stem from the recent Business Outlook Survey. The response to the question on credit conditions indicated that although conditions have continued to deteriorate since April, the pace of weakening has slowed.
But while there has been measurable improvement in Canadian credit conditions, they are still not back to historical trends. All this suggests the need for some further repair. As such, a rate hike at this point would be far too early and disrupt the ongoing repair in credit markets.
What Will the Bank Say?
Given that the market is pricing in steady rates, the focus will be on the accompanying statement. A great deal of attention will be paid to any revisions the Bank will make to the economic forecasts. These revisions generally only occur in every second rate decision because it is when the MPR is released. This next decision is one such opportunity. In the last MPR, the Bank forecast H2 inflation of 1.9% Y/Y and core inflation of 1.5% Y/Y. There could be upward revisions to those figures and the full details will be released on Thursday with the Monetary Policy Report Update. Note, however, that the BoC's surprise pause in June was almost certainly backed by an internally revised economic and inflation forecast. Since very little time has passed since the last decision, it is unlikely that a revised forecast will translate into a substantially revised bias for the future.
We expect that the statement will stick to the broad outline set out in the last statement, and still maintain a generally neutral bias. As such, the statement “the Bank now judges that the current stance of monetary policy is appropriately accommodative” is likely to remain a fixture in the communiqué, in addition to a statement that the risks remain balanced.Outlook for Rates
There are a number of upside inflation risks that argue for higher rates going forward, but some of the froth on inflation will come off as the Canadian economy begins to cool. That suggests there is a window of opportunity for the Bank to assess what is happening with inflation trends in Canada. Consequently, we expect the Bank has now entered a protracted period of sitting on the sidelines and will not entertain serious thoughts of hiking rates until H2 2009. By that time, the Canadian economy will have gone through the storm and will be sufficiently strong to withstand higher rates.
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