Leading Indicators Slump

Good day… And welcome to the end of what has been a pretty flat week for the currencies. A quick look at the five-day returns illustrates just how tight the trading range has been this week. The best performing currencies of New Zealand (NZD) and Australia (AUD) are up right at 1% versus the U.S. dollar, and the worst performers of the week are the British pound (GBP) and South African rand (ZAR) which are down just over 1% versus the dollar. We will end the week with some pretty important data in the United States as we will see personal income, personal spending, the PCE Deflator and U. of Michigan Confidence.

But before we review the upcoming numbers, lets look at what was reported yesterday. The final revision for third quarter GDP brought us no additional adjustments so the strong 4.9% growth remains. Personal consumption also came in as expected, rising 2.8%. The weekly jobs data and GDP Price Index both came in slightly higher than expected, which were seen as inflationary. But these numbers were offset by the leading indicators number, which came in well below expectations.

The Conference Board’s leading indicator measure dropped 0.4%, slightly more than expected, to the lowest level in more than two years. So while third quarter growth was surprisingly strong in the United States, the fourth quarter numbers look to come in substantially weaker. The leading index is down at an annual pace of 2.3% over the last six months, short of the app. 4% drop that the Conference Board economists say signals recession.

The National Retail Federation in Washington has forecast the smallest gain in holiday sales since 2002, so don’t look for Christmas spending to bail us out. The softening job market combined with declining home values and rising fuel costs may contribute to a slackening in spending during the holidays. Consumer spending, which has been the backbone of the U.S. economy for several years, is going to slow considerably from the third quarter.

We will get a better picture of consumer spending today, as the personal spending report for November will be released. Spending is expected to have increased 0.7% following a 0.2% increase in October. The problem with this report is that personal income is expected to have risen just 0.5% during the same period, so consumers continue to spend at a faster pace than they are earning. Consumer debt continues to increase, and personal bankruptcies are also increasing at a record pace. Is anyone else worried about this trend?

The figures released today will also show inflation pressures are increasing, as the PCE Core number is expected to show a 2% increase YOY. Last week’s report of a bigger than forecast jump in November CPI reignited concern that inflation may pick up. That would give the Fed less room to cut rates to try and stimulate growth. “Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation,” policy makers said in a statement after their December 11 meeting.

The Fed continues to pump money into the economy to try and encourage banks to lend to each other. Direct loans by the Fed to banks climbed to the highest since September 2001. Loans at the discount window rose $1.6 billion to a daily average of $4.6 billion. This was in addition to the ‘special auction’, which the Fed announced last week. The Fed received $61.5 billion in bids at this auction yesterday, more than three times the amount in loans it had available. Winning bids were awarded at 4.65%, below the Fed’s recently cut discount rate of 4.75%. The Fed also announced it would hold another auction today, selling $20 billion in 35-day credit.

While these actions seem to be holding off the credit crisis, we will be paying for these injections next year in the form of higher inflation. On average, liquidity increases take six to eight months to filter through to the inflation figures. So we haven’t even fully seen the impact of the Feds first rate cuts. Look for inflation to spike up in mid 2008, just when most economists are predicting a bottoming of economic growth in the United States.

So we have a combination of slower growth and rising inflation. STAGFLATION

The best performing currency versus the U.S. dollar this week? It was the New Zealand dollar which rose the most in a month after a government report showed that the economy grew faster than forecast, reducing speculation the central bank will lower the nation’s record high interest rates. GDP in New Zealand climbed 0.5% last quarter, beating a median estimate of 0.4% by economists. Reserve Bank of NZD Governor Alan Bollard has raised the official cash rate four times this year to squash consumer demand, which he says is fanning inflation. He left the rate on hold at his last two reviews, saying inflation still remains at the top of the bank’s preferred 1% to 3% band.

The Aussie dollar also gained versus the U.S. dollar, as investors moved back into the commodity based currencies. The Brazilian real (BRL) and Canadian dollar (CAD) round out the top four performers this week. China’s economy is predicted to remain strong in 2008, so demand for raw materials will continue. These commodity-based currencies are off their all time highs but should continue to recover.

The Chinese renminbi (CNY) rose for a second week, touching the highest since the dollar peg was ended in July 2005. The currency benefited from speculation the central bank will seek a stronger currency to curb inflation after raising interest rates to a nine-year high. The currency is set for a 6% gain this year, almost double last year’s. The central bank today said it would boost the flexibility of the renminbi and let the market play a bigger role in setting the exchange rate. China’s central bank needs to use a combination of higher rates and a stronger currency to help slow consumer prices which rose 6.9% last month. The government named economic overheating and inflation as the key risks for 2008, and announced it would shift to a ‘tighter’ monetary policy next year. I look for a continued steady increase in the value of the renminbi, but no dramatic ‘one time’ revaluations.

Currencies today: A$ .8641, kiwi .7653, C$ 1.002, euro 1.4375, sterling 1.9877, Swiss .8656, ISK 63.79, rand 7.0093, krone 5.5923, SEK 6.5646, forint 176.57, zloty 2.5149, koruna 18.39, yen 113.37, baht 30.34, sing 1.4671, HKD 7.8011, INR 39.545, China 7.3688, pesos 10.8215, BRL 1.7970, dollar index 77.629, Oil $91.29, Silver $14.285, and Gold… $804.16

That’s it for today… I had a great day yesterday, as I got to attend my children’s Christmas Mass at their school and then our family went downtown and served lunch at a homeless shelter. Seeing these people really made me realize just how blessed I have been. It was a big sports night in St. Louis, as both the Rams and Blues had Thursday night games. The Blues beat one of their archrivals, the Detroit Red Wings, and the Rams… Well there is always next year!! Hope everyone has a Fantastic Friday, and a Wonderful Weekend!

Chris Gaffney
December 21, 2007