Unemployment and Consumer Debt: The 800 lb Gorilla in the Room
When I left you Tuesday morning, the currencies were hanging on, but as Chuck explained yesterday, we saw a considerable sell-off in response to the rate increase from China as the day wore on. The euro (EUR) had briefly dipped into the 1.36 handle and the dollar index rallied the most in two months. It looks as though this was just a knee-jerk reaction as we opened yesterday morning with the euro in the mid 1.38 handle and rose all the way up to 1.3991. It was as if Tuesday was gone with the wind, like it never happened.
I can hear you asking yourself, “What’s the deal?”… Why did the currencies snap right back into place like a rubber band? Well that tug of war I was talking about between the two quantitative easing camps pulled back the other way and traders became focused on the Fed’s Beige Book. There was another economic firm that came out and said the magnitude of QE will be more than what is currently expected so that sent the dollar bulls back into time out, at least for now.
We also had the Chicago Fed President say that the central bank will need to buy securities on a large scale several times in order to give the economy a needed kick-start and fuel inflation. The only problem here is that slow growth and rising inflation isn’t exactly a good combo, so traders sold the dollar on that concern. As Chuck has mentioned several times, it’s a classic case of buy the rumor and sell the fact, so look for this type of volatility until the Fed finally includes the rest of us in on their master plan.
While their wasn’t much in the data closet today, the results of last week’s mortgage apps and the Fed’s Beige Book weren’t what you would call “dollar positive” either. We saw mortgage applications, which is a very volatile figure to begin with, fall 10.5% last week and represented the largest drop in more than four months. This figure is obviously sensitive to the interest rate environment, so as the 10-year has ticked up a bit from where its been, mortgage rates have followed suit.
The 800 lb gorilla remains on the back of real estate as high unemployment and consumer debt levels in addition to tight credit standards make it difficult just to refinance and, not to mention, that many homeowners remain underwater. If you throw in the whole foreclosure mess, it’s just not a pretty sight.
The Beige Book really didn’t tell us anything that we didn’t already know and there weren’t any surprises, be it good or bad. The report just said the economy expanded at a moderate pace in September and into the first week of October with not much in the way of improvement on the horizon. It’s definitely not something that would deter additional QE or create an environment that would cause us to think the Fed would minimize their scope of implementation.
The report said on balance, national economic activity continued to rise, albeit, at a modest pace and consumer spending was flat. We just have to go back and look at past retail sales reports to see this. Again, it’s a bit higher but nothing to write home about. Retailers said consumers are slowly regaining confidence, but remain price conscious and were largely limiting purchases to necessities and nondiscretionary items.
I agree with the Fed there. If you don’t have a job or if you’re worried about losing your job, it’s not very likely or wise to go out and spend money on stuff you don’t need or something that you would just like to have. They also said the housing market was still sluggish or even declining in many regions but there were scattered reports of some improvement. The report went on the say the outlook suggested sales and construction would remain subdued through year-end. So as I said before, not surprised here, but it was slightly more upbeat than the last report.
It’s Thursday, so we have the weekly jobless and continuing claims due out first thing this morning followed by the leading indicators gauge and Philly Fed index. Initial claims are expected to improve a bit but still remain above 450K while continuing claims are forecast to tick up somewhat. While employers have already cut staff to near bare bones levels and remaining content with current staffing levels, we just haven’t seen much deviation from that 450K level on initial claims.
With companies still turning profits and functioning efficiently on short staff, it’s going to take sustained economic growth before we see much in the way of improvement. The September leading indicators are expected to match the last printing in August of 0.3%. This index is a gauge of the economic prospects over the next 3 to 6 months and with employment remaining a problem and manufacturing subdued, I really don’t see much in the way of improvement.
The last piece of data to come out will be the Philly Fed Index, which measures manufacturing in the Philadelphia area. We saw it fall 0.7% in September on less rebuilding of inventory but it’s expected to increase 2% in October. These local manufacturing reports can be fairly volatile, so we’ll see if there really was an improvement.
Moving to currencies, it was a good day for all of the majors. The two currencies heard yelling “winner, winner, chicken dinner” yesterday were the Norwegian krone (NOK) and the Swedish krona (SEK), with the Brazilian real (BRL) bringing up the rear. The euro – which we call the Big Dog, and accounts for a majority of the dollar index – came in 4th place by rising over 1.5% and was the catapult for those Nordic currencies.
Since both currencies have a much smaller trading volume, the euro pretty much determines if they rise or fall on a given day but deviate depending on market conditions. The wind behind Sweden’s sails are thoughts of a possible rate hike next week from the Riksbank, while Norway was pushed up by higher oil prices. Another driving factor was higher risk appetite, since they are thinly traded, so the subsiding fears of slowing global growth from the Chinese rate hike gave them the added push to outperform the euro.
Looking at the opposite end of the currency returns on the day, the Brazilian real was able to muster a modest 0.25% gain. It looks as though the new tax assessment – and thoughts of additional such measures, possibly affecting the stock market next – has the hot money investors thinking twice. These types of traders typically have a short-term memory and future rate hikes could help alleviate a lot of that concern.
We had a mid-month inflation report yesterday that showed October inflation doubled from September and rose 5.03% year-over-year. Brazil has attracted a net $34.6 billion into their bond and stock markets through August, which is more than double the total for 2009, so many economists have upped their year-end inflation outlook to an average 5.20%. While a stronger currency helps offset some inflation, the central bank doesn’t exactly want all of this money flowing in unchecked, hence the intervention measures and taxes.
As Chuck mentioned yesterday, the Australian dollar (AUD) shot right back to nearly the 0.99 handle as it gained back just about everything it lost on Tuesday by rising just under 2% on the day. Since the Australian economy is so closely tied to China these days, the Chinese rate hike really had a profound impact, as would any other economic reports or policy changes. We also had Aussie leading indicators released yesterday, which showed a slight decline month on month, but still remains high as it’s up over 5% compared to last August.
And just to expand briefly on what Chuck said about Canada, the BOC did keep rates on hold and they said the withdrawal of monetary stimulus would be gradual. They did cut growth expectations this year down to 3% from 3.5% and reduced the 2011 forecast to 2.3% from the previous figure of 2.9%. With inflation not presenting any imminent problems, growth expectations cut, and a general uncertainty of how the US economy progresses, they certainly have time to sit on the sidelines and take it all in.
Moving over to Switzerland, the SNB was in the news again as they lowered inflation expectations through 2013. While the franc (CHF) has appreciated against the dollar, it has actually depreciated against the euro over the past month. The SNB gets all flustered when the franc rises disproportionately to the euro and is typically what policy makers refer to when they say it’s too expensive. It seems as though Swiss policymakers have taken a page out of Brazil’s playbook by thinking of alternate ways to curb the appeal of the currency instead of just flat out intervening in the market.
The SNB last month cut its 3-year inflation outlook by the most in history as they lowered the 2011 projection to 0.3% from 1% and the 2012 estimate to 1.2% from 2.2%. These downward revisions have many economists and institutions pushing thoughts of a rate hike out even further as, according to the SNB, inflation will remain below the 2% target well into 2013. I guess we’ll see if this type of creative intervention, if you will, actually works and catches on.
Staying with Europe, we had German Chancellor Angela Merkel say at a gathering that the German economy is doing better than expected and may expand more than 3% this year. She also said governments need to work on an exit strategy from the stimulus and that Europe and the US are giving differing answers as to the timing of such an exit. In fact, she said there are good reasons to take up the exit strategy now in Europe.
I certainly like that type of charisma, but it will probably be a while until we actually see something like that happen. Going off on a tangent, I saw someone calling for the euro trading at 1.50 within the next 3 to 6 months. That seems rather aggressive, but if traders don’t like what they see with the Fed’s QE, who knows.
As I turned the screens on this morning, the currencies are pretty much in the same range as where I left them last night. The euro has managed to trade back up into 1.40 and the pound sterling (GBP) has lost about half a cent so far this morning. Other than that, not much movement overnight.
To recap… The currencies rallied on talk of a more aggressive QE campaign than anticipated so look for this type of back and forth trading until the plan is laid out in front of us. The Fed Beige Book told us everything we already know. The Nordic currencies gained on higher risk appetite, higher rates, and a higher euro. Switzerland tries another approach in an attempt to lure investors away from the franc…