Saturday, 29 September 2007

US dollar at record low against euro despite robust consumer spending

The US dollar fell to a record low against the euro yesterday.

That was despite robust US consumer spending in August, as reported by Bloomberg yesterday.

Consumer spending in the U.S. rose more than forecast in August...

The 0.6 percent rise in spending was the biggest in four months and followed a 0.4 percent increase in July...

Incomes increased 0.3 percent in August after 0.5 percent...

Other indicators were generally also relatively robust.

The National Association of Purchasing Management-Chicago's index of business activity rose to 54.2 in September, from 53.8 the previous month. The Reuters/University of Michigan measure of consumer confidence was 83.4 this month, remaining at the lowest level in a year. Construction spending unexpectedly rose in August, led by factories, hotels and offices, another Commerce Department report showed.

Markets apparently focused on a slowing inflation rate.

The report's price gauge tied to spending patterns and excluding food and energy costs, the Fed's preferred measure, increased 0.1 percent in August for a sixth consecutive month. It was up 1.8 percent from August 2006, the smallest gain since February 2004.

Possibly, markets also noted that Fed hawks have been sounding more like doves, according to MarketWatch.

Two members of the inflation-worrying hawkish camp of the Federal Reserve indicated Friday that they were more focused on the downside risks to economic growth from the recent financial market turmoil than inflation.

Dennis Lockhart, the new president of the Atlanta Federal Reserve Bank, said that the balance of risks to the economy had shifted in August and September from higher inflation towards slower real growth...

In a separate speech, William Poole, the president of the St. Louis Federal Reserve bank, said the [Fed] stands ready to cut rates again to keep the economy on a moderate growth track in the face of the financial market turmoil.

But it not exactly clear that the euro zone is headed for tighter monetary policy soon either. From Bloomberg yesterday:

European confidence in the economic outlook dropped to a 16-month low in September and inflation accelerated above the European Central Bank's ceiling as borrowing costs climbed and oil prices reached a record.

An index of sentiment among executives and consumers in the 13 nations that use the euro fell to 107.1 from a revised 109.9 in August, the European Commission in Brussels said today...

Consumer prices this month rose by 2.1 percent, the most in 13 months, up from 1.7 percent in August, according to a provisional reading by Eurostat...

Joining in the global gloom in sentiment is the UK, where GfK NOP's consumer confidence barometer fell to -7 in September from -4 in August.

But things are looking up in Japan. Bloomberg reports:

Japan's industrial output surged at the fastest pace in almost four years and household spending rebounded, signaling the economy may weather a U.S. slowdown.

Production rose 3.4 percent from July to a record, the Ministry of Economy, Trade and Industry said in Tokyo today. Spending by households climbed 1.6 percent from a year earlier, beating forecasts for a 1.2 percent gain...

Spending by households rose even as the jobless rate increased to 3.8 percent in August from a nine-year low of 3.6 percent in July, according to separate data released today...

Meanwhile, consumer prices excluding fresh food fell 0.1 percent in August from a year earlier, a seventh monthly drop, as retailers absorbed higher costs to attract customers.

Tokyo's core prices, an indicator of the nationwide index, fell 0.1 percent in September, the government said today...

Retail sales unexpectedly rose the first time in three months as demand for clothing and autos increased, the Trade Ministry said today. Sales climbed 0.5 percent in August from a year earlier...

Friday, 28 September 2007

US labour market says no recession, housing market says maybe

Yesterday's economic reports show that the labour market in the United States remains relatively healthy. On the other hand, they also show that the housing market is in worse shape than many earlier thought.

The Commerce Department yesterday updated the second quarter report on US gross domestic report and showed that the economy grew 3.8 percent in the quarter, slightly down from the 4 percent previously reported.

With the turmoil in credit markets in August, though, the GDP report has limited relevance for estimating growth in the current and, especially, future quarters. However, August data do have greater significance.

Early this month, the Labor Department had reported that US non-farm payroll employment fell by 4,000 in August. I had written then though that despite the apparently deteriorating employment situation, it was probably too early to say that the US economy was headed for a recession.

As it turned out, another Labor Department report yesterday showed that the US labour market may not be as weak as it had looked earlier this month. Initial claims for unemployment insurance fell last week to a four-month low of 298,000. This pulled the four-week average down to 311,500, which is close to its lowest levels in the current expansion.

If the employment data do not suggest a recession, other data have been somewhat more ominous.

Following the weak existing home sales for August reported earlier this week, the Commerce Department reported yesterday that sales of new single-family homes fell 8.3 percent in August to a 795,000 annual sales pace, its slowest rate in over seven years. As a result, the inventory of unsold homes at the end of August rose to 8.2 months of sales at the current sales rate. The median sales price in August was 7.5 percent lower than a year ago.

Indeed, on a year-on-year basis, new home sales have been down over 20 percent for much of the period since the middle of 2006. The accompanying chart shows that in the past, such prolonged weakness in new home sales has usually been followed by a recession.

And if the housing data so far look bad, it could get worse. The recent turmoil in financial markets is likely to exacerbate the housing weakness by tightening credit conditions in the housing market further. The industry itself for one apparently thinks the situation is unlikely to improve soon.

KB Home, one of the biggest home builders in the US, reported a wider-than-expected loss for the third quarter yesterday and its Chief Executive Officer Jeffrey Mezger said in a statement that housing industry conditions are expected "to continue to worsen through the end of the year and into 2008".

Similarly, Fannie Mae Chief Executive Officer Daniel Mudd said in an interview yesterday that the industry will not hit bottom until the end of next year.

Freddie Mac Chief Executive Officer Richard Syron said yesterday that the US economy faces a 40 to 45 per cent risk of recession because of the housing market downturn.

Amid the housing gloom, though, it is useful to remember that at least the data on unemployment claims in September so far indicate that the US economy as a whole is probably not in recession yet.

Thursday, 27 September 2007

Norges Bank hikes benchmark rate

Not every central bank is waiting for credit markets to completely stabilise before proceeding with further tightening. From Bloomberg yesterday:

Norway's central bank increased its benchmark interest rate for the sixth time this year to contain inflation. It said borrowing costs may rise less than previously forecast as market turmoil threatens to slow economic growth.

Norges Bank raised the deposit rate by a quarter point to 5 percent, as predicted by nine of 21 economists surveyed by Bloomberg. The other 12 had forecast rates would be left on hold.

But even the Norges Bank cannot completely ignore the uncertainty in financial markets.

"The global risk is clearly stronger than we had envisaged a few months ago," central bank Governor Svein Gjedrem told a press conference in Oslo today. Increased corporate borrowing costs worldwide will both delay interest rate increases and reduce the peak, he said.

There is not much chance of a rate hike in the US soon, of course, especially after durable goods orders were reported yesterday to have fallen 4.9 percent in August.

The probability of a rate hike in the UK is also fast diminishing despite a report yesterday showing that the economy grew slightly faster in the first half of 2007 than previously estimated. The findings of a Bank of England survey also released yesterday showed that credit conditions are expected to tighten in the coming months.

Wednesday, 26 September 2007

Japan's trade surplus surges, confidence falls in Germany and the US

It looks like exports is again driving the Japanese economy's growth. From Bloomberg today:

Japan's trade surplus expanded three times more than economists expected in August as shipments of cars and steel jumped and import growth slowed.

Exports rose 14.5 percent and imports gained 5.7 percent, the Finance Ministry said in Tokyo today, helping the surplus more than triple to 743.2 billion yen ($6.5 billion) from a year earlier. The median estimate of 37 economists surveyed by Bloomberg News was for the gap to swell to 235.5 billion yen.

The reports released elsewhere yesterday were not as positive.

The Ifo index of German business confidence fell more than expected in September to 104.2, a 19-month low, from 105.8 in August.

In the US, consumer confidence also fell in September with the Conference Board's index of consumer confidence falling more than forecast to 99.8 from 105.6 in August. In addition, existing home sales dropped 4.3 percent in August and home prices fell 3.9 percent in the 12 months through July according to the S&P/Case-Shiller home-price index.

Tuesday, 25 September 2007

Emerging markets touch new highs

US stock markets may have closed down yesterday but the rate cut by the Fed last week has essentially arrested the correction in global equities for the time being. From FT:

The Dow closed down 0.4 per cent, the S&P 500 lost 0.5 per cent and the technology-heavy Nasdaq Composite index fell 0.1 per cent.

In contrast, the Morgan Stanley Capital International emerging market equity index broke into uncharted territory as it recouped all the losses incurred during the credit squeeze in July and August.

Shares in India, China and Brazil all touched new records.

However, John Hussman thinks that the impact of the Fed action was largely psychological.

If you examine the data you'll find that the total level of “liquidity” that the FOMC deals with is minuscule in relation to a $13.8 trillion economy, and the variation is even smaller. The total reserves of the U.S. banking system are about $40-$45 billion, and are very stable. The Fed simply does not “inject” meaningful amounts of “liquidity” to the banking system.

Indeed, the latest cuts in Fed controlled interest rates were effected without any injection of “liquidity” into the banking system at all. Total borrowings by depository institutions from the Federal Reserve...actually fell last week to $2.421 billion, from $3.158 billion the preceding week...

Outside of the banking system, you'll notice that while Fed-controlled interest rates dropped last week, market-controlled interest rates rose...

The bottom line – the much celebrated move by the Fed last week created no new liquidity, no new reserves, and no new purchasing power. Given all that, it's unlikely that all of this will result in any material improvement in the solvency of the mortgage market.

Saturday, 22 September 2007

Slower growth ahead for euro zone

The euro zone may be slowing faster than many expected. From Bloomberg:

Europe's manufacturing and service industries grew this month at the weakest pace since 2005 after a sudden increase in credit costs hurt banks.

The slowdown may spell the end of almost two years of interest-rate increases by the European Central Bank. Gains in oil prices and the euro's increase to a record already threaten to damp economic growth.

Royal Bank of Scotland Group Plc said today a preliminary estimate of its composite index fell to 54.5 in September from 57.4 in August. The gauge of services which account for about a third of the economy, had its biggest decline since it was compiled in 1998, after the collapse of the U.S. subprime mortgage market...

The manufacturing index declined to 53.2 from 54.3, while the gauge of services dropped to 54 from 58. Both numbers were lower than economists forecast. A reading of manufacturing orders dropped to 52.4 from 54.8 and the services' measure of new business also declined. A level above 50 indicates growth.

Yesterday, though, investors did not show too much concern about a slowdown. Again from Bloomberg:

The Dow Jones Stoxx 600 Index added 0.5 percent to 376.77...

The dollar fell to a record low against the euro. European government bonds posted the biggest weekly drop in almost two years. The risk of owning European corporate bonds fell today, according to traders of credit-default swaps.

Friday, 21 September 2007

Economies hold up but not the US dollar

It's still early perhaps but the US economy appears to be holding up relatively well.

The Conference Board's index of leading economic indicators fell 0.6 percent in August but is up 0.5 percent over the past six months.

The employment picture appears to be rebounding from August, initial claims for unemployment benefits falling by 9,000 last week to a seven-week low of 311,000. This was accompanied by a fall in the four-week moving average by 3,500 to 320,750.

And manufacturing in the Philadelphia region improved in September, the Philly Fed index rising to 10.9, up from zero in August.

And it is a similar picture of resilience in the UK, with retail sales and mortgage lending rising strongly in August and firms surveyed by the Confederation of British Industry remaining confident about output growth prospects in September.

Meanwhile, confidence in Japan also seems to be recovering, the government reporting that its index of business confidence among large Japanese companies rebounded to 6.2 in the three months to September from minus 0.9 percent in the previous quarter.

Confidence in the US dollar, however, has dropped in the wake of the rate cut on Tuesday. FT reports:

The dollar slumped further on Thursday, oil hit a record high and gold reached a 27-year peak, while stock markets showed signs of strain just two days after the Federal Reserve’s surprise half-point rate cut waned...

On currency markets, the beleaguered dollar breached $1.40 against the euro to hit a record low, taking its losses to more than 1 per cent since the Fed’s move on Tuesday. It also fell to parity versus the Canadian dollar for the first time since 1976 and lost 1.5 per cent against the yen.

Thursday, 20 September 2007

BoJ holds rates

The Bank of Japan left interest rates unchanged yesterday but the next move is still likely to be up. Bloomberg reports:

Bank of Japan Governor Toshihiko Fukui reiterated the need to raise interest rates in the world's second-largest economy after policy makers kept the benchmark rate at 0.5 percent today.

The bank acknowledges the risk of keeping rates low for too long, Fukui told reporters in Tokyo. He cited the yen carry trade, where investors borrow the currency to buy higher-yielding assets overseas, as an example of how resources can be misallocated as a result of cheap credit.

"Given that Japan's economy is stably growing at a rate of about 2 percent, the current level of interest rates is very low," Fukui said. "There's no change in our stance that adjusting interest rates is a major policy issue."

Fukui and his colleagues voted 8-1 to leave the key overnight lending rate unchanged, after the economy shrank last quarter and the U.S. Federal Reserve cut borrowing costs to avert a recession. Fukui said policy board member Atsushi Mizuno proposed a rate increase.

Japan's index of leading economic indicators for July, which was revised up to 72.7 from the initial estimate of 70.0, certainly suggests that the economy is likely to shake off its second quarter contraction soon.

The US economy, though, is likely to remain dragged down by housing for a while more after housing starts and permits both fell to 12-year lows in August. The consolation is that inflation continues to moderate, with overall consumer prices falling 0.1 percent in August and the core rate rising 0.2 percent.

Wednesday, 19 September 2007

Fed cuts 50 basis points

So the Fed went for the jugular yesterday, cutting both the federal funds rate and the discount rate by 50 basis points.

Yesterday's economic reports made the extent of the cuts a bit easier to justify. From Bloomberg:

Prices paid to U.S. producers fell more than forecast in August...

The 1.4 percent decrease, the biggest since October, followed a 0.6 percent increase in July, the Labor Department said today in Washington. So-called core prices, which exclude fuel and food costs, rose 0.2 percent after a 0.1 percent gain the month before...

A private survey by RealtyTrac Inc. showed the number of Americans who may lose their homes to foreclosure more than doubled in August from a year earlier as subprime borrowers with adjustable-rate mortgages saw their monthly payments rise.

Confidence among homebuilders tied a record low in September as increased lending restrictions and higher borrowing costs concerned buyers, a report from the National Association of Home Builders/Wells Fargo said. The index of builder sentiment dropped to 20, matching the January 1991 reading as the weakest ever, the Washington-based association said today.

Investors took the rate decision well, sending stock markets soaring, the S&P 500 closing the day up 2.9 percent.

Investors in the UK, already rocked by Northern Rock, can perhaps also start dreaming of a rate cut after the latest UK inflation numbers. From FT:

Inflation fell last month to its lowest level in more than a year, official data showed on Tuesday, giving the Bank of England more leeway to focus on the turmoil in the financial sector.

August’s annual consumer price inflation rate dipped to 1.8 per cent, below the Bank’s 2 per cent target for a second consecutive month, after falling sharply to 1.9 per cent in July. Economists had expected inflation to remain at 1.9 per cent.

Meanwhile, in Germany, investor confidence declined as the ZEW index fell from minus 6.9 in August to minus 18.1 points in September.

Tuesday, 18 September 2007

China's slowing imports could hurt other Asian economies

Bloomberg reports that Europe's trade deficit with China jumped 22 percent to a record in the first half of 2007 on a surge in imports. However, Andy Mukherjee thinks that it is a slowdown in China's own imports that may pose a problem.

Much of the analysis of China's bloated trade surplus focuses on exports, when it's the imports that deserve greater scrutiny.

In the first eight months of this year, China's exports grew 28 percent. That's less than the annual export growth of 35 percent recorded in both 2003 and 2004.

More importantly, the 20 percent increase in imports so far this year pales in comparison with the 36 percent expansion in 2004 and the 40 percent surge in 2003...

Chinese imports have decoupled from exports since 2005 because assembly lines in the country are increasingly purchasing intermediate parts from local suppliers, according to Li Cui, an economist at the International Monetary Fund.

The substitution of imports with locally produced components has important implications for the rest of Asia, which has become more and more reliant on Chinese factories to tap final demand in the U.S., Europe and Japan...

"As China begins to specialize in more parts of the production chain, its imports of intermediate goods from the region could start to fall," the IMF's Li says...

In the first eight months of this year, Singapore's non-oil exports to China grew 1 percent, slowing from 13 percent in the same period in 2006 and 27 percent for all of 2005.

A problem could arise if the region's economies remain coupled to a US slowdown but become decoupled from Chinese growth.

Having said that, Singapore's trade data cited in the article also show that its exports to China appear to be on a rebound, jumping 11 percent from a year ago in August, so we should be careful about extrapolating the trend.

Meanwhile, Asia's biggest economy continues to have difficulty generating domestic demand. From Bloomberg:

Demand for services in Japan fell in July as typhoons and declining wages kept shoppers away from stores and amusement parks.

The tertiary index, a gauge of money households and businesses spend on services ranging from phone calls to leisure, slipped 0.5 percent from June, the Trade Ministry said today in Tokyo, matching the median estimate of 27 economists surveyed by Bloomberg News.

Monday, 17 September 2007

ADB raises Asian growth forecast

Will developing Asia be able to decouple from a US slowdown? The Asian Development Bank thinks so and, in fact, has just raised its growth forecast for the region. Bloomberg reports:

Asia's developing economies will expand faster than earlier estimated in 2007 and 2008, and are well placed to weather any U.S. slowdown and turmoil in global credit markets, the Asian Development Bank said.

Growth in Asia excluding Japan and Australia is predicted to be 8.3 percent this year, beating a March estimate of 7.6 percent, the Manila-based lender said in a report released in Singapore today. The region will expand 8.2 percent in 2008, faster than an earlier forecast of 7.7 percent, according to the ADB...

The ADB raised its 2007 forecast for economic growth in China to 11.2 percent from 10 percent estimated six months ago. It increased its prediction for expansion in India to 8.5 percent from 8 percent estimated in March.

A US recession, however, is another matter.

Still, the region will not be immune to a U.S. recession...

A recession in the world's largest economy would reduce the Asian region's growth rate by as much as 2 percentage points, the ADB said.

I would think that growth of over 6 percent isn't too bad either, under such circumstances.

Most investors in Asia, however, weren't celebrating the news today. From Bloomberg:

Asian stocks dropped for the first time in five days after the U.S. Justice Department began investigating makers of flash-memory chips and falling crude prices drove down oil producers.

Saturday, 15 September 2007

US shows slowing growth now, may see accelerating inflation in future; China hikes rates

Recent US economic growth doesn't appear to be too strong, according to this Reuters report:

Retail sales rose a slim 0.3 percent last month, the Commerce Department said. When motor vehicles and parts were stripped out, retail sales fell 0.4 percent, the sharpest drop since September 2006.

The Fed said industrial production rose 0.2 percent, propped up by a surge in utility output that managed to offset drops at factories and mines.

Another government report showed that U.S. import prices fell unexpectedly in August by 0.3 percent, the first decline since the start of the year as petroleum costs also retreated.

Excluding a 1.3 percent drop in imported petroleum prices, import prices declined 0.1 percent last month, the Labor Department said...

The Reuters/University of Michigan Surveys of Consumers said its preliminary September figure on consumer sentiment was 83.8, slightly above a median forecast of 83.4 and the final August reading of 83.4.

A separate Commerce Department report showed the U.S. current account deficit narrowed in the second quarter to $190.8 billion, roughly in line with expectations, from an upwardly revised gap of $197.1 billion in the first quarter.

But the problem in the longer term, says Alan Greenspan, is inflation, according to this Bloomberg report:

The Federal Reserve may have to double its benchmark interest rate to at least 10 percent by 2030 to stem inflation, sparking a political showdown that could challenge its independence, former Chairman Alan Greenspan said.

Slowing productivity and rising wages abroad will probably cause U.S. inflation to accelerate in the next quarter century, Greenspan wrote in his book, "The Age of Turbulence: Adventures in a New World," published by Penguin Press. His outlook includes a reversal of many of the trends that aided the success of his own tenure at the Fed...

To keep inflation under 2 percent, "the Fed, given my scenario, would have to constrain monetary expansion so drastically that it could temporarily drive up interest rates into the double-digit range not seen since the days of Paul Volcker," Greenspan wrote.

A 10-percent interest rate and a 2-percent inflation rate suggests that Greenspan sees an 8 percent real interest rate. Probably not exactly, but it does give you a feel of the scenario he seems to be painting.

I guess this is what happens when the focus is almost exclusively on stabilising consumer price inflation.

A major reason that Greenspan sees accelerating inflation in the US is rising inflation in China.

"The rate of flow of workers to competitive labor markets will eventually slow, and as a result, disinflationary pressures should start to lift," Greenspan wrote. "China's wage growth should mount, as should its rate of inflation. The first signs are likely to be a rise of export prices, best measured by the prices of Chinese goods imported into the United States."

Costs of China's products are already rising in U.S. Labor Department statistics on import prices, he noted.

From the BLS report on import and export prices released yesterday:

Import prices from China rose 0.3 percent in August, the fourth consecutive month that the index has risen by at least that magnitude. Prior to May, the index had not risen by more than 0.2 percent since publication began in December 2003. Prices of imports from China increased 1.1 percent for the year ended in August.

And the inflation picture in China itself does indeed appear to be worsening, sparking yet another interest rate hike yesterday. From Bloomberg:

China raised interest rates for the fifth time since March to curb the fastest inflation since 1996 and damp speculation in stocks and real estate.

The benchmark one-year lending rate will increase to a nine-year high of 7.29 percent from 7.02 percent, starting tomorrow, the central bank said today on its Web site. The rate has risen from 6.12 percent on March 17...

Money supply grew 18.1 percent in August, exceeding the central bank's annual target of 16 percent for the seventh straight month. Urban fixed-asset investment climbed 26.7 percent in the first eight months of this year.

Friday, 14 September 2007

ECB sees inflation risks, central banks in Switzerland and Chile hike rates

The ECB may not be done with monetary tightening. From Bloomberg:

The European Central Bank said it will act in a timely manner to keep "upside" inflation risks at bay, suggesting the bank may raise interest rates once volatility subsides on financial markets.

"The medium-term outlook for price stability remains subject to upside risks," the Frankfurt-based ECB said in its monthly bulletin published today. "By acting in a firm and timely manner, the governing council will ensure that risks to price stability over the medium term do not materialize."

Other central banks are not waiting.

Not Switzerland's.

The Swiss central bank raised its benchmark interest rate for the eighth time since late 2005 to head off inflation even as rising credit costs threaten to weigh on economic growth.

The Swiss National Bank's governing board, led by Jean- Pierre Roth, increased the 3-month Libor target rate by a quarter-point today to 2.75 percent, the highest since September 2001...

Nor Chile's.

Chile's central bank raised its overnight lending rate for the third time since July at its monthly meeting, seeking to tame inflation driven by food prices.

Policy makers lifted the benchmark rate today by a quarter percentage point to 5.75 percent, matching the expectations of 24 out of 25 economists surveyed by Bloomberg. Rising costs for wheat and dairy helped push Chilean consumer prices up 4.7 percent in August from a year earlier.

But Turkey's central bank went in the opposite direction. Bloomberg reports

Turkey's central bank unexpectedly lowered its benchmark interest rate by a quarter point, the first cut for more than a year, on expectations a global economic slowdown will help ease pressure on inflation.

The Ankara-based bank reduced its overnight borrowing rate to 17.25 percent, according to an e-mailed statement today...

But then, Turkey is an unusual case with a real interest rate of about 10 percent.

For other central banks, an easing in the commercial paper market slump might just be the catalyst for more rate hikes. This Bloomberg report suggests there is a chance that such an easing may be coming:

The decline in the U.S. commercial paper market slowed last week, prompting speculation that the worst of the short-term credit rout may be over.

U.S. stocks rose and Treasuries fell after the Federal Reserve reported short-term debt dropped by $8.2 billion, compared with a decline of $54.1 billion a week earlier. That coincided with Countrywide Financial Corp. obtaining new financing and banks finding buyers for loans to fund Kohlberg Kravis Roberts & Co.'s buyout of Alliance Boots.

Thursday, 13 September 2007

RBNZ keeps interest rate unchanged

The Reserve Bank of New Zealand has become the latest central bank to decide to wait out the on-going turmoil in credit markets. AFP/CNA reports:

Reserve Bank of New Zealand Governor Alan Bollard said the official cash rate would remain at 8.25 per cent, one of the highest rates in the developed world.

"Credit concerns and heightened risk aversion have led to significant turbulence in global financial markets," Bollard said.

"This development increases the likelihood of a weaker economic outlook for the United States and New Zealand’s other key trading partners than in recent forecasts."

Meanwhile, in a BusinessWeek article, Michael Englund, chief economist for Action Economics, says that "there are no signs of widespread ill effects" from the turbulence in credit markets thus far, with yields generally remaining "low" and spreads "arguably in line with historic levels". These and other benign observations have been reflected in recent commentary by Fed officials.

In total, the mix of Fed commentary thus far, in the context of the available data on the evolution of the credit crunch, almost uniformly suggests that the Fed is less prone to entertain a more aggressive policy trajectory than some market participants assume...

Nevertheless, the FOMC will be pilloried if it doesn't act. We expect a quarter point easing at the Sept. 18 meeting, followed by a similar move in October.

I doubt that Fed officials would be too bothered if the pillory comes only from investors. But criticism from recession-intolerant politicians and economists would be another matter.

Wednesday, 12 September 2007

China's inflation, trade surplus jump, US trade deficit narrows

It looks like more tightening is in store for China after inflation hit a 10-year high last month, and a rising trade surplus is not helping. Bloomberg reports:

Consumer prices rose 6.5 percent in August from a year earlier after gaining 5.6 percent in July, the statistics bureau said today. The trade gap widened 33 percent to $24.97 billion, the second-highest monthly total.

Food costs drove the increase in inflation, jumping 18.2 percent after a shortage of pigs pushed up meat and poultry prices.

Exports rose 22.7 percent in August from a year earlier and imports gained 20.1 percent...

But even as China's trade surplus continues to climb, the US trade deficit appears to be stabilising, thanks largely to buoyant exports. MarketWatch reports:

The value of U.S. exports of goods and services to the rest of the world increased 2.7% in July, the fastest seasonally adjusted growth in more than three years, the Commerce Department reported Tuesday.

With imports growing 1.8%, the deficit between imports and exports narrowed by 0.3% to $59.2 billion in July, close to the market's expectations, from an upwardly revised $59.4 billion in June.

Both exports and imports reached record levels in July, reflecting strong global demand and higher prices. U.S. producers exported record values of capital goods, consumer goods, autos and foods, while U.S. consumers imported record values of foods and feeds.

Understandable then that Federal Reserve chairman Ben Bernanke thinks that there has been progress in reducing global trade imbalances but he thinks further progress is unlikely without significant increases in US saving and greater spending by oil exporters and China. The latter, though, could result in the decline in the global saving glut and potentially cause real interest rates to rise. I think his final words make good advice, especially in the wake of the turmoil in financial markets.

Accordingly, we are again reminded of the need to maintain appropriate humility in forecasting returns and asset prices.

The full speech by Bernanke is here.

Tuesday, 11 September 2007

Japanese economy contracts in second quarter

Japan released a disappointing second quarter economic report yesterday. Bloomberg reports:

Japan's economy contracted at almost twice the pace forecast by analysts in the second quarter, reinforcing speculation the central bank will leave interest rates unchanged this year.

The economy shrank at a 1.2 percent annual rate in the three months ended June 30 as business spending slumped, the Cabinet Office said in Tokyo today. The government initially forecast a 0.5 percent expansion...

Japan's economy contracted 0.3 percent from the previous quarter...

But perhaps that's just payback for the strong first quarter.

Even after the contraction, Japan's economy expanded at a 2.5 percent annual pace in the first two quarters, the government said, higher than the economy's potential growth rate of 2 percent.

The economic difficulty may be lingering in the third quarter, according to another Bloomberg report yesterday.

Sentiment among Japan's barbers, shopkeepers and other merchants on the front lines of the economy dropped to a four-year low in August as consumer spending slowed and financial markets slumped.

The Economy Watchers index, a gauge of domestic demand, fell to 44.1 points, the fifth straight decline, from 44.7 in July, the Cabinet Office said today in Tokyo...

On the other hand, other data have been more positive, for example on bank lending yesterday.

Growth in Japanese bank lending accelerated for the first time in eight months in August as property-related financing expanded.

Loans excluding trusts rose 0.5 percent from a year earlier, the Bank of Japan said in Tokyo today, quickening from a 0.3 percent gain in July. Lending adjusted for currency fluctuations, bad loan write-offs and securitizations increased 1.3 percent compared with a revised 1.2 percent in July.

But perhaps more importantly, Bloomberg reports today that the second quarter setback in investment spending may be short-lived.

Japan's machinery orders surged at three times the pace forecast by economists in July, easing concern the economy is ailing after last quarter's contraction.

Orders surged a seasonally adjusted 17 percent to 1.12 trillion yen ($9.9 billion) from June, the Cabinet Office said in Tokyo today. The median estimate of 38 economists surveyed by Bloomberg News was for a 5 percent rebound from June's 10.4 percent slump.

Monday, 10 September 2007

Fed rate cut looks imminent, recession probably not yet

The United States economy lost jobs in August. This makes it likely that the Federal Reserve will cut interest rates in September.

On 7 September, the US Labor Department reported that non-farm payroll employment fell by 4,000 in August. This was the first decline since August 2003. In addition, the number of jobs gained in June and July were revised lower by a cumulative 81,000.

The weak employment report sparked fears of a recession and caused stock markets and bond yields to plunge. On the day of the report, the Standard & Poor's 500 Index fell 1.69 percent to 1,453.55. The 10-year US Treasury yield fell 15 basis points to 4.37 percent and federal funds futures show traders fully pricing in a rate cut by the Federal Reserve in September.

The picture of a deteriorating employment situation is supported by other reports to varying degrees. The household survey data released by the Labor Department on the same day showed a loss of 316,000 jobs in August. A report from ADP earlier last week showed that private employers added just 38,000 jobs in August. Other data from the Labor Department showed that initial claims for unemployment insurance were higher in August compared to July, having risen to a weekly average of 325,750 for the four weeks ending 1 September from an average of 306,000 for the four weeks to 28 July.

Despite the market reaction, however, it is probably too early to say that the US economy is headed for a recession. One month's payroll number, especially one that is very likely to be revised subsequently, is seldom very significant. Furthermore, even with the decline in August, employment remained higher than in the second quarter, suggesting that the US economy probably still continued to expand in the third quarter. And the reported 19,000 fall to 318,000 in initial claims for unemployment insurance for the week ending 1 September provides some hope that the situation may have stabilised recently.

If the US economy is not already in recession, then leading economic indicators show that it is not likely to fall into one very soon, although growth is likely to slow. The Conference Board's US leading index increased by 0.4 percent in July and by 0.1 percent in the six-month span through July. The Organisation for Economic Co-operation and Development's (OECD) composite leading indicator (CLI) for the US was unchanged in July while its six-month rate of change decreased.

The surveys of purchasing and supply executives by the Institute for Supply Management (ISM) also tell similar stories. The ISM's PMI for the manufacturing sector fell to 52.9 in August from 53.8 in July, indicating continued but slower growth in the sector. The ISM's index of business activity in the non-manufacturing sector was unchanged at 55.8 in August.

The high-frequency Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) was also up in the week ended 31 August but the annualised rate of growth declined to 0.6 percent, the lowest growth rate since November 2006, from 1.3 percent in the prior week. Lakshman Achuthan, managing director at ECRI, had this to say: "With WLI growth at a 43-week low economic growth prospects have clearly dimmed, but not yet in a recessionary way."

So the indicators show that the US economy is very probably not facing imminent recession. However, there has also clearly been some loss of momentum in economic growth even though the economy has probably not felt the full impact of the recent tightening in credit markets, which could bode ill for the economy further out in time.

Therefore, the market expectation for a cut in the federal funds rate this month looks realistic. What remains uncertain is how far the Federal Reserve needs to cut to avoid or, if already unavoidable, to roll back a recession.

Saturday, 8 September 2007

Markets fall with US nonfarm payrolls

Stock markets in the US and Europe plunged yesterday.

Perhaps the interest rate hike by Sweden's central bank had something to do with it? From Bloomberg:

Sweden's Riksbank raised its benchmark interest rate to a four-year high to contain inflation, adding that the financial market turmoil will prevent it from picking up the pace of rate increases.

The central bank increased the repurchase rate by a quarter point to 3.75 percent, the ninth increase since January 2006, the Stockholm-based bank said today in a statement. It kept a June forecast that the key rate would reach about 4 percent by year-end and 4.5 percent in two years.

More likely, though, investors just didn't like yesterday's US employment report for August. MarketWatch reports those details:

Nonfarm payrolls fell by an estimated 4,000 in August, the Labor Department said. This is the first decline since August 2003.

The nation's unemployment rate held steady at 4.6%...

Adding to the sense of weakness in employment, payrolls in June and July were revised lower by a cumulative 81,000. Read the full report.

Friday, 7 September 2007

ECB and BoE hold rates, tightening continues elsewhere

As expected, both the European Central Bank and the Bank of England left interest rates unchanged yesterday, citing financial market volatility as a factor.

One central bank that apparently sees no need to stop tightening is the People's Bank of China. Yesterday, it announced that the required deposit reserve ratio would rise by 0.50 percentage points to 12.5 per cent on September 25.

Interest rates are also rising in South America. Peru's central bank yesterday raised its overnight reference rate by a quarter percentage point to 5 percent, the highest level since at least July 2001. Overnight interbank rates in Venezuela rose yesterday, closing at 30 percent after the central bank said it would halt some of its lending operations to financial institutions.

In the meantime, there is still little direct evidence that the US economy is in serious difficulty. The ISM's non-manufacturing index remained at 55.8 in August, unchanged from July. In addition, Reuters reports that initial claims for state unemployment benefits fell last week while retail sales held up well in August although foreclosures on homes rose in the second quarter.

And the economy might continue to do well if the corporate bond market continues to hold up, as it appears to be doing so far despite the seizure in the commercial paper market.

Thursday, 6 September 2007

Brazil cuts, Fed next?

While investors wait for the Fed to cut interest rates, Brazil's central bank has been cutting for some time and continued that trend yesterday, lowering its benchmark lending rate to 11.25 percent from 11.5 percent.

Elsewhere, central banks continue to watch and wait for the effects of the financial market volatility to appear, with Canada and Australia keeping rates unchanged yesterday.

The let-up in monetary tightening may be appropriate, if the OECD is correct. The OECD thinks global economic prospects have become less buoyant, trimming its 2007 growth forecast for the US to 1.9 percent from a May figure of 2.1 percent. Jean-Philippe Cotis, the OECD's chief economist, said that there is "a case" for a quarter-point interest-rate cut at the Fed's meeting this month, but a rate increase by the ECB may be "warranted" after markets steady.

Yesterday's US economic data seem to support the view of weaker US growth. From Reuters:

Pending sales of existing U.S. homes plunged by a record 12.2 percent in July, and private employers hired the fewest workers in more than four years in August, according to reports released on Wednesday that point to a weakening U.S. economy.

Planned lay-offs at U.S. companies surged by 85 percent in August due to turmoil in the subprime mortgage market, another report said.

However, the Fed's Beige Book released yesterday reports that financial market turbulence has hurt housing activity but has had little effect on other sectors of the economy so far.

And elsewhere in the world, activity in the services sector appears to be holding up well, the purchasing managers index slipping slightly for the euro zone to 58.0 in August from 58.3 in July but rising for the UK to 57.6 in August from 57.0 in July.

Wednesday, 5 September 2007

Markets rally on Fed cut hopes

US and European stocks did well yesterday. US data were somewhat mixed though.

Manufacturing in the US cooled slightly, the ISM manufacturing index falling to 52.9 in August from 53.8 in July, while auto sales held up better than expected in August.

On the other hand, construction spending fell 0.4 percent in July, worse than economists expected.

But markets are mostly focused on a rate cut by the Fed. From MarketWatch:

Investors will pore over the economic data in the coming week, looking for reasons the Federal Reserve should or shouldn't cut interest rates. But the data will probably be irrelevant to the decision.

It's likely that the Fed will make its move, whatever it is, regardless of how strong hiring was in August, or how exuberant manufacturing purchasing managers were about their order books.

It's likely that the Fed will cut rates on Sept. 18, economists say.

However, Macro Man thinks that "easing rates would be a mistake for the Fed" as he has "yet to see evidence that [credit rationing] is occuring".

He may be right, but I think that there is tremendous pressure on the Fed to cut rates nevertheless simply because there is very little tolerance among politicians and economists for a recession. This may be changing slowly as more and more people realise the excesses such an attitude tends to generate. But a decisive change in mindset is more likely after a market crash or a severe recession, not now.

A central bank that is not willing to raise interest rates when consumer price inflation -- the lower of two measures of inflation -- exceeds 2 percent does not suggest a mindset change. A central bank that raises interest rates when inflation is at zero does.

Tuesday, 4 September 2007

Manufacturing growth holds up

So far, the global financial turmoil seems to have left manufacturing activity relatively unscathed in much of the world.

Bloomberg reports that manufacturing growth in the euro zone weakened slightly:

European manufacturing grew at the slowest pace in 19 months in August as credit-market turmoil, a stronger euro and higher oil prices started to weigh on the economy.

Royal Bank of Scotland Group Plc said its manufacturing index fell to 54.3 from 54.9 in July, the lowest since January 2006. That compares with an initial estimate of 54.2 published Aug. 24. The index is based on a survey of purchasing managers by NTC Economics Ltd. and a reading above 50 indicates expansion.

But manufacturing growth quickened in the UK:

U.K. manufacturing growth unexpectedly quickened to a three-year high last month, a sign the Bank of England's five interest rate increases in a year have yet to cool economic expansion.

An index based on a survey of more than 600 manufacturers rose to 56.3, from a revised 55.9 in July, the Chartered Institute of Purchasing and Supply and Royal Bank of Scotland Group Plc said today. Economists predicted 55, according to the median of 34 estimates in a Bloomberg News survey.

And in China:

China's manufacturing activity accelerated in August as companies increased production and new orders rose, according to a survey by Hong Kong-based CLSA Asia Pacific Markets.

The Purchasing Managers' Index climbed to 53.4 from 53.2 in July, CLSA said today in an e-mailed statement...

A government PMI survey, released by the China Federation of Logistics and Purchasing and the National Bureau of Statistics on Sept. 1, also showed a higher reading. The index rose to 54 in August from 53.3 in July.

Monday, 3 September 2007

Japanese and US economies face downturn

"Normalisation" of interest rates in Japan appear to be moving further and further away.

Following a report last week that Japan's manufacturing PMI edged up to 49.6 in August but remained below 50 for the second month in a row, we have another report today that indicates that the Japanese economy could be in a bit of trouble. From FT:

Japanese companies have cut capital spending for the first time in four years, threatening to push the country’s economic growth into negative territory for the first time in 10 quarters.

Capex, one of the strong points of Japan’s rather patchy economic recovery in recent years, sank 4.9 per cent from a year earlier in the second quarter, according to official figures published on Monday.

That will make it extremely difficult for the Bank of Japan to raise its benchmark interest rate – currently 0.5 per cent - at its next meeting September 19.

The poor capex figures, caused by a sharp fall in spending in the predominantly domestically focused non-manufacturing sector, were accompanied by poor numbers on employees’ earnings, including the biggest drop in total cash payments in more than three years.

Meanwhile, the pessimistic outlook on the US economy wasn't dispelled at Jackson Hole despite the Fed chairman's speech on Friday, if this Bloomberg story is anything to go by:

"I came to Jackson Hole thinking there would be no recession, but I'm leaving thinking we could well have one,'' said Susan Wachter, a professor at the University of Pennsylvania's Wharton School, who co-wrote the first academic paper presented at the conference.

This year's theme...was housing and monetary policy, eliciting forecasts of sliding home prices and criticism the Fed should have done more. Martin Feldstein of Harvard University warned of a "very serious downturn" and called on policy makers to cut interest rates by 1 percentage point...

"There are no optimists in the crowd here," said Ethan Harris, chief U.S. economist at Lehman Brothers Holdings Inc. in New York and a former head of domestic research at the New York Fed. "There's a pretty strong consensus that this has gotten a lot more serious."

There was also criticism of the Fed.

... Edward Leamer, the head of an economic forecasting group at the University of California at Los Angeles...wrote in one of the conference papers that the Fed merited an 'F' for failing to prevent the housing bubble and then not reducing rates as it burst.

How could the Fed have avoided the bubble and its bursting? John Taylor has a suggestion, reported by Reuters:

"A higher federal funds path would have avoided much of the housing boom," said John Taylor, former U.S. undersecretary for international affairs, drawing on a model he designed to simulate housing activity if the Fed had raised rates instead of aggressively easing borrowing costs.

"The analysis also suggests that the reversal of the boom and thereby the resulting market turmoil would not have been as sharp," he said.

At the moment, though, lower global interest rates look like what we are about to get as the Fed contemplates rate cuts and the BoJ and ECB delay rate hikes.

Update: There is more on Leamer's paper at Calculated Risk while James Hamilton at Econbrowser provides some details of Taylor's analysis.

Saturday, 1 September 2007

Strong economic data for July, weaker for August

Market focus yesterday was largely on the speech by Federal Reserve chairman Ben Bernanke and President George W. Bush's announcement of proposals to help subprime borrowers, but the data on the US economy were actually quite good, at least for the month of July. Reuters reports:

A core inflation index from the Commerce Department rose 0.1 percent in July, holding the year-on-year increase in the Federal Reserve's favorite inflation gauge to 1.9 percent for the second straight month.

Analysts polled by Reuters were expecting the core PCE price index, which excludes often-volatile food and fuel costs, to gain 0.2 percent. The June rise was revised to 0.2 percent, from an originally reported 0.1 percent...

The Commerce Department said personal income rose a bigger-than-expected 0.5 percent in July, the largest month-on-month gain since a 0.8 percent rise in March.

Personal spending rose 0.4 percent in July after an upwardly adjusted 0.2 percent increase for June. Analysts polled by Reuters were expecting both personal income and personal spending to rise 0.3 percent...

New orders at U.S. factories jumped by a much bigger-than-expected 3.7 percent in July and a strong 2.4 percent without the volatile transportation component, the Commerce Department said.

Analysts polled by Reuters expected orders to rise 0.8 percent in July after an upwardly revised 1.0 percent gain in June, originally reported as a 0.6 percent rise.

July non-defense capital goods orders excluding aircraft, viewed as a good proxy for business spending, rose 1.7 percent, slightly less than the 2.2 percent July gain reported on August 24, the Commerce Department said.

There were some negatives though in the August data.

On a more worrisome note, a Reuters/University of Michigan survey of consumer sentiment index fell to the lowest level in 12 months as households grew uncertain about economic prospects due to high food and fuel prices and recent financial market turmoil.

Another gauge of future U.S. economic growth fell to a 27-week low in the most recent week due to higher jobless claims, lower commodity prices and softer housing activity, according to The Economic Cycle Research Institute, an independent analysis firm.

Confidence also fell in the euro zone in August while inflation remained contained in July. Bloomberg reports:

An index of sentiment among executives and consumers in the 13 nations that use the euro fell to 110 from 111 in July, the European Commission in Brussels said today. That compares with the 110.3 median forecast of 25 economists in a Bloomberg News survey and is the lowest since February. Inflation held at 1.8 percent in August, according to a separate report...

Consumers nonetheless expect inflation to pick up in coming months, according to today's data. A gauge of price expectations over the next 12 months increased to 26 this month from 19 in July, the commission said.

Rising employment may support consumer spending and economic growth, adding to price pressures. The euro-area jobless rate held at a record-low 6.9 percent in July, according to a separate report today.