The Week in Review October 15 - October 19
United States
The descent of the US housing market accelerated this week, postponing any serious hope for recovery well into 2008. All three major housing market indicators recorded worse than expected results, but the news had little direct effect on the Dollar. There has been so much bad news from this sector that almost anything short of a complete cessation of all sales is already factored into the market. The dollar took its biggest single hit on Thursday from Weekly Jobless Claims a volatile and relatively minor statistic. The reaction to this number evidenced the extreme fragility of the Dollar to anything that indicates weakness in the US economy particularly in job creation.
Projections for 3rd quarter corporate profits for American heavy equipment manufacturer Caterpillar, among others on Friday slammed the major US equities averages and returned what had been a mildly recovering Dollar to the defensive. The equities have been one of bright spots in a wary economic picture.
The sub prime and credit crunch which began two months ago took its toll of foreign investment in August with the net long term capital flows registering their first decline since 1995. This is the second month in a row that capital funding has been less than the amount needed to offset the US trade deficit.
The Fed Beige Book prepared for the Oct 30-31 meeting of the FOMC showed continued expansion in all districts, but it cited decelerating growth since August. Consumer spending rose but reports varied from district to district. Real estate continued to weaken. All in all this book reflects the trend we have been seeing in this anecdotal survey for many months, with slowly accumulating pressure on economic growth and heightened uncertainty among responders about the economic outlook. GDP in the 4th quarter appears that it will be considerably weaker than in the third.
Eurozone
Economic growth in the EMU is slowing but for an ECB very uneasy about inflation it is not enough to make them break inflation cover and reduce interest rates. If the economic picture continued unchanged then logic and their own statements would put them on hold until the end of the year. If however, the Fed cuts American rates at the end of the month and the Euro then reaches 1.4500 and higher, the game changes. It will be hard for the European central bank governors to deflect the outcry from politicians and the media. And, more importantly, their own economic projections will point to the same dangers currently so evident from Washington. The ECB governors may not quite realize it but their next rate decision will probably be determined on Halloween in Washington.
United Kingdom
Retails sales for September were six times the expected rate and will certainly give the Monetary Policy Committee (MPC) pause when it contemplates its next rate decision on November 8th. But recent inflation numbers may lean the MPC in the opposite direction. Headline CPI was 1.8% in September, better than expected. And, most impressively, core CPI was only +1.5% year on year, much lower than the +1.8% prediction and a large improvement from the +1.8% rate in August and the +2.0% in June. MPC had voted 8-1 for unchanged rates at beginning of the month. The majority on the committee is shy of cutting for two reasons: lower rates could ward off the economic slowdown predicted in their August report and that the MPC expects to keep a lid on inflation; secondly, they did not want to appear to be overly supportive of the financial markets in its recent troubles. Preliminary GDP for the third quarter, +0.8% and +3.3% annualized was the highest quarterly figure in three years and is perhaps another militating factor against a rate cut. If the main argument for reducing rates is the potential for economic slowdown from housing and lingering financial markets effects then the accuracy of that view is undermined by the recent retail sales that were the driving force behind 3rd quarter growth. Given the distribution of votes on the Monetary Policy Committee, the recent economic results and the relative calm in the credit markets rate cuts might not be granted for some time. Much will depend on the world reaction to the US equity fall on Friday.
China:
With the end of the 17th Communist Party Congress market expectations are for further Peoples Bank of China rate increases. Food inflation is a serious concern for the Beijing Government. The average Chinese family spends almost 40% of its budget on food and the potential for political unrest in the poorer provinces is never far from the government's mind. The end of the twice a decade Beijing political chautauqua frees policy makers from distraction and they will return their focus to the rampant growth and speculation that are their main concerns.
At the Party Congress President Hu Jintao said that the Chinese economy continues to strengthen and pledged to make economic growth more balanced instead of relying on investment and exports. For investment read Foreign Direct Investment, for exports read replace exports with domestic consumption. China's biggest development problem is the income disparity between the booming wealthy coastal cities and the rest of the country. The party's biggest problem is that poverty, corruption and economic envy in the hinterland is a potentially explosive political situation. If the government is to encourage domestic consumption and investment then it must find a way to spread growth and wealth to the interior of the country.
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