Market Directions Sunday, October 14, 2007

• Credit markets amnesia, will the Central Banks put away their knives?
• The Europeans learn to love a strong Euro?
• The G7 meets and meets and meets?

The Week in Review October 8 - October 12

Two weeks of inconclusive movements have left traders looking outside the market for new impetus. If the Federal Reserve now appears much less likely to cut rates at its next meeting October 31, so to does the ECB when it convenes on November 8th. If the EMU economies seem to be defying the third and fourth quarter slowdown anticipated by many just four weeks ago, so the American consumer has hardly paused working and spending. The surmise that the US economy has more to fear from the sub-prime and credit markets has carried the Euro to historic levels against the Dollar, but is it still justified? Is the Euro really leading the way?

Because ECB and BOE rate cut expectations, predicated almost solely on the financial market turmoil which began in August, have diminished as well as that of the Fed, the Dollar has been left no better off. Officials of all three central banks have been at pains to remind the markets of the still extant inflation threat and their own determination to rein it in.

The G7 meeting this coming Friday in Washington will not produce an agreement to support the Dollar. As if to underline this American President George Bush said in a interview with the Wall Street Journal published Friday that a strong dollar policy is the "correct policy", and that the "best way [to value] a currency is through the market".

The basic assumption driving the Euro has been the risk evaluation that the Fed preventive rate cut was substantive, that the US economy courted recession in the coming months and the Fed would be forced to cut again. But so far the evidence has not proved the case. If anything it has pointed the other way with US job growth and consumer spending remaining strong. US GDP expansion could well be above 3.0% in the third and fourth quarters with European growth falling to 2.5% or less. Even in the 2nd quarter the differential between the US and EMU economies was 1.3% in favor of the Americans.

The decisive move of the past two weeks has been the resurgence of the Euro/Yen and the Yen crosses. These currencies thrive in a stable rate environment. If a retreating US economy promised further Fed rates decreases, market judgment would also assign a higher probability to a future ECB reduction. If the ECB was going to cut rates, even if only for precautionary reasons, where would that leave the Euro/Yen? Currency markets are predicting that the August credit market panic is history, that it will not foster a worldwide economic slowdown and that the US economy will emerge largely unscathed. Otherwise the risk averse Yen crosses would not be within a hair of their all time high. The Yen crosses are the bell weather of today's currency markets, not the Euro or even the Dollar.

Central Bank Rate Actions
Bank of Japan leaves the overnight call rate at 0.5%.
Reserve Bank of Australia keeps the cash rate at 6.5%.

The Week in Review October 8 -October 12

United States

The September 18th FOMC vote to cut the Fed Funds rate was unanimous. The minutes cited two reasons for this "prudent action". First was the concern for the impaired functioning of the financial markets, and second was the potential for reduced economic growth from that impact. Perhaps a bit surprisingly the FOMC members disregarded the August Non Farm Payroll numbers of -4,000. They assumed that "employment was probably not as weak as the most recent monthly data had suggested". The committee was right on target as the upward revision of the August number revealed a week ago.

Also from the FOMC minutes was the prescription for rate policy, "future actions would depend on how economic prospects were affected by market developments and other factors". The major economic statistics from this past week do not indicate a serious slowdown in the US economy. Weekly Jobless Claims have continued to decline. Retail Sales were much better than expected and PPI, particularly core PPI without the automobile price reductions, was very active. Clearly there are building price pressures in the consumer goods pipeline.

There are less than three weeks until the next Fed policy committee. This coming week we will see Industrial Production, core CPI and the 'Beige Book'. None of these are likely to convince the Fed that another rate cut is necessary to float the US economy. The 'moderate expansion' term of the last 'Beige Book' is more indicative of an economy poised for increased growth than one slipping. The US economy has been under stress and a cloud of worry since the third quarter of last year. It is important to remember this background when one charts future prospects. All is not as dire as the economic projections tell. Projections are by their nature linear, people and the economy are not. The statistics will tell the story; it behooves traders to listen to exactly what they are saying. Or, to paraphrase John Maynard Keynes, 'If the facts haven't change, why change your mind?"

Despite the greatly reduced expectations for a Fed Funds rate cut at the October 31st Fed meeting the Dollar Index is only 0.5% above its all time September 28th low.

Eurozone

ECB officials deployed their public comments this week promoting the dangers of EMU inflation and the bank's steadfast role in countering it. The commotion among the united currency's finance ministers early in the week when they met, ostensibly to consider the 'strong Euro' came to naught. The ministers could not even agree among themselves that the current Euro level was a problem. Except for France and Italy, none of the other finance ministers appeared to think it was.

Industrial Production recovered nicely in August and the second reading of GDP for the second quarter at 2.5% is one that the ECB can live with, wary as it may be of its effect on inflation. ECB economists consider that GDP rate near the limit for non inflationary growth.

Despite the curious comment from Jean Claude Trichet on Tuesday's that 'the headline M3 number may overstate [its] actual strength', in testimony before the EU parliament, the bank left no doubt that it still considerers inflation the primary threat. "We need further gathering of data but the baseline scenario [good economic growth and potential inflation] is very much confirmed at the present moment", said Mr.Trichet.

Germany

German Finance minister Peer Steinbrueck would rather have a strong Euro than a weak one. "I love a strong Euro", is his now famous formula. And as a finance minister who wouldn't adore a strong currency. It restrains domestic inflation, reduces government financing costs, draws private investment and promotes business efficiency. Hank Paulson, the American Treasury Secretary, and his predecessors have long said the same thing.

United Kingdom

British officials, like their continental counterparts, returned the focus to inflation. There were no hints in the Pre Budget Report of the Bank of England Governor Mervyn King that a rate cut is being considered. As a prescription for financial panic he said that the Monetary Policy Committee (MPC) will not "insulate" the banking sector from the re-pricing of risk. It is not likely he would have made such a comment if he thought there was real chance of returning credit market turmoil.

Chancellor of the Exchequer Alastair Darling reduced the government estimate for 2008 GDP growth forecast to 2.0%, specifically "because of the problems...coming out of America this summer are now affecting economies across the world..." But like King, he was careful not to infer monetary policy from his observation.

The Business and Financial Services sector is the largest industry in Britain, comprising one quarter of the economy and responsible for almost all private sector job growth. Though it has not yet showed in the statistics the financial market events of the past three months must necessarily have negative effects.

Japan

Economic Releases October 8 -October 12

United States

Thursday: the International Trade Balance sank in August to -$57.5 billion almost 2.5% under the median projection of -$59.8 billion; July's deficit was trimmed slightly to -$59.0 from -$59.2 billion. The Euro rose 30 points against the dollar on the release. Imports fell 0.4%, the most in six months; exports rose the identical amount. The 2.4% decline from July to August in the overall deficit came despite a 7.0% hike in the cost of oil imports, the biggest increase in five months. The trade balance is currently benefiting both side of the equation, with a slower US economy importing less and a weak dollar prompting foreign buying from American producers.

Weekly Jobless Claims for the week ending October 6th fell 12,000 to 308,000 substantially more than the expectation of -2,000 and 315,000. The four week moving average slipped to 310,250 continuing the downward trend begun a month ago.

Import Prices jumped 1.0% in September as predicted with a 5.4% rise in petroleum accounting for the entire increase. Non petroleum prices fell 0.2.

Friday: Retail Sales in September at +0.6% doubled estimates, the markets had been looking for +0.3%; August was unrevised at +0.3% but July added 0.1% to +0.6%. Sales ex auto was also better than forecast, +0.4% as opposed to +0.3%; August was unchanged at -0.4%. The Dollar gained 25 points against the Euro on the release but stalled and then reversed at 1.4150.

Most consumption estimates for the third quarter are now north of +3.5%, which should put GDP for the quarter near 3.25%, a very respectable number in the post sub prime world. Analysis of the details of the Retail Sales report varied with the beholder. Some commentators found the overall reading, twice the market expectation, indicative of an unworried consumer and robust spending heading into the holiday season. Others focused on the fact that price inflation in the two strongest selling categories, gasoline and food, accounted for almost all their increase.

The Produce Price Index (PPI) for September jumped 1.1% more than twice the predicted +0.4%. The PPI core (ex food and energy) rose only 0.1%, half the preliminary estimate. Automobile prices are included the PPI core measure and were the reason the core increase was moderate. Car prices fell 1.8% in September and light truck charges dropped 0.5%. Without this drag the core would have risen a much more inflationary 0.3%. Other categories displaying large increases were pharmaceuticals +0.5%, home furniture +0.5% and alcohol +0.6%, this last particularly worrisome heading into the holiday season.

Consumer Sentiment in October, according to the University of Michigan preliminary reading, deflated to 82.0, below the forecast of 84.0 and the lowest result since August 2006, when it was also 82.0.

Eurozone

Thursday: second quarter GDP was unrevised on its second issue at +0.3% for the quarter and +2.5% for the elapsed year. The yearly result for the first quarter was revised up 0.1% to +3.2%; the quarterly figure was unchanged at +0.7%.

Friday: Industrial Production expanded 1.2% in August, much more vigorously than the expected +0.3%. July was adjusted higher by 0.1% to +0.7%. The yearly rate was 4.3% in August; the prediction had been +2.1%; the July rate was +3.7%. EMU planners can now look for Industrial Production to add substantially to GDP growth in the third quarter; it had slowed in the second.

Germany

Monday: Total Manufacturing Orders for August at +1.2% were well under the expectation of +2.0%, but as July was revised up by almost the same amount that August was under, to -6.1% from -7.1%, the effect was moot. The seasonally adjusted Trade Balance for August was +E15.3 billion, less than the +E16.4 billion median projection. Imports rose 5.6%, exports gained 3.0%. In July both had fallen, 2.8% for imports and 0.3% for exports. The overall July number was adjusted to +E16.5 billion from +16.4.

Tuesday: Industrial Production rose 1.7% in August, more than three times the forecast of +0.5%. The growth was led by manufacture of consumer durable goods. July's result gained slightly on revision, to +0.2% from +0.1%.

Wednesday: the German Chamber of Industry and Trade (DIHK) Balance of Business Expectations fell in September to 15 from 24 in August. This trade group polls 25,000 companies each month and calculates this indicator by subtracting the number of those firms whose business expectations to be poor from those firms who judge expectations to be good. "The economic euphoria is over", said DIHK. The trade group also cut its GDP forecast for 2007 to +2.5%, it had been +2.8%.

Thursday: Wholesales prices as recorded by the Federal Statistical Office (FSO) rose 0.9% in September, the highest monthly increase since April of last year. The annual rate was 4.0%; in August the yearly rate was 2.5%.

United Kingdom

Monday: Manufacturing Output in August reached its highest level in six years gaining 0.4% for the month and +0.6% year to year. July's results were -0.3% and +0.8% respectively. Industrial Production rose 0.1% in August, +0.7% on the year; the July statistics were -0.1% monthly and +0.9% yearly. Output Producer Prices jumped 0.1% in September, a +2.7% yearly rate. In August these prices rose 0.1% and 2.5%. Core Output Prices gained 0.2% m/m and 2.2% y/y in September. Input prices rose a dramatic 3.2% in September more than twice the forecast of +1.5%. The yearly rate was +6.4%, also well in advance of the prediction for +4.5%. In August the same 'input' statistics were -0.5% m/m and +0.6% y/y. Soaring crude oil prices were the greatest contributing factor in the input price rise.

Wednesday: British Retail Consortium (BRC) Retail Sales in September were twice as strong as forecast, +3.0% versus +1.5%.; August had registered +1.8%. British consumers seem to be unaffected by the Northern Rock bank rescue by the BOE early in the month.

Thursday: Royal Institute of Chartered Surveyors (RICS) House Price Survey which measures the difference between gainers and losers in house prices exhibited -14.6 in September, nearly three times the -5.0 forecast. The August reading was revised down to -3.3 from -1.8. House buyer inquiries were at the lowest level since 2003.

China

Friday: the Trade balance in September fell 4.3% to +$23.9 from Augusts' +$24.9 billion. Nevertheless, the balance for the first nine months of 2007 was +$185.66 billion an astonishing 69% higher than the same period in 2006.

The Week Ahead October 15 -October 19

United States

Tuesday: Treasury International Capital System (TICS) net long term securities transactions for August at 9:00 ET; July +$19.2 billion. Industrial production for September at 9:15 ET; August +0.2%. Capacity Utilization for September at 9:15 ET; expected 82.2%, August 82.2%. NAHB Housing Market Index for October at 13:00 ET; September 20.

Wednesday: CPI for September at 8:30 ET; August -0.1%, core +0.2%. Housing Starts for September at 8:30 ET; August 1.331 million units. Building Permits for September at 8:30 ET; August 1.322 million units. Federal Reserve Beige Book, September "moderate expansion' in 10 of 12 Federal Reserve districts.

Thursday: Jobless Claims for week ending October 13; prior week -12,000 to 308,000.

Eurozone

Tuesday: ZEW Survey for October at 9:00 GMT; 'Expectations' -20.3 in August, 'Current Conditions' 65.6.

Thursday: Preliminary Trade Balance for August at 9:00 GMT; seasonally adjusted -E0.6 billion, non seasonally adjusted +E4.6 billion in July. Final HICP for September at 9:00 GMT; preliminary +0.1% m/m, +1.7% y/y. Construction Production for August at 9:00 GMT; August 0.0% m/m, +1.7% y/y.

Germany

Tuesday: Final CPI for September at 6:00 GMT; preliminary -0.1% m/m, +1.9% y/y. Final HICP for September at 6:00 GMT; preliminary -0.1% m/m, +2.0% y/y. ZEW Survey for October at 9:00 GMT; September 'Economic Expectations' -18.1, 'Current Conditions' 74.4.

Friday: PPI for September at 6:00 GMT; September 0.1% m/m, +1.0% y/y.

United Kingdom

Sunday: Rightmove House Prices for October at 23:01 GMT; September -2.6% m/m, +9.6% y/y.

Monday: DCLG House Price Index for August at 8:30 GMT; July +12.4% y/y.

Tuesday: Core CPI for September at 8:30 GMT; August +1.8% y/y. HICP for September at 8:30 GMT; August +0.4% m/m, +1.8% y/y.

Wednesday: ILO Unemployment Rate for August at 8:30 GMT; July 5.4%. Average Earning including bonus for August at 8:30 GMT; July +3.5% y/y. BOE minutes for the October 3&4 Monetary Policy Committee meeting.

Thursday: Retail Sales for September at 8:30 GMT; August +0.6% m/m, +4.9% y/y.

Friday: Third quarter GDP, first estimate, at 8:30 GMT; second quarter +0.8% q/q, +3.1% y/y.

Japan

Monday: Consumer Confidence for September at 5:00 GMT; August 44.0. Industrial Output for August at 4:30 GMT; July -0.4%.

Wednesday: Tertiary Index for August at 8:50 GMT; July -0.5%. Revised Leading Index for August at 5:00 GMT; July 72.7, 'Coincident Index' 70.0.

China

No important releases

Market Directions Sunday, October 7, 2007

• The stoics-the Bank of England and the European Central Bank
• Job growth returns to the US, but not optimism to the Dollar
• The ECB wants a strong dollar but not a strong Euro?

The Week in Review October 1 - October 5

It was status quo in the central bank market this week. All three banks with decisions kept their fingers off rate button as the Bank of England, the European Central Bank and the Reserve Bank of Australia left their base rates unchanged. Only the American Federal Reserve has felt the need to chop rates in this post sub-prime world.

In the immediate aftermath of the recent credit problems the currency markets have placed the onus squarely on the Usd. The States were the source of the original problem and the most likely sufferer from its aftereffects. The Fed September rate cut and the admission it represented for the immediate health of the American economy drove the Usd down and down. The skein did not completely play out until this past Monday when the Euro reached its lifetime high at 1.4280.

The fears that financial markets would freeze up in credit scarcity brought on by defaults in the sub prime housing and asset backed sectors have subsided. And while another large bank or mortgage company failure would make headlines it is unlikely it would incite the worldwide panic of early August. One of the chief fears in August was the unknown extent of the problem. How much questionable debt was held and how much would come due for refinancing in the following weeks. The period until the end of October was seen as crucial. We are now more than two thirds through that period and the credit markets have returned to normal functioning, if not to entirely normal spreads. The Europeans and the British central bankers, while acknowledging the severity of the credit liquidity situation, have demonstrated their resolve. They judge that their economies do not require preventative medicine. The remaining question is the health of the US economy; it weighs heavily on the dollar.

The situation is similar to that of last December. From October to December the then relatively new housing market collapse was expected to crack the wider US economy and produce a severe slowdown if not recession. The dollar sank against the Euro through the last quarter of the year in anticipation of the economic result. However, the US economy did not falter and the statistics improved throughout December. In January the Dollar gained almost 3.4% against the Euro. The case here is not to predict a Dollar recovery but to underline the fact that the market assumption is not yet proven. The speculative urge that is driving down the Usd is produced by anticipation of events not the events themselves. It may prove to be correct and the American economy may slip to neutral or recession. But the two figure fall in the Euro on Thursday reminds traders of the potential fragility of that assumption.

The difference between the economic views of the ECB and the Fed as expressed in their actions and policy are driving the dollar lower. Both are based on projections of current economic trends that are not yet fully substantiated.

United States

The US economy has not rolled over; it is still growing and creating jobs, the basic value for a consumer economy. But most economic numbers are sliding. Both ISM numbers, manufacturing and services, and factory orders were below forecast. The slowing trends that are evident in most US statistics originated before the credit crisis surfaced. However, there does not seem to be a generalized depiction of weakness, moderating growth is still the order of the day. With the Christmas and Holiday season approaching and the credit crisis behind a return to more buoyant spending is always possible. The main forward looking statistics, the purchasing managers indices and the consumer sentiment numbers were no doubt swayed by the emotional effects of the credit market crisis.

The Fed and Chairman Bernanke should be pleased with the NFP report. Job growth was not unduly affected by the credit liquidity crisis and recession fears are reduced as a consequence. Moderate but not dramatic job growth can support consumer spending without aggravating inflation. And while the three month moving average has been falling steadily all year, from +190,000 in January to +97,300 in the latest month this may help spur productivity and forestall rising labor cost pressures. Average Hourly Earning gained in Sptember and with PCE Core Inflation at only +1.4% there is room for an increase in retail spending.

Eurozone

The ECB program for rate policy is clear and well expressed in the statement accompanying the rate decision. The reference to an "accommodative' rate policy was eliminated and replaced by "upside risks...to price stability". The wording may be different but it is hard to see how the rate stance has changed. Economic "fundamentals...support a favorable outlook for economic activity...on balance risks to the outlook for growth are judged to lie on the downside...[but] these downside risks relate mainly to the potential for a broader impact from the ongoing reappraisal of risk in financial markets..". In brief, except for the financial and credit market problems, the EMU economies are expanding at or above trend, producing a serious future potential for inflation that remains the bank's central concern. By implication, if the credit problems disappear then the bank will have no reason to be other than vigilant against inflation and the governing council will raise rates when and if it deems necessary.

Earlier in the week Jean Claude Trichet, ECB President speaking in Valetta Malta, reminded his audience that the US Treasury and Federal Reserve Bank have historically supported a strong dollar. His point was not to lecture the dignitaries that a strong Euro is good for the EMU economies and that the Europeans should stop complaining, but to remind the US officials of their traditional stance.

On Tuesday French Finance Minister Christine Lagarde had suggested that US Treasury Secretary Henry Paulson should say "loud and clear that a strong dollar is good for the US economy". If a strong Dollar is good for the US economy why wouldn't a strong Euro be good for the EMU economies? Would not all the advantages that a strong currency confers on the US also accrue to the EMU? Are the laws of economics different in the Old world than the New?

Or as one commentator, Barbara Rockefeller of Rockfeller Treasury services put it, as quoted by Market News International, "the chance of ECB or G7 intervention is nearly zero, especially if it depends on the US participation". The Fed does not appear to be worried about the Dollar and the Treasury is unlikely to be either with exports up over 12%. While the US say "a strong dollar [is in its] best interest", it does nothing to support such a policy. "The real policy is let the markets decide". As for the Euro, the European have long said that they wanted a currency that could compete with the dollar's reserve status, "now let them live with it". No major industrial country predicates its economic, fiscal or monetary policy on exchange rates. The overriding operational factor is the health of the domestic economy; the Europeans are no different.

Japan

The Tankan Survey for the third quarter from the Bank of Japan held ground with large manufacturing firms reporting sentiment the same as in the second quarter, 23. Since GDP contracted 1.2% in that quarter according to the latest government figures the status quo reading was a small victory, reflecting strong demand from non US customers.

Economic Releases October 1 - October 5

United States

Monday: the Institute for Supply Management Survey of Manufacturing for September recorded a decline for the third month in a row at 52.0. This is consistent with a 2.5% growth in manufacturing. The median prediction had been 52.9, the same as the August reading. "Prices Paid' fell to 59.0 from 63.0, "New Orders' to 53.4 from 55.3. Only the result for 'Employment' increased to 51.7 from 51.3.

Tuesday: the Pending Home Sales Index from the National Association of Realtors (NAR) plunged 6.5% in August to 85.5. It is down 21.5% from the same period last year. Pending sales are those where a price between the seller and buyer has been agreed but the sale has not closed. The decline reflects the increased difficulty in mortgage financing for retail home buyers. The Pending Index acts as a leading indicator for 'existing home sales' and promises further weakness in the largest category of home purchase in the US. It also underlines the still lively potential for wider economic impact from the year long decline in the residential housing market.

Wednesday: the Institute for Supply Management Non-Manufacturing Index (ISM) at 54.8 was slightly better than the 54.5 forecast but below the August reading of 55.8. Though this was a bit less than the 56.6 average for the past it is nevertheless indicative of continued moderated growth into the fourth quarter. The 'Employment' Index staged a recovery to 52.7 from 47.9 in August; 'New Orders' fell to 53.4 from 57.0.

Thursday: Factory Orders for August underperformed expectations at -3.3% against the median forecast of -2.8%. It was the largest monthly drop since January when they fell 5.7%. The Euro climbed 50 points immediately after the release.

Friday: Non Farm Payrolls returned to positive territory in September as excepted adding 110,000 jobs. More interestingly the August deficit of -4,000 was erased with the adjustment to +89,000 for the month, most of the addition being in government payrolls. July's number was adjusted higher to +93,000 from +68,000 for a total revision of 118,000 over the two months. The unemployment rate moved 0.1% higher to 4.7%. The three months moving average has almost halved since the beginning of the year: January 180.7, February 159.3, March 142.3, April 129.0, May 162.3, June 127.0, July 117.3, August 83.7, September 97.3. Average Hourly Earning moved up 0.4% for the month, now 4.1% annually, a gain of 0.2% over July and August and slightly better than the average for the past year.

Eurozone

Monday: The final issue for the September PMI manufacturing number was 52.3 as expected and unchanged from the preliminary issue. It is the third monthly decline since June registered 55.6 and the lowest reading since February of last year.

Tuesday: the Produce Price Index gained 0.1% in August as expected, flattening the yearly rate to 1.7% from 1.8% in July. Energy prices ebbed 2.2% in August helping to lower the overall result but prices have since surged higher in September and were the chief cause for the spike to 2.1% in the preliminary HICP rate as reported last week. The ECB is unlikely to take much ease with this number. Unemployment in the EMU was steady at 6.9% in August, the third month in a row that it has sustained the historic low for this series which began in 1993. German unemployment fell to 6.2% from 6.4%; French to 8.6% from 8.7%. The jobless rate in the US is 4.6% and in Japan it is 3.8%.

Wednesday: Retail Sales rose only 0.1% in August, a quarter of the +0.4% forecast. The annual rate was +0.5% as predicted. The July result was revised to +0.4 from +0.1% monthly, and to +1.3% from +0.5%. The Euro was unmoved by the disappointing monthly number, the July adjustment negating the August result.

Germany

Monday: the NTC/BME Manufacturing Purchasing Managers Index (PMI) dropped to 54.9 in September 1.1 points lower than August.

Wednesday: the NTC PMI Report on Services registered a sharp drop to 53.1 in September from the August reading at 59.8. It was the lowest result in more than a year. NTC Economics is a private British economics date and research firm that produces a wide array of data on the economies of 20 of the worlds largest industrial countries.

United Kingdom

Monday: the CIPS/NTC Manufacturing Purchasing Managers Index (PMI) for September fell slightly to 55.1 from 56.1.

Wednesday: Reuters Services PMI for September eased to 56.7 from 57.6, a tad below the 56.8 median forecast and the weakest result in 13 months. "Employment' fell to 51.8 from 43.7 and "Prices Charged" jumped to 53.7 from 53.1. The British Retail Consortium (BRC) Shop Price Index in September gained 0.2% and was 0.4% ahead of last year's prices. Food prices were the main culprit, up 0.6% in September, and 2.7% annually. It was the largest increase since last December. In August the yearly inflation rate for food prices was only 2.1%. Non-food prices sank 0.1% in September, a +0.7% annual rate. The 'final' RBS/NTC Report on Services PMI added 0.2 to 54.2, a substantial drop from the 58.0 reading in August. Nationwide Consumer Confidence rose to 99 in September a major improvement over the 94 reading in August. However, the current relevance of the September score is questionable because 90% of the data was collected before the BOE rescue of Northern Rock.

Japan

Monday: The BOJ Quarterly Tankan Report presented a mixed picture for the Japanese economy. Business confidence at large manufacturing companies remained at 23, as it was in the second quarter but better than the forecast of 21. All other major categories of business confidence recorded losses: 'small manufacturing firms' were 20 against 22 in quarter two; 'large service firms' were 20 versus 22 in the second quarter and 'small service sector firms' categories were -10 as opposed to -7 in the second quarter. Firms were polled for their opinion between August 28th and September 28th.

The Week Ahead October 8 - October 12

United States

Monday: Columbus Day Holiday US markets closed

Tuesday: FOMC minutes at 2:00 ET for the September 18th meeting when the Fed unexpectedly cut rate 0.5%.

Thursday: International Trade Balance for August at 8:30 ET; July -$59.2 billion

Friday: Retail Sales for September at 8:30 ET; August +0.3%. Retail Sales ex Food and Auto for September at 8:30 ET; August -0.4%. Producer Price Index (PPI) September at 8:30 ET; August -1.4%. PPI for September at 8:30 ET; August +0.2%. University of Michigan Consumer Sentiment for October at 10:00 ET; September 83.4.

Eurozone

Thursday: GDP for the second quarter (second issue) at 9:00 GMT; first quarter +0.7% q/q, +3.1% y/y. EU Commission GDP forecast at 9:00 GMT; Q3 2007 +0.3%-0.8%, Q4 2007 +0.2%-0.8%, Q1 2008 +0.2%-0.8%.

Friday: Industrial Production for August at 9:00 GMT; Jul +0.6% m/m, +3.7% y/y.

Germany

Monday: Total manufacturing Orders for August at 10:00 GMT; expected +2.0% m/m, +4.3% y/y. July -7.1% m/m, +6.1% y/y.

Tuesday: Industrial Output for August at 10:00 GMT; expected +0.5% m/m, +3.9% y/y. July +0.1% m/m, +4.4% y/y. Manufacturing Sector Output for August at 10:00 GMT. July +0.2% m/m, +5.7% y/y.

Thursday: Wholesale Prices for September a 6:00 GMT. August +0.5% m/m, +2.5% y/y.

United Kingdom

Monday: Manufacturing Output for August at 8:30 GMT; July -0.3% m/m, +0.6% y/y. Industrial Production for August at 8:30 GMT; July -0.1% m/m, +0.9% y/y.

Wednesday: RICS House Price Survey for September at 23:01 GMT.

Market Directions Sunday, September 30, 2007

Market Directions Sunday, September 30, 2007

The Week in Review September 24 - September 28

• The US Dollar sinks, is there a lifeline?
• Oil prices remain at historic highs, the world yawns
• The BOJ looks for inflation and finds deflation

The Dollar fell to a series of record lows against the Euro this week as markets remained focused on the Federal Reserve rate cut and worries that the US economy will slip into recession. Unmarked but on the horizon are the next rate decisions of the European Central Bank (ECB) and the Bank of England (BOE). Neither bank will be raising rates this coming Thursday, with the BOE reporting its decision first. But the possibility that one or both central banks might cut rates has been ignored by all. The economic and interest rate situation in the EMU and the United Kingdom is similar to that of the United States, though perhaps less advanced. Ben Bernanke did not drop the Fed Funds rate 0.5% because the American economy was in a tailspin but because the Fed Governors feared what the recent financial and housing market turbulence might exact from the economy in the future. The economic situation is the same on the continent and in England with the added drag that very expensive currencies inflict on a nation's export trade. A reduction in European rates or moderation in the ECB economic risk outlook is wholly unpriced for the currency markets.

Oil prices have also cast a pall over economic growth prospects in the industrial world but the effect is different on either side of the Atlantic. The European Monetary Union (EMU) exports more goods and services to the Middle Eastern oil producers that does the United States. Higher oil revenues in the Gulf States and Iran translate into more purchases by Middle Eastern consumers and governments and higher export earning by the EMU economies. Such exports will help to offset the already evident declines in EMU domestic consumption. The US economy, because it exports proportionally less to the Middle East, will have less income returned as payment for US products and less support for domestic production.

Another factor in the oil price effect in Europe is the ECB definition of inflation. The EMU wide HICP statistic, which the ECB has targeted at 2.0%, includes energy prices. A rise in oil and gasoline prices is a direct contribution to inflation accounting. This effect is somewhat mitigated by the overall value of the currency which lowers the prices of imports and reduces the pricing power of domestic firms. In the US the Fed watches core inflation, without the monthly changes in food and energy prices. A sustained rise in oil prices will still contribute to inflation but in a more diffuse fashion as a basic industrial product rather than a first line consumer price increase.

For both reasons rising oil prices tend to keep greater upward pressure on European interest rates than they do in the United States and to support the Euro more than the Dollar.

United States

A raft of secondary statistics pointed to an American economy more resilient than depicted, despite the ongoing housing collapse. Personal Income, Personal Expenditures, Construction Spending and the Chicago Purchasers Index all met or surpassed forecasts. Only the two consumer confidence numbers, easily the most emitionally laden of the forward looking statistics, were weaker than forecasts. Personal Income and Expenditures seem to belay worries of a pending consumer spending collapse. Despite concerns of falling consumer spending, constrained by the decline in the housing market and worries about pending job losses due to credit market contractions, the American consumer seems to have, at least temporarily, resumed normal spending habits in August. Expenditures rose half again as much as predicted and doubled the rise in personal income. Core PCE Prices further moderated in August and have now been at or within the Fed range of 1-2% for four months. Core PCE Prices peaked at 2.5% in February.

Weekly Jobless claims unexpectedly fell for the second week in a row chopping the four week moving average to 311,500 from 321,000 and easing concerns about job creation. Estimates for this Friday's September Non Farm Payrolls number remain at +115,000. The unemployment rate is predicted to stay at 4.7%.

Eurozone

Last week Jean Claude Trichet, the ECB President, said that the central bank has been successful in "very solidly" anchoring price stability in the EMU. This week, in an interview on Dutch television, he said that the ECB will do what is needed to anchor inflation around 2.0%. Last week inflation was anchored, this week the anchor has slipped. At the risk of a parse too far the significant difference in the two comments is the phrase 'around 2.0%', instead of 'at or below 2.0%'. The ECB has long forecast that inflation would rise above 2.0% despite it year long sojourn below that level. This projection has been the prime rationale for increasing interest rates and in August the flash HICP rate finally climbed to 2.1%. A target of 'around 2.0%' is considerably more expansive than one 'at 2.0%'. Is the ECB introducing the notion of a rate cut despite an inflation rate higher than 2.0%?

Admittedly this is a heavy burden for one small phrase. But central bankers do not free associate during interviews and the interpretative leeway between the two phrases would give the ECB much room to maneuver that it does not now have.

Another question for the ECB is does the 8% money supply target matter anymore? Would the M3 number, by itself, prevent the ECB from cutting rates? The answer is already evident. M3 did not prevent the bankers from halting their series of rate hikes last month; it will make no difference should the governors decide to cut rates.
The EMU economies are showing fatigue. Not dramatic but noticeable. As we noted last week, GDP peaked in the fourth quarter of 2006. Business sentiment and consumer confidence are falling in the EMU as a whole and specifically in its largest economy, Germany. What is to prevent the ECB governors from taking the same much applauded precautionary view as the FOMC? The ECB may now be learning one of the drawbacks of a public target for inflation.

Germany

All German statistics this week indicated a slowing economy, falling consumer spending and decreasing business confidence in the immediate future.

The IFO Survey came in with its lowest reading in more than 18 months, undercutting hopes for a sustained expansion in the EMU's largest economy. Chief Economist of the IFO Survey Gernot Nerb said that domestic demand in Germany was sluggish. At the beginning of almost every European economic expansion government and private officials express hope and sometimes confidence that 'this expansion' will be borne to a greater degree by domestic consumption and so be less susceptible to external factors. The results almost always disappoint.

GfK Consumer confidence fell for the second month in a row. "As was already evident in August the positive consumer mood has been affected…of late… the entire credit crisis in the USA and rising food prices are responsible for the somewhat less than euphoric consumer attitudes", said GfK in a written statement.

Retail Sales in August, as collected by the Federal Statistical Office, fell 1.4%, the worst result since May's 3.2% collapse. As business investment turns uncertain, as shown in the IFO report above, and by last week's ZEW Survey, the German consumer has, once again, been sought as a source of spending and continued growth. Once again it does not seem that the German consumer is willing to oblige.

Japan

Yasuo Fukuda was elected presidents of the Liberal Democratic Party (LDP) by a vote of 330 to 197 over Taro Aso and thereby becomes the next Prime Minister of Japan. Mr. Fukuda is 71 years old, was first elected the Diet in 1990 and has served in various leadership roles in the LDP since 1997. He is considered a moderate on foreign policy. His first task will be to extend a law that permits the Japanese military to assist American naval operations in the Indian Ocean as part of the war in Afghanistan. This was the issue that forced Shinzo Abe to resign. The opposition Democratic Party of Japan (DJP) controls the upper house of the Diet and the blocked passage of the extension legislation. The head of the Democratic Party of Japan, Ichiro Ozawa, has promised to end LDP control of Japanese politics. Except for one brief period in the mid 1990s the LDP has ruled Japan since its formation in 1955.

It is in domestic and economic policy the Mr. Fukuda will face his greatest challenges. Under the stewardship of Shinzo Abe the LDP lost much of the public approval and popularity it had enjoyed with the previous Prime Minister Junichiro Koizumi. If Mr. Fukuda does not improve his and the LDP's standing with the electorate his party could very well lose the next election for the lower house of the Diet. The majority party in the lower house of the Diet elects the Prime Minister. The DJP would like to hold an election for the lower house as soon as possible before Mr. Fukuda can effect any positive change in the LDP's popularity. Mr. Fukuda has said he will not call an election until the spring at the earliest. The LDP simply cannot afford to add a faltering economy to its rooster of problems.

National CPI in August fell for the seventh month in a row keeping deflation fears current. GDP in the second quarter declined 1.2%, surprising everyone, and though Retail Sales rose in August one half of one percent, it was the first gain in three months. . Japanese industry and finance faces serious constraints in the years ahead. Its population is aging and falling, shivering the economic backbone of domestic consumption. Its main competitor across the Sea of Japan will soon be following the Japanese economic model, building high value-added industries, like cars and electronics, that have long been a Japanese specialty. The Korea auto and steel industries have already accomplished this transformation.

China is not only an economic giant; the Beijing government has been busily creating a military that can project power into the seas surrounding the mainland. The Japanese central government will soon have the twin financial burdens of a growing military and a growing pensioner roll. It cannot meet these obligations with a static or falling GDP.

The Bank of Japan is more deferential to the desires of the Tokyo politicians than any other central bank is to its own political establishment. The BOJ has tried hard over the past year to keep inflation and future rate hikes in the political mix. Miyako Suda, BOJ board Member said, the "Japanese economy is growing in line with our forecast…risk[ing]…an inflationary rate rise faster than our forecast". The BOJ wants to keep its field of action as wide as possible. But with falling consumer prices, a 2nd quarter GDP decline, the Fed cutting rates and the Europeans soon perhaps to follow, and an unpopular and tired LDP in charge in Tokyo there will be no rate increase this year. In reality, Japan may be in for a prolonged stay at the 50 basis point mark.

United Kingdom

The Bank of England September policy statement and the minutes of that meeting suggest that the members of the Monetary Policy Committee (MPC) feel more time is needed before they reach a conclusion about the impact of the credit market problems on the real economy and inflation. The subsequent Northern Rock rescue by the BOE, which has ballooned to over eight million pounds, may have concentrated minds on the MPC as to the real economy risks ahead. Andrew Sentence, an external member of the MPC and normally considered a rate hawk, hinted a such a recognition. "Global forces can…inject volatility into the real economy…recent changes in global financial market conditions could weaken demand conditions". This is logic that would play very well on Capitol Hill in Washington. As with the Euro, any change in rate policy by the BOE is not priced into the value of the Sterling.

Economic Releases September 24 – September 28

United States

Tuesday: the Case Shiller Home Price Index for July fell to 215.94, 0.6% lower than June and the steepest decline in 16 years. The index is now 4.5% lower than last year. The Conference Board Consumer Confidence Index sank to 99.8 in September, well below the median forecast of 104.0 and below the August reading of 105.00. Existing Home Sales in August slid to their lowest level in five years at 5.5 million units, a 4.5% monthly drop. It was the second largest fall in over a year; the biggest fall was the 7.93% drop from February to March this year. The market supply of unsold homes at current prices rose to 10.0 months from 9.5 months in July.

Wednesday: Durable Goods Orders declined 4.9% in August; a drop of 3.1% had been anticipated. The July statistic was revised up to +6.1% from +5.9%.

Thursday: In August New Home Sales sank to 795,000 units, an 8.3% fall in one month and well under the 835,000 units that had been expected. The July return was adjusted down to 867,000 from 870,000. The unsold market supply climbed to 8.2 months from 7.5 in July. The median sale price fell 8.3% to $225,700, off 7.5% on the elapsed year. In its third and final release second quarter GDP lost 0.2% to 3.8%; the initial or 'advanced' release was 3.4%; the second or 'preliminary' was 4.0%. Weekly Jobless Claims for the week ending September 22nd fell by 15,000 to 298,000; a rise of 9,000 to 320,000 had been forecast. It was the second week in a row that claims dropped rather than rising as anticipated.

Friday: Personal Income rose 0.3% in August as expected but Personal Consumption Expenditures (PCE) outstripped predictions climbing 0.6%, +0.4 had been forecast. It was the best performance for this gauge of consumer spending since July 2005. Core PCE Prices moved ahead 0.1% in August as expected, dropping the year on year increase to 1.8%. It was the lowest yearly rate since February of 2004 and below the preferred Fed target of 2.0%. The September Chicago Purchasers Index surprised at 54.2, bettering both the median prediction of 52.9 and the August result of 53.9. 'New Orders' fell to 56.2 from 58.4 in August and 'Prices Paid' diminished to 59.0 from 71.8. Construction Spending in August was substantially better than expected at +0.2% on a predicted decline of 0.5%. Non-residential construction moved up 2.3% but was partially negated by the 1.5% drop in residential building. The August result was revised higher to -0.4% from -0.5%. The final return of the University of Michigan Consumer Confidence for September dropped four tenths to 83.4; the preliminary issue had been 83.8.

Eurozone

Monday: Industrial New Orders for July dropped 4.0% from June, greater than the predicted 3.0% decrease. The June result was revised up 0.1% to +4.5%. Orders for July 2007 were 10.9% ahead of the prior year, this was a better result than the +10.2% predicted. The June year on year figure was adjusted 0.2% higher to 14.0%.

Thursday: the European Monetary Union Money Supply (M3) rose 11.6% in August as expected, a slight but welcome decrease from July's 11.7% reading. The three months moving average was +11.4% as predicted; in July it had been +11.1%. The August 11.6% increase in M3 was the first decline in the rate of increase in four months.

Friday: the European Commission Economic Sentiment Indicator for September came in at 107.1 well below the expectation of 109.0. The August result was revised lower to 109.9 from 110.0. It was the sharpest one month fall since October 2001 and the lowest reading of the past year. Even so it remains well above the long term average of 100.0 The Business Climate Indicator for September was 1.09 a precipitous drop from the August reading of 1.37, which was itself a revision from 1.41. It is the lowest reading since May of 2006. Consumer Confidence dropped to -5 in September from -4 in August but it is still well above the long term mean of -11.0. The 'flash' Harmonized Index of Consumer Prices (HICP) result for September arrived at +2.1% as expected, much higher than the 1.7% rate in August. It is the first time in a year that the headline HICP number has topped the 2.0% ECB target.

Germany

Tuesday: the IFO Survey of Financial Experts one of the most followed German business indicators fell across all categories in September: 'Business Sentiment was 104.2 on expectation of 105 and July's reading of 105.8; 'Current Assessment' was 109.9 on expectations of 111.0 and the August issue of 111.5; 'Business Expectations' were 98.7, on a prediction of 99.6 and an August result of 100.4. GfK Consumer Confidence fell in October to 6.8, well under the median prediction of 7.1. The September statistic was revised lower to 7.4 from 7.6. It was the 2nd monthly drop in a row.

Thursday: the 'flash' or first issue of the September (HICP) showed a 0.2% gain for the month and a 2.7% year over year rate. Both results were higher than the median forecasts, for a flat month and a 2.5% increase for the year. The Consumer Price Index also beat expectations in September coming in at +0.2% for the month and +2.5% yearly; 0.0% and +2.3% had been anticipated. This was the first national CPI number over 2.0% since July 2006 when it registered +2.1% and the highest since September 2005 when it was also 2.5%.

Friday: Retail Sales in August fell 1.4%, an unusually large distance from the predicted rise of 0.3%. The drop was greater than all polled forecasts. It was the largest fall in consumer purchases since the 3.2% drop this past May. The July result was also adjusted lower to +0.6% from +0.7%. The year on year rate for Retail Sales was 2.2% less than the previous August, shrinkage of 1.6% had been expected; the decrease from last July to this July was 1.9%.

United Kingdom

Tuesday: Total Business Investment in the second quarter was revised down to +0.4% from +0.8%, and the yearly figure was adjusted up to +7.8% from +7.4%. Manufacturing investment fell 6.0% in the quarter, leaving it 1.3% higher for the elapsed year. Investment in the services sector climbed 0.8% in the quarter and 7.9% yearly.

Thursday: the Nationwide House Price Survey rose 0.7% in September over August, a 9.0% yearly rate. In August the increases were +0.7% monthly and +9.6% yearly.

Japan

Friday: Retail Sales gained 0.5% in August, it was the first rise in three months; in July they had fallen 2.3%. Industrial Production gained 3.4% in August a major improvement on July's 0.4% contraction. The unemployment rate rose 0.2% to 3.8% as expected and left behind the 3.6% rate which had been the lowest since 1998. Core National CPI fell for the seventh month in a row, dropping 0.1%, deflation fears are uncomfortably alive. Household spending rose 1.6% year on year; in July it sank 0.1%.

The Week Ahead October 1 – October 5

United States

Monday: ISM Manufacturing Index for September at 10:00 ET; expected 52.9, August 52.9.

Tuesday: NAR Pending Home Sales for August at 10:00 ET; July 89.9.

Wednesday: ADP National Employment Report for September at 8:15 ET; August +38,000. ISM Non Manufacturing Index for September at 10:00 ET; expected 54.5, August 55.8.

Thursday: Jobless Claims for the week ending September 29 at 8:30 am ET; expected +12,000 to 310,000, prior week -15,000 to 298,000. Factory Orders for August at 10:00 ET; July +3.7%.

Friday: Non Farm Payrolls for September at 8:30 ET; expected +115,000, August -4,000. Unemployment Rate for September at 8:30 ET; expected 4.7%, August 4.7%.

Eurozone

Monday: Manufacturing Purchasing Managers Index (PMI) for September at 8:00 GMT: August 54.3.

Tuesday: EMU Unemployment for August at 9:00 GMT; expected 6.9%, July 6.9%. Industrial PPI for August at 9:00 GMT; expected +0.1% m/m, +1.8% y/y, July +0.3% m/m, +1.8% y/y.

Wednesday: Services PMI for September at 9:00 GMT; August 58.0. Retail Trade for August at 9:00 GMT; expected +0.4% m/m, +0.5% y/y, July +0.1% m/m, +0.5% y/y.

Thursday: ECB rate announcement and press conference.

Germany

No important statistical releases

United Kingdom

Monday: CIPS Manufacturing PMI for September at 9:30 GMT; expected 55.7, August 56.3.

Wednesday: Nationwide Consumer Confidence for September at 23:01 GMT; August 94. CIPS Services PMI for September at 9:30 GMT; expected 56.8, August 57.6.

Thursday: BOE rate announcement at 12:00 GMT.

China

No statistical releases

Japan

No statistical releases