In This Issue.
* ECB and Fed to show their hands
* Global data shows a wider slowdown
* UK data continue to disappoint
* Aussie dollar touches 4 month high
And, Now, Today's Pfennig For Your Thoughts!
Waiting on the Fed.
Good day, and welcome to August. As Mike mentioned, July will go down as the hottest month ever here in St. Louis and we aren’t alone in our battle against the heat as the entire country will probably set a record for the average temperature in July. At least our power hasn’t shut off and we can enjoy some AC, unlike the folks in India where there was a massive power outage over the past few days.
The dollar rally seemed to lose power yesterday as currency investors were afraid to take positions ahead of the ECB and Fed announcements. The world’s two top central banks continue their meetings today and the markets will look to the post meeting announcements for some direction. The Fed head, Ben Bernanke, will be the first up to the podium this afternoon and then he will be followed by the ECB President Mario Draghi who will hold his press conference tomorrow. I don’t think we will see any dramatic action taken by our Fed this meeting, as they chose instead to ‘kick the can’ for another month. But things are different for the ECB who will be forced to come up with something.
The global economy continues to slow, which has put increased pressure on both central banks to come up with some sort of stimulus. Data released yesterday here in the US showed consumer spending stagnated in June after dropping a revised .1% the month before. Personal income was up slightly both months, which indicates US consumers continue to tighten their belts. This data, along with the stagnant employment picture here in the US shows the problem Bernanke and the rest of the FOMC members face. They need to try and stimulate the US economy, but their only tools are their ability to control interest rates. Typically the Fed only has a direct impact on the short end of the curve, and the only way for them to control longer rates was by ‘jawboning’ them up or down by adjusting the markets inflation expectations. But during the credit crisis, the Fed felt rates were still too high on the long end so they took a lead from the UK and Japan and instituted a couple of ‘quantitative easing’ plans to try and drive them down. The Fed became big buyers of longer dated bonds which helped drive the 10 year yields to record low levels (I question just how much of this drop in rates was due to the Fed as the Euro crisis has probably done more to reduce rates here in the US than ‘operation twist’!). But have these lower rates had any kind of stimulative impact on the US economy?
Yes, every time the Fed announces another easing program the stock market has rallied a bit, but the last time I checked the Fed’s dual mandate did not include keeping equity markets in the black. The purpose of lower rates are to try and get consumers and businesses to make the decision to borrow and spend, stimulating the economy. But as I just mentioned, US consumer spending has stagnated, and companies don’t seem to be confident enough to begin hiring workers. Lower mortgage rates are great for those of us who are working, but I have to believe most homeowners who have the ability to re-finance have already done so. So just how much stimulus will lower rates bring? Not much if you ask me. Both consumers and businesses will continue to be worried about the outcome of the elections, and what that will mean for tax policy here in the US. There is also that nagging ‘fiscal cliff’ which is lurking out there at the end of 2012. I certainly don’t envy the position our boys and girls over at the Fed have put themselves into, and I think they will take the ‘safer’ option today and simply tell the markets they will continue to monitor the situation and stand ready to ‘take action’ if needed (what exactly that action is will remain a mystery).
As Mike wrote yesterday, the ECB President has painted himself into an even more difficult position with his assurance that the ECB will do ‘whatever is necessary’ to support the euro. The currency markets have certainly priced in some action by the ECB. Nobody expects either central bank to take action on rates, as they are just about as low as they can go. Instead, the markets have been pricing in some other type of stimulus program, either an extension of their current quantitative easing programs or new ones designed to pump more liquidity into the markets. I think currency traders will probably give Bernanke some room, but now is the time for Mr. Draghi to put up or shut up. But the problems in Europe won’t be solved with one dramatic announcement. Draghi can only hope to convince the markets that the ECB has a long term plan to deal with the crisis, but I think the risk is that the markets won’t be convinced by his words and the euro will give back all of the appreciation we have seen over the past week.
There is no ‘silver bullet’ which will kill the debt crisis in Europe. The collapse of the Greek economy is well underway, and the ECB can only hope a similar situation does not occur in Spain or Italy. The labor markets are bad here in the US, but are even worse in Europe with the jobless rate reaching a record level. According to a report released today, unemployment in the eurozone reached a revised 11.2% in May and held at that record level in June. And the ECB won’t be able to depend on a global economic rally as data indicates the globe will continue to be stuck in a ‘slow growth’ mode for the next few years. Euro-are manufacturing contracted for a 12th month in July according to a report released today; falling to a 37 month low of 44 from 45.1 in June.
A report released in Canada this morning showed GDP in our neighbor to the north rose just .1% in May, less than economists forecast. Another report showed China manufacturing, which most believe will be the force driving the global economic recovery, stalled out in July and is teetering on the edge of contraction. The Purchasing Managers’ index in China unexpectedly fell to 50.1 in July, the weakest in eight months from 50.2 in June. Another piece of data due out today is predicted to show manufacturing in the US also stagnated in July. The ISM factory index is due out this morning, and is expected to show a slight increase from last month’s reading of 49.7, but the index isn’t expected to rise much above 50 which is the dividing line between contraction and expansion. Regional reports in the US released yesterday confirmed that manufacturing is sputtering with manufacturing gauges in Wisconsin and Ohio declining.
The pound sterling dropped a bit overnight after a report showed UK manufacturing shrank the most in more than three years in July. The gauge fell to 45.4 from a revised 48.4 in June, weaker than any of the 30 forecasts on Bloomberg. The Bank of England is meeting today and tomorrow, and is expected to announce no change in their policies. The BOE was the first to institute a bond buying program designed to stimulate their economy, a model followed by the US and Europe. Unfortunately, the results of this QE program have not lasted. This is worrisome for the US and the ECB, as our stimulus programs were instituted after those of the BOE. While the economies are definitely different, it is not good to see a QE program which has been in place longer than our own seemingly having little lasting impact on the UK economy. The pound barely even got a lift from hosting the Olympics.
There was one bright spot in all of the manufacturing data released yesterday. Sweden’s manufacturing unexpectedly expanded in July, with a purchasing managers’ index rising to 50.6 in July from 48.4 the previous month. The Swedish economy expanded 1.4% in the second quarter as consumer spending rose and an increase in exports of services offset a decline in exports of goods. The news sent the Swedish krona higher as currency traders lowered bets that the Riksbsank would lower rates in September. The Swedish krona was the second best performing currency during the month of July, rising 2.45% vs. the US$.
The top performer during last month? It was the Australian dollar which rose 2.77% vs. the US$. The aussie dollar touched the highest level in more than four months moving solidly through $1.05. The currency was helped by a report which showed house prices unexpectedly rose in the three months through June as lower rates helped stimulate the housing market. Another report showed building approvals decreased by less than economists had expected, which was another good piece of news for the important housing sector in Australia. There was a pickup in the number of first time homebuyers, increasing the amount of liquidity in the housing market.
Then there was this. As I mentioned in the opening paragraph, people in India faced a massive power outage over the past few days. I was actually made aware of the outage well before anything was reported about it here in the states, as I continue to work with programmers based out of India. I was scheduled to be on a call with a programmer early yesterday morning, and was a bit upset when he never called in as we were waiting on some code improvements which we wanted to get in place prior to the month end. We were finally able to reach an associate of his in London who told us about the power outage. India has gone through some tremendous growth, but their infrastructure hasn’t been able to keep up with the changes in the population. Throw in a drought and high temps similar to what we have been experiencing here in the Midwest, and you end up with a power system which just couldn’t handle the demand. Apparently over 620 million were without power across India, that equates to almost two times the entire population of the US.
While the power is expected to come back on sometime today, the drought is continuing and Goldman Sachs announced yesterday that they were lowering their GDP growth forecasts for India because of the lack of rain. Goldman reduced India’s FY2013 GDP forecast to 5.7% from 6.6% due to the weak monsoon season. They also reduced their rate cut forecast to 25 bps in 2012 which will probably occur in the 4th quarter. Goldman maintained their view that the RBI will cut an additional 50 bps in 2013. None of this is good news for the Indian rupee.
To recap. The ECB and FED begin their meetings today, and Bernanke should make an announcement this afternoon. I don’t expect our Fed to take any new action, but the markets are expecting something big from the ECB. The currencies remained in a tight range waiting for any news. Manufacturing data released across the globe verified a global slowdown is underway. UK manufacturing data weighed on the pound and Sweden was the sole bright spot, posting a positive manufacturing number. The Australian dollar was the top performer in July, and added to its gains moving up above $1.0530. And finally, there was a massive power outage in India, with over twice the population of the US losing power.
Currencies today 8/1/12. American Style: A$ $1.0531, kiwi .8129, C$ .9989, euro 1.2310, sterling 1.5630, Swiss $1.0248. European Style: rand 8.2568, krone 6.0121, SEK 6.7564, forint 227.72, zloty 3.3377, koruna 20.5835, RUB 32.3128, yen 78.15, sing 1.2446, HKD 7.7539, INR 55.5175, China 6.3687, pesos 13.2847, BRL 2.0569, Dollar Index 82.582, Oil $88.27, 10-year 1.48%, Silver $27.93, Gold $1,614.90, and Platinum $1,410.25
That's it for today. Thanks to all the readers who sent me notes regarding Lucy. I am happy to report that she pulled through last Friday’s operation with no complications and is almost back to her sweet self. I enjoyed watching the US girls grab the gold in gymnastics last night, and enjoyed watching Phelps set the record as the most decorated Olympian ever. The crew is coming in and the phones are about to turn on, so I better end this and get it out the door. Hope everyone has a Wonderful Wednesday, and thanks for reading the Pfennig!!
Chris Gaffney, CFA
EverBank World Markets