A Forex View From Afar

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Forex Analysis

U.K Economy Going Lower

Written by A Forex View From Afar on Thursday, July 10, 2008

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The Bank of England faces a pretty hard situation: a stalling economy and a high degree of inflation. More and more economic releases point out a major slowdown, if not contraction, is coming.

House prices fell the most since 1993, consumer confidence hit an 18-year low, while the service, manufacturing and especially the construction parts of the economy are contracting at an increasing speed. The only indicator that is holding tight is retail sales, which easily beat estimates, but now everyone expects a major revision from it. All of this points to the UK central bank iprobably following the Fed’s footsteps in the next months.

A cut may be on the table and will probably start to be seen soon in the pound’s market valuation. Who knows, maybe the BoE will even open its own “mergers and acquisitions” department, as the Fed did. This may be the ultimate sell the rumor, and buy the news, of a U.K. rate cut.

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The credit crunch's effects over the real economy

Written by A Forex View From Afar on Wednesday, July 09, 2008

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The credit crunch is here and despite most analyst estimates, including Fed economist, the credit crunch has not been contained and it did spill over the real economy.

Excluding the credit crunch’s effects we see on a daily basis, like a weak dollar, high gas and oil prices, and a bear stock market shaking at the smallest sound of trouble ahead, the credit crunch is starting to reach were it hurts the most: in the money supply side.

A chart provided by Bloomberg, tracking the Fed’s loan officer surveys, shows that credit is harder to get and especially more expensive then ever. That is quite strange to have the highest borrowing cost in the last few years at the same time that the Fed Funds are at 2%, near their historical lows; this is the crude reality, interest rate cuts do not impress a credit decimated market it seems. Banks are crippled by the credit crunch and this is reflected in the credit cost.

credit crunch's effects over the real economy

The easing in Fed Funds was used to promote a cheap money policy (flooding the financial arteries with money) but it seems that these lower rate funds never reached the end-user, the consumer, and will not reach them in the coming period either.

Cutting the consumer’s safety net- their credit line- especially in a country like the U.S. where the saving rate is negative, does nothing more then fuel even more the economic slowdown. An large part of the economy relies on consumer spending, about 70% and that GDP component will soon have a surprise; a consumer with no money in their pockets complaining about the high prices. Add to that, gas running near $4 per barrel.

Putting this all together reveals that the slowdown will continue far into 2008 and maybe in 2009 despite all of the 2-4% GDP in Q4 headlines that we are seeing. The U.S. is not alone, the same credit crunch is happening in Europe and in the UK, so the dollar won’t get too much weaker than it is right now. My long term view remains stable at this point in time; a prolonged range on the euro, having two economies in a visible slowdown, but one of them ahead of the Credit Crunch curve, the U.S.

Source:
Bloomberg: U.S. Credit Crunch Is Worsening, Nomura Says: Chart of the Day

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Even the Fed’s members are gloomy

Written by A Forex View From Afar on Monday, July 07, 2008

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Today, the Federal Reserve Bank of San Francisco President Janet Yellen laid a gloomy outlook for the coming months in a speech at the University of California San Diego’s Economics Roundtable.

Mr. Janet Yellen said credit conditions are still tight, despite the Fed’s more than 300 basis points cut. Inflation expectations are still anchored, despite the fact that she expects inflationary pressures to persist as a problem in the coming months.
Speaking about the housing market, the current problems will continue throughout 2009 as residences in some areas can still be considered too expensive in the current lending climate.

Well, until now she didn’t say anything new, I just do not know from where she took the “inflation expectations as reasonably well anchored” part, when you have the CPI running at over 4%. Probably because she is the one who will have to keep inflation expectations tight and at the same time assure us that the CPI will not get too high. It seems that the Fed partially failed in fulfilling its mandate.

What I really liked in her speech is she admitted that “a few months of data don’t make a trend, particularly because we can’t be sure how large the effects of the roughly $100 billion temporary tax rebate program have been.” Now, if even a Fed member is not sure how much of an impact the free $600 had, than who should. Those analysts who modify their forecast every few months? To me, it’s quite strange to hear something like this from a person who sets the monetary policy.

Furthermore, having the Fed not sure what are the rebate’s effects over the real economy, we could have a plausible explanation why there was such a drastic change in monetary policy lately; from cutting rates inter-meeting, straight away then going to a 'wait and see policy'.

These put together, reassures me that the Fed will stay on hold for the time being, not moving the Fed Funds anywhere and only jawboning about inflation, which in turn should empower the dollar. So, compared to the currency on the other side of that trade you are just about to take, does the dollar look that weak any more? Unlike most regions right now, there is no chance of a cut coming from the Fed it seems, the euro, pound, aussie and yen may want to keep an eye on the market's feel of their fair value.

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The Big Mac Index

Written by A Forex View From Afar on Sunday, July 06, 2008

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Classic financial theory states that any given asset should have the same price anywhere in the world.

But things don't work this way it seems, identical assets have different prices from country to country. Economists like to put these different values on the currency shoulders, considering expensive assets are backed by over-valued currencies.

This analysis is called Purchasing Power Parity (PPP) and is used to measure the influence of the exchange rate over the same asset in two different countries.

Editors from the Economist found a unique way of measuring the PPP by using a matchless asset, the Big Mac. The hamburger was chosen due to world-wide spread and availability. The Big Mac index was started in 1986 and is measured annually, showing which currencies are over/under valued.

Big Mac Index

The swings in the Big Mac index takes years to happen, if ever, so this is why the index is often avoided by currency traders, who focus more on short term trades. Using this for real world trades, the 2007 Big Mac Index showed that the most overvalued currency was the Icelandic kroner, by 123%, against the dollar. This is quite interesting, since recently the kroner was hit by a currency crisis, depreciating at a very fast pace.

The most undervalued currency in 2007 was the Chinese yuan, by 55%. No wonder the Chinese government was accused of manipulating its currency to help exporters.

The Big Mac Index has its own limitations too. The price of a McDonald's meal depends on a lot of variables. Just to name a few: taxes, competition, import functions.

The Big Mac can be a good long time indicator for the currency trends, but these imbalances take years to correct and most importantly, the price of eating out at the local Mac doesn't represent the whole economy.

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Press Conference: Prepare to assure price stability

Written by A Forex View From Afar on Thursday, July 03, 2008

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• Weak real GDP growth in the second quarter of 2008
• Expectation of moderate ongoing growth
• Domestic and foreign demand are expected to support real GDP growth, albeit to a lesser extent than during 2007
• Growth in the world economy is expected to remain resilient, benefiting from growth in emerging economies
• Fundamentals of the euro area economy remain sound
• Euro area does not suffer from major imbalances
• Employment rates and labor force participation have increased significantly in recent years
• Unemployment rates have fallen to levels not seen for 25 years
• Uncertainty surrounding the outlook for economic activity remains high
• Risks stem from the dampening impact on consumption and investment of further unanticipated increases in energy and food prices
• Risks continue for the ongoing financial market tensions to affect the real economy more than anticipated
• Annual HICP inflation has remained well above the level consistent with price stability
• On the basis of current futures prices for these commodities, the HICP is likely to remain well above 2% for quite some time, moderating only gradually in 2009
• Experiencing a protracted period of high annual rates of inflation, which is likely to be more persistent than anticipated some months ago
• Risks to price stability for the medium-term horizon remain on the upside and have increased further over the past few months
• Strong concern that price and wage-setting behavior could add to inflationary pressures via broadly based second-round effects
• Imperative to ensure that medium to longer-term inflation expectations remain firmly anchored
• Upside risks to price stability at medium to longer-term horizons
• Sustained underlying strength of monetary and credit expansion has created upside risks to price stability
• Annual M3 growth has remained very vigorous in recent months, supported by the continued strong growth of MFI loans to the private sector
• Monetary analysis clearly confirms the assessment of increasing upside risks to price stability over the medium term
• Very vigorous money and credit growth and the absence thus far of significant constraints on bank loan supply
• Risk of countries’ budget deficits coming close to or even exceeding the 3% of GDP reference value has increased

During the ECB press conference we saw the same Trichet, he is ready to counter inflation at any given time. The Governor said that the growth rate in Q2 is expected to slow, in part due to a strong Q1 growth and they should be analyzed together. During the rest of the session, Mr. Trichet re-iterated the same things as in the last conferences: wage-growth to add to inflation, price stability is essential, euro-area fundamentals are safe, and strong money supply will contribute to inflation.

During the Q&A session Mr. Trichet accentuated that the Governing Council has no bias and they are not committed, but are prepared to assure price stability over the medium term. After this sentence was uttered, the euro selling seemed to stop, at least for a while, after loosing more then 150 pips since the session began.

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When the release data doesn’t match

Written by A Forex View From Afar on Wednesday, July 02, 2008

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For some time we have heard that the export industry is thriving under a weaker dollar, but that cannot be seen in the statistics.

It’s true that the ISM release shows that the export industry is expanding, and has been for a long period of time. But it’s expanding at a sluggish pace, with the reading barely above the 50 line, and expansion getting slower and slower.

What is more important is that the export industry numbers cannot be seen where it is critical to see them; in the trade balance. If there really was a strong and flourishing export industry then the trade deficit should have shrunk a little, especially now that the weak dollar is on everyone’s lips, and consumers appear to have reduced their shopping trips for forign made imports. The trade deficit however is not shrinking, and at best the deficit still remains at a floating rate that is far too high for comfort.

The same export industry should have been seen in the employment data too. But it is not. The ADP release just showed that the goods producing industry shred 76k jobs, while the service industry got rid of 3k jobs. Service corporations shed 29k jobs in the last month, while small service business (less then 50 employers) added a robust 34k new jobs. The ADP release is inline with the ISM release, which shows the employment index is contracting at the fastest pace in 8 months.

All this put together shows that things may not improve too fast in the next few quarters, although some improvements can be seen. My call is for a 'no rate increase' on the horizon from the Fed, while the ECB will “unleash” a 25 basis points it seems. Let’s see if we have a classic case of “buy the rumor, sell the news” on the euro, because I can’t see the Euro-zone accepting too easily a 1.60 exchange rate on the eur/usd

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© 2008 A Forex View From a far Trading Blog

Trade Desk View

Fundies and Trading
There is a constant question from some traders as to why anybody would ever need to consider the ‘F’ word when trading. Fundamentals: what is so damaging at looking at both Technical charts and having a Fundamental filter to gauge how many Lots to put on? Why is it that accepting that Technicals give us price points to trade, but Fundamentals determine the direction that we travel is so difficult for some traders to accept? Without a Fundamental Filter very few pure Technical traders would have seen this Dollar move coming today.

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