Bernanke holds currencies hostage; European Central Bank keeps the market guessing; British pound: Are UK banks in trouble?
DailyFX Fundamentals 08-30-07
By Kathy Lien, Chief Strategist of DailyFX.com
Bernanke holds currencies hostage
Fed Chairman Ben Bernanke is holding currencies hostage ahead of his speech at Jackson Hole tomorrow and the symposium over the weekend.
Whatever gains were made yesterday have been given back today. The most recent data on the housing market tells us that prices are falling and foreclosures are rising. The labour market is also showing signs of buckling with jobless claims increasing by the largest amount since April.
The help wanted index released by the Conference Board also sunk to a 49 year low. With interest rates on mortgages rising, lenders being more stringent and more inventories expected to flood the markets over the next six to 12 months, there are not many positive things that Bernanke can say about the housing market.
Yet the topic that everyone is talking about today is whether Bernanke will focus on the financial or economic crisis. If he is focused exclusively on the financial crisis, then one could argue that the credit markets have stabilised which means that the Fed may not feel the urgency to lower interest rates.
If it is worried about the economic crisis on the other hand, then a rate cut is certainly warranted because even though second quarter GDP was the strongest in over a year, growth in the third and fourth quarter will not be as pretty.
Greenspan was more reactive than proactive in his last few years as Fed Chairman, and it appears that Bernanke has been doing the same. We however continue to believe that a rate cut is necessary because eventually the weakness in the labour market will lead to softer consumer spending.
The Fed will probably make an internal decision about what to do with interest rates, but given the amount of time still left until the next monetary policy meeting, they do have the luxury of waiting for more up to date economic data as well as watching how traders behave when they return from their summer holidays.
The Fed will not be the only central bank representing at Jackson Hole, officials from the Bank of England and Bank of Japan will also be in attendance. Originally European Central Bank (ECB) President Jean-Claude Trichet was supposed to attend the symposium, but he cancelled today due to "personal reasons".
Some people are speculating that he has decided to not attend so that he could stay in Brussels to monitor market movements. Although we could see more volatility in the currency and stock market tomorrow, don't expect Bernanke to provide much more clarity on the September rate decision.
Nearly every other central bank including the Bank of Canada, ECB and Bank of England will be meeting before the Fed, which means that the market's focus should quickly shift to what other central banks are doing.
ECB keeps the market guessing
With less than two weeks to go before the next European Central Bank meeting, Trichet is still keeping the markets guessing.
Who can blame him however, since the ECB may not be sure about whether they want to raise interest rates either. The credit markets have stabilised slightly, but demand for three month loans hit a record high yesterday which means that banks are still seeking liquidity.
Economic data has been mixed. Even though confidence among businesses and consumers are falling, retail PMI rose for the first time in four months as the German unemployment rate dipped to a 14 year low.
The futures market is pricing in a 40 per cent chance of an interest rate hike, but 70 per cent of analysts polled expect rates to remain unchanged. We expect the ECB to leave rates unchanged, but remain hawkish to avoid triggering another dramatic move in the financial markets.
British pound: Are UK banks in trouble?
The Bank of England announced that they loaned $3.2bn to an undisclosed bank at their penalty rate of 6.75 per cent. The emergency loan facility is usually tapped only when banks have funding problems, but earlier this month, Barclays borrowed $630m because a loan from HSBC was delayed.
Therefore the market is taking this in stride because it could once again be related to a settlement issue instead rather than a major liquidity problem. The British pound is still lower however partly because of the loan but also because the CBI industrial trends survey fell to a nine month low in August. This suggests that retail sales in general may be weakening.
Question marks over Bank of Japan rate hike
Today's sell-off in the yen crosses is nothing more than a correction of yesterday's rally. Carry trades are stuck in range as the recent recoveries have been rather baseless.
Japanese economic data remains weak as retail sales continued to drop in July. Tonight, we have additional data including consumer prices, unemployment, overall household spending, PMI, and industrial production.
Although the labour market will remain tight, it will be some time before Japan is able to escape deflation. Last week, Bank of Japan (BoJ) Governor Toshihiko Fukui said that the central bank still plans on increasing interest rates. But comments from BoJ member Atsushi Mizuno this morning suggest that a rate hike may not come until the end of the year at the earliest, because a Fed rate cut could change his stance.
The newly installed cabinet also appears against a hike. Finance Minister Fukushiro Nukaga said that Japan has yet to overcome deflation and as a result, he wants the BoJ to make policy consistent with the current economy.
Canadian dollar traders cautious ahead of GDP
The Australian and New Zealand dollars have pulled back today after weaker than expected economic data and renewed flight to safety into US dollars.
The Canadian dollar on the other hand rebounded on stronger current account numbers and a sharp increase in raw material prices. Its rally however has been limited by the possibility of softer GDP numbers tomorrow.
Australia has retail sales and trade balance due for release tonight. Spending could remain positive as the trade deficit improves.