Daily Forex Commentary
By Jack Crooks
Key News
- Australia's central bank raised its key interest rate by a quarter percentage point to 6.0%.
- The Bank of Japan may raise interest rates for a second time this year. (Bloomberg)
- The mainland [China] has issued new rules to control escalating real estate prices in major cities to prevent a collapse in the property industry from roiling the economy. (The Standard/Bloomberg)
Key Reports (WSJ)
8:30am: Initial jobless claims for the week of July 29. Consensus: +10K. Previous: -7K.
10am: June factory orders. Consensus: +1.8%. Previous: +0.7%.
10am: July non-MFG ISM business index. Consensus:58. Previous: 57.
10am: DJ-BTMU business barometer for the week of July 22. Previous: -0.2%.
7:00am: UK August BOE rate decision (Expected: 4.75% Previous: 4.5%)
7:45am: German interest rate decision, Frankfurt (Expected: 3.0% Previous: 2.75%)
Quotable
"It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong." - George Soros
FX Trading
1997 was a year of great symbolic importance for the US economy. It was the first time in 30 years that household sector net worth moved back above its longer-term trend. And, of course, it was only the beginning of what we now know to have been the greatest surge of US wealth creation in the post-World War II era. There have been two major legs to this explosive surge in net worth. Reflecting a powerful equity bubble, real household sector net worth surged nearly 28% above trend by early 2000.
That was followed by a 16% pull-back in the aftermath of a wrenching post-equity bubble shakeout. But then, courtesy of the property bubble, a second leg kicked in - taking real household sector net worth up about 23% above trend as of early 2006. From bubble to bubble, US wealth creation broke the mold of anything seen in the past. Trend growth in real household sector net worth has averaged 5.5% since 1995 - more than 50% faster than average gains of about 3.5% over the prior 40 years. - Stephen Roach of Morgan Stanley." (Our emphasis)
A housing downturn will have obvious and important implications for US GDP growth. The direct effects are straightforward: Over the past three years, 2003-05, residential construction activity has boosted real GDP growth by about 0.5 percentage point per year. In data just released for 2Q06, the sector was estimated to have reduced annualized GDP growth by 0.4 percentage point.
To the extent the decline in new building activity remains orderly, reductions could continue at the second quarter pace. Relative to the heady gains during the final stages of the boom, that means the contribution of residential construction activity could swing from +0.5% to -0.5% - imparting about a one percentage point drag on overall real GDP growth for at least the next couple of years. - Mr Roach
The key phrase in the above paragraph: "To the extent the decline in new building activity remains orderly ..." In other words, a soft landing in housing.
Ben Bernanke at the Fed is between a house and a hard place. Reported "inflation" is rising - more than expected. Growth is softening - more than expected.
From Bloomberg's Caroline Baum on Monday (our emphasis):
There were two big surprises in last week's second-quarter GDP report, which saw growth undershoot the consensus forecast by 0.5 percentage point. The most significant was the decline in spending on equipment and software. The 1 percent drop, the first since the first quarter of 2003, wasn't notable for the magnitude but for the implications for growth going forward.
"The Fed was expecting consumer spending to slow, and business investment to be robust," says Neal Soss, chief economist at Credit Suisse. "Guess what? The data don't confirm it."
At his semi-annual monetary policy report to Congress on July 19 and 20, Fed chief Ben Bernanke said that "business investment seems likely to continue to grow at a solid pace, supported by growth in final sales, rising backlogs of orders for capital goods, and high rates of profitability".
Does the Fed opt for "loaded" choice A, or B?
A)Hike rates again and risk a hard landing in housing and consumer spending, leading CEOs to hang on to their cash and not spend on capital goods, which effectively worsens the GDP numbers; in an effort to keep the inflation genie from escaping the proverbial bottle; or
B)Do nothing in the belief they have done plenty and it's time to sit back and admire their handy work.
Our spin of the wheel lands on B - do nothing. And doing nothing within an environment where the Reserve Bank of Australia and the European Central Bank are doing something and the Bank of England and the Bank of Japan may do something a bit later is probably not fertile ground for a strong dollar - at least over the intermediate term.
