Will the Fed raise rates later this month? Here’s my forecast…
US Dollar
The dollar rebounded for the second consecutive
day against the Euro as the post-Katrina recovery efforts continue. However
before traders get too excited about the dollar rally, the latest move could be
nothing more than the calm before the storm because we have yet to see any
economic data that would reflect the impact of Hurricane Katrina. Once that
filters in, another bout of dollar weakness would not be surprising. There is
little chance that spending, sentiment and economic activity could continue at
an accelerating pace with oil prices at such elevated levels and the nation
struggling with more than a million displaced people in the Gulf States.
The government has already shared their forecast
of tougher times ahead. US Treasury Secretary Snow said yesterday that the
combination of higher energy prices, job losses and closed businesses could
shave as much as 0.5% off of GDP growth in the quarters ahead. The government
also raised their winter energy forecasts to $70 a barrel and announced that up
to 400,00 jobs could be lost as a result of Hurricane Katrina. This begs to
question whether we could see a pause in the Fed tightening cycle. We answered
this question already yesterday when we forecasted a quarter point rate hike
later this month but suggested that the November decision was far more
uncertain.
The question that we are tackling now is whether
a potential November pause could be a mid-cycle pause with a resumption of
tightening in early 2006. It is undeniable that inflation is on the rise. Just
today, we saw unit labor costs, a measure closely followed by the Fed jump 2.5%
in second quarter compared to the initially reported 1.3% rise. This upward
surprise definitely does not help the Fed in making what is already a difficult
decision. If inflation does continue to rise not only on a headline level, but
also on a core level, the Fed may have no choice but to continue raising rates
later on, even if they do pause momentarily. Meanwhile the same report indicted
that productivity growth took a sharp dive as well, rising only 1.8% compared to
2.2% the previous month. Even though some critics are saying that this weakness
may cause the Fed to reconsider a now familiar line in the FOMC statement that
says “robust underlying growth in productivity, is providing ongoing support to
economic activity,†we doubt that the Fed has enough information about the
impact of the recent setback to eliminate the sentence later this month. It has
been a staple on FOMC statements since since September 2003.
Euro
The Euro is weaker for yet another day but
economic data out of the region continues to show resilience to the rise in oil
prices. German industrial production rose 1.2% in the month of July compared to
the market’s expectations calling for a 0.3% slide. Although this number is
fairly volatile, taken together with yesterday’s strong factory orders number
and we see that economic activity was expectionally strong. However, these
numbers are for the month of July. Right now, we are in September, which means
that the current state of the economy could be very different. In our opinion,
the future health of the Eurozone economy is largely dependent upon the value of
the Euro as well as oil prices. If the Euro rises but oil prices stay steady at
current levels, the region’s growth could dissipate.
British Pound
There were some interesting findings in the U.K.
economy today as traders digested both the HBOS Plc housing report and National
Institute for Economic and Social Research’s estimates for growth domestic
product on the eve of the Bank of England policy meeting. According to the
country’s biggest mortgage provider, housing prices actually rose by 1.6% the
month of August, the largest since September of 2004. However, the report leaves
some skeptical, as the recent figure is currently at odds with previous housing
data provided by Nationwide, the U.K.’s largest building society, last week.
According to the Nationwide report, housing valuations actually dipped 0.2%. As
a result, rising notions that the housing market may have seemed to stabilized
rather than pickup have been sparked, lending to speculation that policy makers
may now have enough evidence for a pass on another repo rate cut this time
around. Additionally contributing to the theory were GDP estimates furnished by
NIESR. According to the leading think-tank, the domestic economy looks to be
advancing in line with trend and may not need further cuts to bolster growth.
Europe’s second largest economy grew by 0.5% in the past three months after
facing a prior slowdown. This is also contradictory according to results by the
statistics office released yesterday that stated that industrial production was
still off, declining 0.3% in the month.
Japanese Yen
To the delight of Yen bears, today’s Japanese
economic data remained indicative of the slow pace at which the world’s second
largest economy is growing. According to the Cabinet Office, the economy’s index
of leading indicators fell to a reading of 50 from the previous month’s 63.6
figure, slightly better than the consensus 44.4. Compiled using data from a
number of factors including new job offers, consumer sentiment and Tokyo share
prices, the figure looked to be propped higher by rising employment figures and
increasing equity share valuations while being offset by lower consumer
sentiment. Lending to notions of declining consumer sentiment looked to be
retail gasoline prices that are near a 14-year high. The nation’s refiners
including Nippon Oil and Idemitsu Kosan raised wholesale gasoline prices due to
surging underlying crude oil prices for the past week. Now with higher gasoline
to pay, consumers may be even more reluctant to spend in tandem with the recent
pro-tax legislation, adversely affecting the overall economy. However, this
notion remains questionable when compared to the most recent consumer confidence
data that actually rose for the third time in four months. As a result, yen
bulls may have to continue in their pursuit for dramatically uplifting data that
would confirm a strong turnaround in the Japanese economy. Subsequently, the
coincident index was released dramatically lower than expected at a reading of
22.2 versus a 100 reading from the previous period. Although dramatic, the
figure garnered little attention as it remains to be a compendium of previous
releases and thus is somewhat predictable.
Kathy Lien
Kathy Lien is the Chief Currency Strategist at
Forex Capital Markets. Kathy is responsible for providing research and analysis
for DailyFX, including technical and fundamental research reports, market
commentaries and trading strategies. A seasoned FX analyst and trader, prior to
joining FXCM, Kathy was an Associate at JPMorgan Chase where she worked in Cross
Markets and Foreign Exchange Trading. Kathy has vast experience within the
interbank market using both technical and fundamental analysis to trade FX spot
and options. She also has experience trading a number of products outside of FX,
including interest rate derivatives, bonds, equities, and futures. She has a
Bachelors degree in Finance from New York University. Kathy has written for
Stocks and Commodities, CBS Market Watch, ActiveTrader, Futures and SFO
Magazine. She is frequently quoted on Bloomberg and Reuters and has taught
seminars across the country. She has also hosted trader chats on EliteTrader,
eSignal, and FXStreet, sharing her expertise in both technical and fundamental
analysis.