FX News Trading For The Week Of April 29-And Beyond

It All Comes Down To The Almighty Consumer:

Consumer spending remained the big prop holding up Q1 GDP, according to the first estimate. The BEA stated that "the increase in real GDP in the first quarter primarily reflected positive contributions from personal consumption expenditures (PCE)". Consumer spending is about 70 % of the US economy and as the consumer goes-so goes everything else. Where might consumer spending go from here?

From the BEA's first GDP estimate for 2007 (be aware that this report is a first estimate that will be revised twice in each of the next two months as more information comes in):

"Real (adjusted for inflation and chained to year 2000 dollars) disposable personal income increased 4.5 percent, compared with an increase of 5.3 percent in the fourth quarter".

As a consequence of the above, "real personal consumption expenditures increased 3.8 percent in the first quarter, compared with an increase of 4.2 percent in the fourth quarter".

In other words income and expenditures, though increased, grew at a slower rate then before. Consumers are making and spending more, but at a slower pace.

The question now is whether this is the beginning of a trend or a one or two quarter abberation. A big factor in this will be the ultimate direction of the housing market. Home asset appreciation has provided much of the capitol for the healthy spending levels seen in the past several years. As that wanes, the difference will need to be made up. Contributions from investments (like the stock market) and personal income can potentially offset the lack of home valuation that looks likely to be on the decline, but these are very complicated relationships that are difficult to assess.

Housing plays a critical role in the US economy because a downturn in housing can cause ripple effects in many diverse areas. For example many purchases related to housing including construction materials, furniture, plumbing and electrical fixtures etc will decrease, but it goes beyond that. Less jobs in real estate and mortgage banking. Less trucking to deliver goods that are now being purchased at lower levels. Less advertising for houses in newspapers and on the web. Less purchases of flooring, bedding, dishes and all the other things that people tend to buy for a new house. Less money for governments to collect from real estate taxes and all the hidden fees from home purchases.

And it isn't confined just to new home buying. Home price appreciation allowed for home equity loans that were used to purchase everything from the dormers, pools and extensions that everyone seemed to be doing to the vacations and tuitions people want for themselves and their children.

Absent in all of these government calculations is what can be referred to as "Psychological Effects". How will a typical consumer react to the fact that their house value has declined and may look to decline further? Does this make them likely to spend less? It's an "X" factor that no one can really estimate with any great certainty.

Another surprise in the GDP report was related to imports and exports:

"Real exports of goods and services decreased 1.2 percent in the first quarter, in contrast to an increase of 10.6 percent in the fourth. Real imports of goods and services increased 2.3 percent, in contrast to a decrease of 2.6 percent".

This is exactly the opposite of what should occur as a nations' currency depreciates like the dollar has. What could possibly be the explanation for a situation like this? Simple; the dollar has not depreciated by much against the basket of currencies made up from the emerging market economies because those economies control (manipulate) their currency valuations, keeping them artificially weak and thereby their products relatively cheap.

If the value of my major asset (my house) has decreased (or looks to decrease) I want to shop for some bargains. Imports from emerging economies (especially from China) are still very cheap. That's were the bargains are and it makes sense that as people get more and more nervous about their future they will look for the bargains more and more.

So how does the $ trade from here? Everywhere you look there seems to be talk about further $ depreciation. Housing, the consumer and the overall economy look to be getting worse before they get better. We had a Fed Bank President (Yellen from S.F.) talking about the possibility of recession, increased risks to growth and the need for the Fed to remain open to all options over the week end.

In the meantime we have some very important reports being released this week including information on prices, spending, the Chicago PMI, both ISM numbers and last but certainly not least, the NFP.

It could be one of the most important weeks of the year. Stay tuned.

The BoJ's inflation report last week, which slashed inflation expections to the bone for this year, is bound to have some far reaching implications. Besides the too low inflation numbers other recent reports showed factory output fell, retail sales declined for a sixth month and household spending rose a less-than-expected 0.1 percent. The unemployment rate held at a nine-year low of 4 percent.

This leads to where the real problem is for Japan-the Japanese consumer. For a nation with high employment, increased prospects for jobs and increasing corporate profits, consumer spending is growing at a very low rate. The main reason for this simple; wages in Japan have stagnated and untill the consumer sees some growth in those wages (and in real GDP), consumer demand (and prices) will stay low.

This is the main difference between the US and Japanese economies now-while American consumers are spending all they can, Japanese consumers are saving all they can. Japanese consumers have liitle faith in goverment pension systems and US consumers have too much.

How Does This Figure for the Carry Trade System?

Very good actually. Little or no growth in consumer spending will prevent the BoJ from raising rates for some time to come, but there's more to it then that. The Japanese are desparate to keep the Yen weak for two other reasons-exports and the inflationary pressure a depreciated currency tends to exert on the economy. Right now Japan needs some inflation.

Unless something major happens that causes a big upsurge in risk aversion, the JPY crosses figure to appreciate further. They pattern is likely to be a repeat of what we've recently seen: Temporary pull-backs on profit taking followed by a fresh round of buying.

The carry trade is indeed very alive and very well.

From the Overseas profit, it implies that US companies are comfortable with the way USD is weak vs other currencies.

Comfortable?...lol...They're LOVIN' it!!

Hmm... So perhaps, US companies would add fuel to the USD selloff bandwagon too.

Well, multi-nationals don't announce their currency strategies on BB, but there's no doubt a weaker $ is helping their bottom line...and is likely to continue to do so.

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Most significant in today's numbers-MoM corePCE was unchanged, the YoY is decreased to 2.1 and consumer spending grew at a slower rate. The Fed isn't likely to change their inflation outlook from one reading, but things do seem to be pointing in the right direction.

The inflation numbers fit nicely into what the Fed is looking for and the consumer number should really come as no surprise. The housing effect may be starting to take hold on the consumer as well it should. Still, the consumer is being supported by jobs, income growth and gains from Wall St.

Spending fell by the most since September 2005 when adjusted for inflation. The Fed is counting on the consumer to keep the economy propped up but this number is definately an early indication that the consumer is starting to fell a bit of a pinch.

Gasoline prices also likely exerted a big affect on the consumer and if housing continues to weaken at the same time gas is rising, spending can only worsen. The Fed has projected growth to pick up in the 2nd half of the year and get back to trend levels by the 4th quater, but it can't pick up without the continued contribution from consumer.

While no trends have been set, the first signs may be there. Decreasing inflation and consumer spending will certainly further weaken the $ as traders increase bets on a Fed cut. Don't expect an actual cut while the UE rate remains low and labor markets tight; Friday's number is going to be very important.

I'll give a brief explanation of each and explain how the $ should trend. These are the 4 basic states I look for in order to identify trends, but are not the strict definitions used by the government. Also, the economy can be in transition phases from one state to another. Using the 4 states to identify where the economy is transitioning to can also be used as a leading indicator in how the $ can trend.

INFLATIONARY:

Exists when economic growth is expanding at or above trend (currently 2.5-3.0%) in the GDP while inflation remains above the Fed's target of between 1-2% (using YoY core PCE, the Fed's preferred measure). The $ will trend stronger as long as the outlook remains the same, primarily because the market will be expecting a Fed rate increase.

DEFLATIONARY:

Growth will be below trend and looking to go lower while inflation is in the target range or below. Markets are looking for a rate cut which puts a lot of negative pressure on the $.

STAGFLATIONARY:

Growth will be below trend while inflation remains above the Fed's target. This is generally a weak trend for the $ because markets are looking for a rate cut, but as long as inflation remains above target (and things like the job market look strong), the Fed is likely to remain on hold or even raise rates when inflation looks to be trending up. Still, we want to trade with the trend and it's markets that set price.

The last one is something i've defined for lack of a better term

ELATIONARY:

Growth is at or above trend while inflation is in the Fed's target. A rare state of existence-we'll worry about it if and when it occurs again.

Where is the economy right now?

Before the latest figures were released on GDP and corePCE-the economy was pretty clearly in a stagflationary phase, with growth perhaps just about at trend levels and looking to go down, while core PCE remained above target and trending up on a YoY basis. Markets have been looking for a rate cut and this has put a lot of negative pressure on the $. So far, the Fed has maintained an inflation bias. While the Fed is unlikely to cut rates while the unemployment rate is low (currently 4.4%) and the job market is strong, markets are looking for one and this figures to keep the $ at depressed levels.

With the latest figures on GDP (1.3% and below trend) and core PCE (just above target at 2.1% on a YoY basis), the economy looks to be transitioning from a stagflationary to a deflationary phase, but there are a couple of things to realize:

The Q1 2007 GDP number is just the first estimate. Another estimate will be made next month and the final number will be released the month after that. Likewise, the core PCE is a prelimonary number which can be revised next month. Either number can be revised up or down. Market participants are likely to see growth to be in a declining trend, but it's way to early to make the same assesment for inflation since today's number was the first one to decrease on a YoY basis since November . The Fed will not change their bias from one PCE reading.

Still, the economy looks weak and inflation has improved. The $ has been weak and looks to be getting weaker, at least against the GBP and EUR. Markets will surely be thinking that a rate cut is closer.

There's a lot more that can be said; if you have an interest in getting deeper into this please let me know. Most people who trade i'm sure would just like to have a signal, make a few pips and be one their way, but if you're really into trading and want to be involved for a long time, I can only say that this is the kind of thing you really need to know about.

Initially, I have this bias that US companies prefer a strong USD. Knowing the currency exchange profit could give more buck per xxx currency means extra "magic" profit from thin air, then I would not be surprised to see "bad" US data derived from US companies (such as PMI, ISM, Philly Fed..).

We did get a lower PMI today, could we get bad ISM tommorrow?

I think you have that backward BK; US Multi-Nationals much prefer a weak $, as it makes their products cheaper (and more competitive) and gives them more $'s when they convert back.

Many economists do expect a weaker ISM reading coming off the weaker CHI PMI. You should also note that The CHI PMI headline number and components indicate that the economy is not near recession.

Just another note on consumer consumption-

Consumer spending is the "shoe" that everyone has been waiting to drop. With housing in the spin it's in, economists have been predicting the downturn to have an eventual effect on consumer demand. The consumer is 70% of the economy so watch the retail sales figures as they come out. As the consumer goes, so goes the US economy and so goes the $.

wouldn't weak dollar help manufacturing because more orders for export?
or it will have effect on long term?

Newstraderfx already mentioned that companies like a weak dollar, as it makes their products more competitive.

In the long-term, the USD will remain weak, or get weaker, as long as they keep dumping 12.8% more new dollars each year to pay for the debt.

The ISM numbers printed much stonger then expected-including the prices paid component. Inventories were adjusted down and that signals a boost production to satisfy demand.

Pending home sales fell by 4.9% to the lowest level seen in 4 years. While the February number was revised up to 1.1%, the index is down 10.5% when compared to the March 2006 number.

From BB:

"The index of pending home resales is considered a leading indicator because it tracks contract signings. The Realtors' existing-homes sales report tracks closings, which typically occur a month or two later. The Realtors group reported April 24 that sales of existing homes, which make up about 85 percent of residential sales, dropped 8.4 percent in March to the lowest level in more than three years".

Foreclosures are up by over 35% this year and homebuilders are reporting that the spring season has been weak. Spring is the major season in housing markets.

From BB:

"Residential construction fell at a 17 percent pace in the first quarter, subtracting 1 percentage point from overall economic growth, following bigger declines in the second half of 2006. Most economists are forecasting home construction will continue to drag on growth through this year and will turn neutral in 2008".

This indicates the Fed projections are pretty much on the money. Housing will probably continue to be a drag, but a good ISM indicates things can turn around in Q3 and Q4 as the Fed has projected. Fed policy is very likely to remain unchanged; the inflation bias will remain, especially with the prices paid component of the ISM being up and rates are more likely then not to remain unchanged.

Several analyists are saying that the jump in the April ISM is a lag result of the March CHI PMI. They are expecting the bump in ISM to be short-lived, because the April CHI PMI was well off the March reading.

Economists are looking at things like lower borrowing costs and a strong job market to provide a floor in housing and to provide continued support for things like consumer spending. The Friday NFP and unemployment numbers figure to be especially important this week.

I love your posts NFX, please keep them coming!

Just another note, the housing market woes have always made me wonder whether the FED has to lower interest rates to spur the economy as the market is one gigantic puzzle. So if the spillover from the housing market starts affecting the economy e.g. consumer spending, retail sales, manufacturing stuff, the FED would lower interest rates which would lead to a softer dollar.

However the reports today show that manufacturers have not been affected that much, and to add on to that, the soft dollar seems like it has affected exports such that exporters have more confidence as their profit margin rises.

Therefore, a lower interest rates would have a lower probability of playing out now as the FED seems like its still intent on battling inflation.

I would agree with that Jody-I have always felt that the Fed would remain on hold for longer then the market thinks-however-the $ is being driven lower by market expectations of a rate cut and the fact that right now-a weaker $ is supportive for the US economy. Multi Nationals are doing very well in a weak $ enviorment and it's in the best interests of the G7 economies to not see the US go into any kind of prolonged weakness.

It comes down to self-interest. Emerging market economies are rapidly expanding and that concerns the G7, despite the fact that they say they welcome it. The G7 controls 2/3's of global wealth and they want to keep it that way. That's why they constantly call for free floating currencies and trade barrier reductions.

While the ISM may provide a bit of a pop to the $, I still see the overall trend as being weak.

Excellent point DD-that could be one reason why the Fed decided to detach money supply from policy.

Comments by ISM Survey Head Robert Ore

Further comments by ISM survey head Robert Ore reflect doubts that further gains in the ISM will be seen, because the strength seen today was from a "low base effect that is not likely to be repeated". He stated that today's number "was likely to be a high for the quarter".

He went on to say that "underlying factors are not showing improvement" because "interest rates are not more favorable, consumer and government spending are flat and business investment has backed off".

The jump seen in employment was due in part to the wood products industry and was a "major and likely temporary factor".

The increase in Apparel was likely due to a seasonal jump, which would indicate a tempoary condition.

The comments were taken from a phone interview conducted by Market News International.

It took several years from 11000 to 12000
It took several months from 12000 to 13000

It was only a week since DOW climbed to 13,000 mark. Could DOW go to 14000 in shorter period? its already 800 points left to get there. Frenzied by the strong Profit reports by big companies.

With that, USDJPY has climbed back up and its now 120+. Hmmm Carry still very strong? or a correction coming very soon?

Well with such low ADP nonfarm employment #s out, could that be an indication of what we might see on fridays #'s?

The Carry Trade pairs-GBP/JPY, EUR/JPY, AUD/JPY and NZD/JPY have been in an upward trend for many months. The only time that carry trades really "unwound" was during the Feb. market rout. They all recovered in several weeks and are now above the pre-rout levels, as are many of the markets that corrected in the rout.

Within any trend are the inevitable retracements-likely due mostly to profit taking. As for the "carry trade" itself-it's alive and well. Several banks will be offering indexes that will track carry trade currencies-so the market is likely to grow.

With the latest data from Japan, it's obvious that the BoJ is going to have a difficult time normalizing rates. Right now, it looks like one more increase this year is the most likely scenario, but even with an increase-the carry trade will still be profitable.

As for trading them-the plan is simple; buy on the dips.