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Daily Currency Market Focus

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DJIA: Does the Panic of 1907 Offer Hope?

Thu, Oct 16 2008, 08:26 GMT
by Kathy Lien

GFT

FX MARKET HIT BY WEAK DATA, PRESSURE GROWS ON FED TO CUT INTEREST RATES

The currency and equity markets were hit by another wave of liquidation as weak economic data and a pessimistic Beige Book report highlighted the need for further interest rate cuts by the Federal Reserve. The biggest beneficiaries of the sell-off in equities continue to be the two lowest yielding G7 currencies which are the US dollar and Japanese Yen. Low yielding currencies tend to do well in times of slowing growth and volatility while high yielding currencies perform terribly. The equity market is having a very difficult time rallying as investors shift their focus from one problem to the next. Last week, it was the frozen credit markets and now that credit is thawing, the focus has turned to the potential severity of the US recession.

Expect Third Quarter GDP to Turn Negative

The definition of a recession is two consecutive quarters of negative GDP growth and so far we have only seen one quarter of negative growth which was then followed by a 2.8 percent increase in GDP in the second quarter. However the recent trend of consumer spending, which constitutes 70 percent of GDP suggests that there is a strong chance third quarter growth will be negative, putting the US halfway to qualifying for the technical definition of a recession. Retail sales fell by the largest amount since August 2005 as consumers cut spending on cars, furniture, electronics, clothing and sporting goods. Americans are eating out less and only spending on the necessities like health care and gas. Consumer spending has now declined every single month in the third quarter. The Empire State manufacturing survey fell to the lowest level since July 2001 while business inventories grew by a tepid 0.3 percent. According to the Beige Book report, all 12 Fed Districts saw slower growth last month with consumers cutting back and capital spending plans put on hold in light of the economic uncertainty. As for inflation, core producer prices increased but headline prices declined. The headline numbers have become just as important as the core numbers which means that the data today will pressure the Federal Reserve to continue cutting interest rates.

Bernanke: Signaling More Rate Cuts?

In a prepared speech to the Economic Club of New York, Fed Chairman Ben Bernanke said that the credit markets will take time to freeze and that an economic recovery will not happen immediately. He also indicated that the turmoil in the financial markets pose significant threats to growth. He has pledged to continue fighting the crisis and indicated that the TARP is not a “total solution.” Bernanke may be hinting to us that further rate cuts are needed, making 1 percent interest rates a growing possibility. Fed fund futures are pricing in an 85 percent chance that interest rates will be slashed to 1 percent before the end of the year.

DJIA: Does the Panic of 1907 Offer Hope?

After the horrid US data released this morning, there are plenty of reasons to believe that the equity markets including the Dow Jones Industrial Average are headed lower. However in every battle there are reasons for hope. According to a very interesting study published by Barclays Capital this morning, the current equity market movements are strikingly similar to that of the “Panic of 1907.” Back then, there were 5 waves in the equity market sell-off; a decline of 17%, followed by a 13% rise, another 22% decline, a 12% recovery and then the final push lower that drove equities down 37 percent between the second and fourth quarter of 1907. Taking a look back at the Dow’s move between 2007 to present, the numbers are eerily similar. Starting in Oct 2007, the Dow first slipped 18%, then rallied 13%, declined another 18%, recovered 10% and the latest decline from the August high to of 11,867 to the October low of 7,882 has been approximately 34%. This suggests that there could be one final push lower below 8000 before a long term bottom. When the rally does happen, it could be as much as 20 percent and after that, expect a long phase of consolidation. Back in 1907, there was a 15 year consolidation before the stock market picked up once again taking us into the Roaring 20s.

Consumer Prices, Jobless Claim, TIC and Industrial Production

The US economic calendar continues to be very busy tomorrow with consumer prices, jobless claims, industrial production and the Treasury’s International Capital flow report due for release. We expect most of the data to be dollar negative, but the one that we are most interested in is the TIC report. Although the data is for the month of August, which was before the meltdown in stocks, it will be interesting to see if there has massive repatriation of assets by foreign investors as the credit crisis escalates.

Published on  Thu, Oct 16 2008, 08:28 GMT