Highlights

  • First manufacturing survey data for July show slower downward movement

  • Fed predicts sluggish growth in H2, sharper acceleration in 2010/11


Balancing act in Congress: Bernanke explains monetary policy

Equity markets are continuing to dominate exchange rate movements. Corporate earnings data published so far suggest that the pessimism in the run-up to the reporting season was exaggerated; US banks and the technology sector in particular have posted better than expected results. However, the impending insolvency of US commercial lender CIT blotted the favourable picture. At any rate, the equity markets firmed significantly during the course of the week; the Dow Jones rose by about 7%, the Dax by over 9%. However, the equity markets are still quite a way from reaching the highs of the beginning of June.

Exchange rate movements were not as pronounced. Compared to last Friday’s fixing, EURUSD has risen in the last few days by around 2 US cents to 1.41, breaching 1.4150 at times.
Rates are thus at the upper end, but clearly within the trading range of the last two months. As equity markets strengthened again, so did USD-JPY after making a foray towards 92. At the end of the week, the dollar is trading at slightly below 94.

This week there was no strong impetus from fundamentals. The few European data published were somewhat disappointing: the ZEW economic sentiment for Germany has deteriorated by 5.3 points compared to the previous month to 39.3. The assessment of the current situation has only improved marginally to –89.3, thus remaining more or less stuck in the cyclical low. Despite significant increases in Germany and France, EMU industrial production in May only rose by 0.5% month-on-month; it was thus still about 17% lower than the previous year.

On the US side, the figures were mixed: at –0.4%, industrial production continued its decline, albeit at the slowest rate in the last eight months. The most important manufacturing industries – automobiles, mechanical engineering, and electronics – are still clearly trending downwards. The decline in the whole of the second quarter was thus 3.1%, not as sharp a drop as in Q1 (–5.2%).

The future prospects for the manufacturing sector are not yet clear. Whereas the NY Empire manufacturing index for July posted a relatively noticeable improvement from –9.4 to –0.6%, the Philly Fed index fell equally noticeably from – 2.2 to –7.5. All in all, the survey data suggest that the weak downward trend is set to continue for the time being. Both surveys show an improvement in the assessment of industrial new orders (more or less sideways), whereas employment is judged to be heading clearly downwards. Thus the decisive question as to whether the weak labour market is dragging demand down and thus prolonging the downward trend, or whether the stabilisation of demand can boost the labour market, remains open.

On the whole, the US economic indicators merely confirm the notion that the situation is stabilising. However, despite massive fiscal and monetary policy support, the data still show no sign of an economic recovery.

The Fed is assuming that a recovery will set in during the second half of 2009; it is expected to be sluggish at first, but then accelerate in 2010 and 2011. The minutes of the FOMC meeting of 23 and 24 June give the Fed’s latest projections, which have been revised upwards; growth is predicted to be –1.25% (0.25) this year, about 2.7% (0.6) in 2010 and as much as 4.2% (0.4) in 2011. However, the upwards revision of the growth projections is to some extent in direct contrast to the developments in the labour market, which The Fed now deems to be worse than before. The Fed is describing an upswing, which is having virtually no impact on the labour market.

Fed chief Ben Bernanke is likely to use the latest projections as the basis for his testimony to Congress next week. On Tuesday and Wednesday, Mr Bernanke will present the new monetary policy report to the respective committees. His main aim will probably be to basically boost economic optimism without questioning the current monetary policy. Market participants will be most interested to gain information on when and how the Fed might switch to a less expansive monetary policy.

We are expecting Mr Bernanke to broach the exit question. However, at the same time, pointing out the fragile nature of the upswing scenario, very low capacity utilisation and subdued price increases, he will underline the necessity of maintaining the monetary policy stance for the time being.