Inflation Scorecard: Goods Prices Flat to Lower

Retail prices, as reported by the U.S. Bureau of Labor Statistics' Consumer Price Index, were unchanged in February, bringing the yearlong increase for the index down to 2.1 percent. Wholesale prices reflected in the Producer Price Index for Finished Goods fell 0.6 percent last month, dropping the year-over-year inflation rate to 4.4 percent. Other inflation markers for the week ending Thursday:

Spring is in the Air

I am reminded that perception is everything.  Let's say I articulate the following to my wife, "Honey you look like the first day of spring today."  She will probably be very pleased and feel very good about herself and be content with me.  Now instead let's assume I am a buffoon, and instead comment to my wife, "Honey you look like the last day of long, cold, hard winter."  Knowing my wife - I would probably be sleeping in the doghouse until next spring when I would finally have a chance to redeem myself. 

Canada Retail Sales Push USD/CAD Toward Parity

    The  USDCAD  has moved to new lows at 1.0061 (trendline support). It is hard to see the USDCAD not testing parity soon.  The upside should be contained by1.0097 now.    

Greenspan's Bubble Review Du Jour

"All bubbles burst when risk aversion reaches its irreducible minimum," former Fed chairman Alan Greenspan writes in a new paper-"The Crisis"-for the Brookings Institution. That minimum, he advises, arrives with "credit spreads approaching zero, though analysts' ability to time the onset of deflation has proved illusive."

Dollar: Should the Fed Raise the Discount Rate?

Although the price action in the forex market today suggests that currency traders are nervous, the jitteriness was not shared by equity or bond traders who sent stocks to new yearly highs and pushed bond prices lower. Traders bid up the U.S. dollar against every major currency except for the New Zealand dollar which staged a very modest rally. The biggest story out of the U.S. was not necessarily economic reports but rather the rumor that the Fed could raise their discount rate mid-day. This never materialized but it brought up a good question about whether the central bank should narrow the gap between the discount rate and the Fed funds rate.

Should the Fed Raise the Discount Rate?

Rumors of a discount rate hike stirred a flurry of intraday activity in the U.S. financial markets intraday. The reason why we think this rumor is worth discussing is because it illustrates the different steps the Fed could take before actually raising the Fed funds rate. If you recall, the difference between the Fed funds rate and the discount rate is that the Fed funds rate is the rate that banks charge each other for loans while the discount rate is the rate that the Fed charges to commercial banks and other depositary institutions on loans. Raising the discount rate would help the Fed normalize monetary policy without affecting households. Prior to this easing cycle, the gap between the discount rate and the Fed funds rate was 100bp while the current spread is 50bp. Therefore this move is one that the Fed will eventually make but they will most likely telegraph it weeks in advance just like they did before they raised the discount rate last month. In fact, we would not be surprised if the Fed telegraphed this move in their next monetary policy statement and then follow through with it shortly thereafter.

U.S. Data Will Not Alter the Fed's Course

Meanwhile U.S. equities reached new 1 year highs this morning but currencies failed to follow. Like producer prices, consumer price growth fell short of expectations last month. CPI was flat in February due primarily to the large drop in gasoline prices. Excluding food and energy, consumer prices rose 0.1 percent. The latest inflation reports indicate that inflationary pressures are modest, but we continue to believe that the dip in inflation will be temporary because gas and oil prices have risen significantly so far this month. The CPI and PPI numbers have simply bought the Fed time and allowed them to gradually ease out of their ultra easy monetary policy. The sell-off in the dollar against the Yen was short-lived as traders realized that CPI numbers will not be a game changer for the U.S. dollar. Instead they found comfort in faster manufacturing activity reported in Philadelphia. Despite the prior dip in manufacturing activity in the NY region, the Philly Fed survey rose for the second month in a row to 18.9 from 17.6. Unlike the housing market which the Fed singled out as an area of concern in their FOMC statement, the manufacturing sector continues to recover. As for the rest of this morning's economic reports, jobless claims dipped but not as much as the market had anticipated. Even though the number of people receiving extended benefits decreased, the number of people receiving emergency benefits and continued benefits increased. The current account deficit also expanded from -$102.3B to -$115.6B while leading indicators rose 0.1 percent. No U.S. economic reports are due for release tomorrow which means it could be another day of quiet trading.

EUR/USD: EU LEADERS RELUCTANT TO OFFER GREECE A LIFELINE

The euro sold off aggressively after it has become increasingly clear that members of the European Union will be more willing to support Greece in knocking on the doors of the IMF than to dig into their own pocketbooks. Initially, the option of the tapping IMF was one that most members of the EU and the ECB ruled out. However the inability of EU finance ministers to create a concrete contingency plan has forced certain countries like Germany to reconsider the IMF option. Although tapping the IMF would be a huge negative for the Eurozone as a whole (imagine the reaction in the U.S. dollar if the U.S. government asked the IMF for help bailing out California), Germany apparently believes that it would be political suicide to ask their citizens to pay for the problems of another country. This morning, German Chancellor Angela Merkel said in the absence of a willing European lender, the "IMF would probably have to be the way out right now if action were to be taken." She even went a step further to say that there should be a mechanism to expel countries out of the Eurozone if they persistently break the Treaty's rules. Although she made it clear that this was not a jab at Greece and is more of a long term consideration, it could still affect Greece if they fall back into their old ways after this crisis is resolved. Greece has given EU leaders 1 week to come up with a financial aid mechanism. If they fail to do so, Prime Minister Papandreou said he may turn to the IMF. EU leaders have a meeting next week to decide on if and how to provide a lifeline for Greece. French President Sarkozy does not support seeking IMF assistance so it should be a heated meeting. Based upon the latest comments from Merkel, we are not very optimistic that they will come to a resolution, particularly since EU members have repeatedly stressed that Greece does not need a bailout at this time. The euro also received no help from economic data. Both the trade balance and current account surpluses turned into a deficit in January due to weakness in Germany. Meanwhile the Swiss Franc fell to the lowest level against the euro since October 2008 and the lowest level against the British pound since November 2007. The weaker than expected trade numbers were offset by stronger industrial production. At some point the Swiss National Bank will feel compelled to intervene and we believe that the franc is nearing that level.

GBP/USD: EMPLOYMENT GIVES NEW LIFE TO THE POUND

Weaker than expected U.K. economic data forced the pound to give up its gains against the U.S. dollar but greater problems in the Eurozone helped sterling strengthen against the euro for the third trading day in a row. In the month of February, mortgage approvals rose only 48k, compared to a forecast of 54k. Public sector net borrowing rose 12.4B last month which was slightly less than the market had anticipated but still the highest level of borrowing ever for the month of February. So far this year, the U.K. government has borrowed GBP131.867, pushing debt as a percentage of GDP above 60 percent. However despite these staggering numbers, sterling traders should find comfort in the idea that the U.K. government is on track to undershoot its forecasted borrowing needs of GBP170.4 billion in the year ending in April 2010. If the U.K. can consistently borrow less than forecast, there would be a lower risk of a downgrade. There has been an interesting turn in the events for the U.K. this week and we strongly believe that the recent rally in the British pound has encouraged short sterling traders to unwind some positions. Yet it is also important to realize that the U.K. economy is not out of the woods. The CBI Industrial Trends survey deteriorated slightly in March which suggests that manufacturing activity may have slowed. There are no additional economic reports due from the U.K. this week.

USD/CAD: UPSIDE POTENTIAL FOR RETAIL SALES

Of the three commodity currencies, only the New Zealand dollar strengthened against the greenback. The rally in the kiwi was quite bizarre considering that consumer confidence deteriorated. Visitor arrivals and credit card spending figures are due for release this evening but these are rarely market moving reports for the kiwi. The market's focus continues to be on the Canadian dollar, which has taken what we believe to be a temporary reprieve from its path towards parity with the U.S. dollar. Canadian economic data has been very strong and this morning's international securities transaction report was no exception. Foreign demand for Canadian dollar denominated securities rose for the fourth consecutive month. Friday will be a particularly busy day for the loonie with consumer prices and retail sales due for release. Although the strength of the CAD could push down inflationary pressures, we expect retail sales to be strong. Canada has reported positive job growth 7 out of the past 11 months while wholesale sales rose the most in 3 years. Strong consumer spending numbers could be just what the Canadian dollar needs to push itself to parity with the U.S. dollar. Canadian officials have been extremely relaxed about the move in the loonie which is yet another reason why we expect further gains. Finally, the Australian dollar ended the NY trading session slightly lower against the greenback. There was no major data released overnight and nothing is expected this evening.

USD/JPY: VOLATILITY CONTRACTS

For the past 6 trading days, the Japanese Yen has ended virtually unchanged against the U.S. dollar. In fact, USD/JPY has been contained within a 148 pip trading range since March 8th and as a result, one and three month option volatilities have fallen to the lowest level in 19 months. This of course suggests that a breakout in USD/JPY is imminent. However there is no U.S. economic data on the calendar tomorrow which means that traders will most likely have to wait until next week to see any big moves in the currency. Aside from the kiwi, the Japanese Yen strengthened against every major currency despite weaker economic data. The BSI All Industry activity index fell from -1.9 to -2.4 in the first quarter and from 13.2 to 4.3 for the large manufacturing sector. Leading indicators were also revised slightly lower while the conicnident indicator was revised higher. Department store sales are due for release this evening and unfortunately consumer spending will probably remain weak.

USD/CAD: Currency in Play for Next 24 Hours

USD/CAD will be the currency pair in play for the next 24 hours. Canada expects an array of economic releases including Consumer Price Index figures at 11:00 GMT or 7:00AM EST and Retail Sales at 12:30GMT or 8:30AM EST. Entrenched in the Sell Zone of the Bollinger bands, USD/CAD has made big strides towards parity. The pair still remains within the Sell Zone, but is rebounding after a prolonged downtrend. The key level of resistance which may stop the current rebound is the first standard deviation at 1.0885. Support is currently placed at a one-year low benchmark of 1.0070, a break of which will push the pair towards parity.

 

 

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U.S. Dollar: Dip in Inflation Should Be Temporary

As we have seen from the price action in the forex markets today, what is good for U.S. equities is not necessarily good for the U.S. dollar. The Dow Jones Industrial Average climbed to a 17 year high intraday while the S&P 500 climbed to an 18th month high. Yet the dollar either remained unchanged or weakened against every major currency except for the euro. Currencies and equities behaved very differently because of the nature of the catalyst. The steeper than expected fall in producer prices help to explain why the Federal Reserve decided to keep rates at extremely low levels for an "extended period" of time. Low interest rates are good for stocks because it limits the cost of borrowing but it is bad for the dollar because it reduces the attractiveness of the greenback from a yield perspective. With that in mind however, the market's reaction to the PPI report is still relatively modest.

What to Expect for CPI and Beyond

Although the decline in producer prices suggests that tomorrow's consumer price report will reinforce the lack of inflation in February, we continue to expect a lackluster reaction in the forex market. Gas prices fell significantly in the first half of last month but have since risen to a 1.5 year high. Producer prices fell 0.6 percent in the month of February due primarily to a big drop in energy costs. Excluding food and energy, producer prices actually rose 0.1 percent. However, with oil prices increasing materially since then, the decline in PPI and in turn, CPI should be temporary. For the Fed, this is a good enough excuse o ease their way out of their easy monetary policy in the most gradual way possible. They want to take it one step at a time by first upgrading their assessment of the economy, ending asset purchases and terminating their liquidity facilities. Then they will probably drop the "extended period," and move to raising interest rates a month or two later. This timing is in line with a prior prediction from Fed President Evans. In his testimony on Capitol Hill today, Bernanke also said that keeping rates "too low for too long" could cause inflation. Aside from the CPI report, which we expect to be mildly negative for the dollar, jobless claims, the current account balance, Philadelphia Fed index and leading indicators are also due for release. The deterioration in the trade balance last quarter and the slightly smaller influx of foreign capital should lead to a softer than expected current account balance. Leading indicators should rise but the Philly Fed survey could drop following the decline in the Empire State Manufacturing report.

EUR/USD: NEW ROADBLOCKS FORM FOR GREEK AID

The euro remains range stricken on the continued uncertainty about the possibility of a Greek aid package. German President Angela Merkel was the latest to weigh in on the subject, saying that governments should not make any "rash decisions" in committing funds to help the debt ridden country. Merkel went further by proposing new rules that would see the expulsion of Euro-zone members who manage to consistently defy the requirements set forth by the Maastricht Treaty. Even though current laws would make such a proposal unlikely, her comments serve as a shot in the arm for those trying to put a package together. In her statement today, Merkel also made an effort to satisfy angered Germans who vehemently oppose any sort of bail-out. Since Germany would have to stand in as the main financial backer of such a plan, it is looking more unlikely that Greece will be receiving help anytime soon. Nevertheless, Merkel finds that the situation is probably the "greatest challenge yet to face the euro." Today's data proved to be another disappointment. Construction Output slowed to the weakest pace in more than a year, led by particular softness coming from Germany. Labor Costs rose at the weakest pace in four years, adding new questions as to the health of the employment market. Tomorrow's event risks come in the form of the Euro-zone's Current Account and Trade Balance.

GBP/USD: EMPLOYMENT GIVES NEW LIFE TO THE POUND

The pound accelerates its winning streak to the best 2-day rally in six months. The gains were precipitated after the release of the employment report, which served as a big victory for the British recovery. The pound has been on very shaky ground since the release of last month's employment numbers, which proved to be a major disappointment to markets. However, in one month's time, the picture has completely reversed. Jobless Claims fell by 32.3K or the largest amount in more than 12 years. To make things better, last month's discouraging gain of 23.5K was revised to the downside to a much more manageable increase. Meanwhile, the unemployment rate eased to 4.9%. This one report changes a lot for the country's outlook, but the number has been consistently volatile meaning that only time will tell if these gains will be sustained. The Bank of England's minutes were also released today and what was most notable in their report was their comment on new inflation risks. The monetary policy committee found that "upside risks increased slightly" and said CPI could remain above target, which is probably one of the most hawkish BoE statements that we heard from the central bank in a very long time. Even though it is easy to see that the BoE is far from convinced, they will most likely refrain from boosting QE on these signs alone.

AUD/USD: RATES COULD STILL RISE

The Australian, Canadian and New Zealand dollars extended their gains against the greenback with the Aussie hitting a 2 month high and the loonie reaching a new one year high. Today's central bank comments helped to fuel further gains in the Aussie. The Reserve Bank of Australia's Guy Debelle said that rates "look likely to rise a bit further." Clearly, with added signs provided by yesterday's reserve bank minutes, interest rates have not yet reached ‘normal levels'. Economic data also managed to boost confidence in the Aussie, with the Westpac Leading Index rising 0.2 percent to its highest since August 2008. In Canada, the loonie ran to its highest since July 2008 and continues to make its way towards parity. The Canadian government removed a big roadblock for continued CAD strength with the comments from the Canadian Industry Minister. He contends that the country's exporters are "learning to live with" the higher currency. After similar comments from the Canadian Finance Minister, it's safe to say that we can no longer expect officials to talk down the currency as we have seen in the past. The Canadian dollar is enjoying its long stretch of strength against its U.S. counterpart/competitor/partner since July. With little resistance in sight, we believe that the loonie will soon reach parity with the U.S. dollar. Oil prices continue to rise while economic data continues to surprise to the upside. In the month of January, wholesale prices rose by the largest amount in 3 years, which is significant because retail sales (which is due for release on Friday) tends to have a strong correlation with the wholesale figures. The surprisingly strong economic reports have encouraged traders to downplay the recent concerns from Finance Minister Flaherty who called the recovery fragile. Based upon the latest numbers - it is far from that! The persistent rise in oil prices will also help to support oil producers and increase pressure on the Bank of Canada to continue unwinding their emergency measures. So far, there are little signs of weakness and as long as the economy is not moving 1 step forward and 2 steps back, it won't be long before the Canadian dollar reaches parity with the U.S. dollar once again. At that time, the more interesting question becomes how long USD/CAD will remain at parity. The last time the currency pair hit that level was in late 2007, early 2008. The move below parity only lasted for about 2 weeks before the loonie choked up its gains. Canada will release its International Securities Transactions report tomorrow while New Zealand will deliver its latest consumer confidence numbers.

USD/JPY: BOJ DOUBLES STIMULUS

The big event overnight was the Bank of Japan announcement. The central bank doubled the size of their special lending program to 20 trillion yen, making them effectively the most dovish G7 central bank. Interest rates were left unchanged at 0.1 percent, but that did not stop the Japanese Yen from trading lower against all of the major currencies. Given that the central bank upgraded their economic outlook for the first time in 8 months earlier this week, their move was clearly an attempt to pacify government officials who have been on their backs to use monetary policy to jumpstart inflation. Not all members wanted to bend over backwards for the politicians however - for the first time since last October, Noda and Suda dissented. In a statement released after the monetary policy meeting, the BoJ said "Japan's economy is picking up, mainly due to various policy measures taken at home and abroad, although there is not yet sufficient momentum to support a self-sustaining recovery in domestic private demand." Shirakawa also said ""Showing the BOJ's clear stance against deflation will help ensure an improvement in the economy and prices." The question now is whether the BoJ's act will be effective in bolstering prices. The BoJ has increased the money supply, but this is not the real problem - the main issue is that Japanese consumers are not willing to take money out of their wallets and spend. Although the Japanese Yen did not have a big reaction because the announcement was not much of a surprise, it provides an additional reason why the Japanese Yen could extend its losses against the U.S. dollar.

EUR/USD: Currency in Play for Next 24 Hours

EUR/USD will be the currency pair in play for the next 24 hours. The Eurozone will be announcing its Current Account balance at 5:00 am ET or 9:00 GMT followed by the Trade Balance an hour later. Then, in the US, we can expect the Consumer Price Index and Current Account Balance at 8:30 am ET or 12:30 GMT followed by the Philly Fed and Leading Indicators at 10:00 am ET or 14:00 GMT.

Even though the euro lost track of earlier gains, the pair still remains within the Bollinger band buy zone. However, this does not diminish the fact that the pair is still within a clearly defined contractionary range. Today's losses represent yet another retreat off of the powerful 1.3800 resistance level, which has served to push prices lower on several occasions. Support, on the other hand, seems to be firmly rested on the 10-day moving average at about 1.3670. Nevertheless, once again we can expect that it will take a significant catalyst in tomorrow's numbers to break the recent trend.

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Two Really Bad Deals

I don't know if Obamacare is going to pass the House or not. As of this morning, the Intrade pay-to-play betting parlor is giving a 75 percent probability that it will go through. So Intrade seems to think so. But here's what I do know: Obamacare's worst tax hike is the imposition of a new 3.9 percent Medicare payroll tax on capital gains and other investments.

What will this do? It will depress the economy, depress wages, and depress jobs. Washington doesn't understand that you can't create jobs without new healthy businesses. Can there be anything dumber?

Look, raising the capital-gains tax to 24 percent from 15 percent, which includes repealing the Bush tax cut, is a 60 percent tax increase. So, instead of keeping 85 cents on the extra dollar invested, you only get to keep 76 cents. That's a 10 percent drop in the after-tax incentive for capital formation. Incentives matter. This is a bad deal for everyone.

If Washington keeps hiking taxes on investment and risk-taking, we're not going to get the new entrepreneurial businesses, job-creation, productivity, or high-risk innovation and invention that are so essential to a healthy and vibrant economy.

Here's another really bad deal: The protected and privileged class of mostly unionized government workers at all levels is bankrupting this country. These workers are demanding exorbitant wages and benefits. Get this: A new Bureau of Labor Statistics report shows these government workers to have a 44 percent excess of total compensation versus their private-sector counterparts. This, despite the fact that these government workers enjoy much better job security.

I've talked about this before. But a recent Barron's article highlights the states' problems, where pensions look to be $3 trillion in the hole with double-dipping and spiking. This is going to create huge problems down the road in the tax-free municipal-bond markets. Of course, it's also going to be a problem for taxpayers who may wind up having to finance these ridiculously exorbitant pensions with all their double-dipping and spiking. It's ultimately one gigantic stranglehold on the economy.

To be blunt: Obamacare's tax-and-spend and government union spend-and-spend are thumbing their noses at taxpayers and economic growth.

Core Inflation Drops To 6-Year Low. Surprised?

Real-time Monetary Inflation (last 12 months): 2.0% It's that time of the month again. For our visit with the Bureau of Labor Statistics, I mean. Yesterday, the government released the February update to the Producer Price Index (PPI) and followed on with this morning's publication of the latest Consumer Price Index (CPI).

Is it Getting Better? Or Just Not Getting Worse?

Sometimes the waiting game is the only game in town when it comes to evaluating the economic numbers du jour. That seems to apply to this morning's updates in consumer inflation and weekly jobless claims. The news tends to be encouraging, but we're still a long way from declaring victory.

The Role of Economic Bloggers

Tomorrow I will head for the Kauffman Foundation Economic Bloggers Forum.  The program is very interesting and includes many panelists whom I frequently cite.  I look forward to meeting and talking with some blogging colleagues.  There is a web link for people who want to keep tabs on the proceedings. Successful Economic Blogging