Forex Investment and Currency Trading

Some easing in market strains, along with growing arguments that monetary policy is sufficiently accommodative, has led market participants to expect little in the way of further Fed rate cuts. While market expect that the FOMC will ease only 25 basis points at its upcoming meeting, market cautions that economic fundamentals remain weak, and still look for a 1.5% funds rate target later this year. Tight credit conditions, mounting job losses, soaring energy costs, and falling home values provide an unfavorable backdrop for consumer spending, as recent reports have indicated. Importantly, few signs of housing recovery have yet emerged, and inventory accumulation in 1Q may point to weaker production ahead.

A 25 basis point ease is now expected at the upcoming April 29-30 Fed meeting, but continue to see moderate further easing ahead. Economic conditions remain weak, with below-1% GDP growth likely in the first half of 2008. Aided by accommodative monetary policy and the recently enacted fiscal stimulus package, market does anticipate gradual economic improvement in 2H 2008. The Fed call has changed for two primary reasons. First, the recent sharp gains in headline inflation, led by sustained energy, food and other commodity price pressures and related in part to lower U.S. interest rates and the weak dollar, are increasingly worrisome to the FOMC. Multiple dissents in March make clear that this issue has already played an important part in Fed deliberations. Secondly, the Fed funds futures market is currently pricing in a 25 basis point cut in the funds rate on April 30th. Unless market and/or economic conditions deteriorate sharply in the coming days, the FOMC is not likely to ease more than Fed funds futures anticipate.

Releases last week for March confirmed the Fed’s Beige Book summary that economic activity has continued to weaken. Ongoing declines in housing were highlighted by the March drop in single-family and multi-family housing starts. Total starts fell a greater-than-expected 11.9% to 947,000 units, and declined at an 34.5% annualized pace in 1Q 2008, suggesting a continued significant housing drag on GDP growth. Building permits, a proxy for future building activity also fell 5.8%. After falling 0.4% in February, retail sales advanced 0.2% in March. However, excluding gasoline store sales, retail sales were flat. The key control group, which is retail sales excluding the automotive, building materials and gasoline categories, advanced at a 0.9% annualized pace in 1Q, the smallest quarterly increase since 2002. While industrial production advanced 0.3% in March, it was flat in Q1 and manufacturing output fell for a second straight quarter.

Producer prices soared 1.1% in March as higher energy and food prices drove up the index. Core producer prices posted a moderate 0.2% advance. Core intermediate goods prices jumped 1.1% in March and are up 5.5% over the past year, an additional source of concern. Boosted by a 1.9% increase in energy costs, the consumer price index advanced 0.3% in March. Stripping out the volatile food and energy components, the core CPI increased 0.2% for a second consecutive month. On a year-over-year basis, the core index is up 2.4%. While a slowing economy will ease price pressures in the months ahead, persistent headline inflation remains worrisome.

Despite less favorable trade trade data in February, market now estimates just above-1% GDP growth last quarter. However, domestic demand likely declined in Q1, and it is expected to remain flat this quarter. Somewhat larger (and undesired) inventory accumulation added an estimated one percent to Q1 GDP growth, and likely points to weaker production this quarter.  A slight GDP decline in 2Q 2008, and a soft rebound in the second half of the year are now expected. The unemployment rate will continue to drift higher for the balance of the year and into 2009.

An interesting dichotomy appears to be developing between existing and new home sales. Over the past five months, existing home sales have somewhat stabilized, albeit at a very low level. Over the same time period, new home sales have continued to weaken. Given the headwinds of falling employment, tight lending conditions and deteriorating credit quality and falling net worth, a recovery in home sales in 2008 remains at best a remote possibility. In addition, declines or downward pressures in selling prices should continue through the year.

The various leading indicators for durable goods orders are pointing to a third consecutive decline. The transportation component is expected to be off sharply as Boeing reported sharply weaker March orders. In addition, a strike at a motor vehicle parts manufacturer likely also weighed on transportation orders. And finally, the Institute for Supply Management reported that manufacturing orders also contracted in March. While uncertainty about economic conditions is leading to a subdued outlook for manufacturers, prospects for capital spending over the balance of 2008 are at least supported by the temporary change in the tax code that allows firms to expense certain depreciable business assets.