Rising inflation and a slowing economy have left central bankers in a tough situation. The US continues to suffer through the doldrums created by the housing slump and credit market turmoil, while other world economies are starting to feel weakness from the housing and credit crises seep into their own economies. Commodity prices have cooled off in the last few weeks, but remain at elevated levels that can still hurt businesses and cause inflation. All this means that central bankers face a long, hot, difficult August in which they will be forced to negotiate the narrow path between growth and inflation, buffeted by events in the equity, FX and commodity markets. The monetary balance is delicate, and any mistakes risk setting off stagflation the likes of which have not been seen since the 1970’s.
Equities Groping for a Bottom
Earnings season will be winding down during the first half of August, but some important companies will report at the beginning of the month, including Cisco (8/5), Proctor & Gamble (8/5), AIG (8/6), RBS (8/8), WMT (8/14), TGT (8/19) and HP (8/19). After recent cautious comments from CEO Chambers, Cisco’s report could be a downbeat capstone on a quarter in which the tech sector has reported mixed results. On the retail front, Wal-Mart has been outperforming rival discount stores, and has become something of an indicator for the belt tightening throughout the economy. Target, with slightly higher end merchandise, may continue to get hit in a weakening economy. AIG and RBS will supply a few more data points for the financial sector, and could help determine if July was truly a bottom for the ailing industry. After mortgage lender IndyMac was taken over by the FDIC last month, any further bank failures could sour the financial sector. As of the spring, the FDIC listed only 90 banks as “troubled,” but that number may officially rise this month when the agency is expected to release an updated list of at risk banks.
Down Under Banks Under Pressure
Up until recently, most investors thought Australian banks would escape relatively unscathed from the credit crisis, but recent writedowns at National Australia Bank and ANZ Bank dispelled any such notions. The CEO of ANZ recently told reporters that Australia's leading banks have been heavily targeted for short selling hedge funds because liquidity on Australian equity markets is thin and local institutional investors are too constrained by their performance versus the stock market indices to take on short sellers. Some analysts also argue that Australia's financial risk makes the Australian dollar look expensive, since any bad debts will impact domestic economic activity.
FOREX Market Roulette
August is usually a time of illiquidity and "illogical" moves in the global asset markets. Currency dealers acutely remember the endless sub-prime summer of last year and the upcoming month appears to developing a characteristic of “headline roulette” as economic data on all continents seems to be slipping into a lower gear or perhaps into reverse, while inflation data is trending higher due to food and energy.
Central Banks continue to debate which type of data should be the catalyst for their monetary focus: inflationary data or economic growth components. The Aug 7th ECB and BOE policy meetings should clarify this debate. Sources indicate that the ECB would seriously consider raising interest rates again if inflation expectations continue to rise despite any contraction in the Q2 Euro-Zone GDP. With NYMEX crude off some $15 off its all-time highs made in July, it could provide some ‘breathing room’ for the ECB to pause from its recent tightening mode and hawkish rhetoric.
During latter part of July, FX dealers were beginning to get a sense that perhaps the multi-year USD downtrend could be coming to an end as the EUR/USD level of 1.60 appears to be the ‘threshold’ of pain for the European Exporters.
In terms of interest rate outlooks, no G7 Central Bank is expected to adjust its monetary policy during Aug, but the SNB is looking likely to raise its key target by 25 in Sept.
The Fed and Economic Data
The FOMC convenes early in August (8/5) for another rate decision. Expectations are for rates to remain on hold at 2.00%, but the committee may ratchet up its rhetoric about hiking rates. In recent weeks, several Fed members have explicitly stated they do not have the luxury of waiting for the markets to fully recover from the credit crisis before raising rates. This opinion is informed by data showing inflation trends above comfort levels, driven by rising commodity costs. To that end, this month’s CPI (8/14) and PPI (8/19) reports will be closely watched. Last month the headline CPI, including food and energy, rose at the fastest rate in over two years, and the headline PPI rose at its fastest rate since an aberrational spike to 2.6% six months ago. A clearer picture of the FOMC’s decision will be revealed in the minutes of the meeting, to be released on Aug. 26.
Commodities Still Stealing Focus
The commodities fever broke, at least temporarily, after crude and natural gas futures moved below their uptrend lines and plummeted to three month lows in July, as banks liquidated winning commodity positions, geopolitical hot spots cooled off, and higher prices caused demand destruction. Natural gas futures fell as much as 35% and crude futures 19% off of highs in the span of three weeks.
As usual, commodity markets can be most affected by unexpected events. On the geopolitical front, major upcoming media events including the Olympics and the two US national party conventions, could increase speculation of a terrorist attack. And there is always the specter of Israel taking unilateral action against Iran’s nuclear program. Iran has an August 3 deadline to respond to the major powers’ latest overtures or it will face new sanctions. Mother nature can play tricks on the commodities market, as well. Gulf of Mexico oil production was unscathed by the first major storm of the season, Dolly, but the threat of storm damage will rise as we enter the heart of the hurricane season.
China and the Games
The Olympic Games will be a major focus for the world this month. China has said terrorism is the greatest threat to the Aug. 8-24 Olympics and that it has broken up several cells of separatist militants in Xinjiang, the oil-rich Central Asian region that borders Pakistan and Afghanistan. Even if there are no disruptions at the Olympics, the outlook for growth is skewed to the downside once the Olympic flame goes out. There is some concern that the Olympics could be an inflection point for the Chinese economy, and that the country could see a letdown after the breakneck economic growth seen leading up to the Games.
Calendar Notable Upcoming Events
Aug 3: Deadline for Iran to respond to latest nuclear talks
Aug 5: FOMC rate decision
Aug 7: BoE and ECB rate decisions
Aug 8: Beijing Olympics begin
Aug 14: CPI report
Aug 19: PPI report
Aug 25-28: Democratic National Convention in Denver
Aug 26: Minutes of the August 5 FOMC meeting
Aug 28: Preliminary US Q2 GDP (second Q2 reading)
Sept 1-4: Republican National Convention in Minneapolis
Sept 5: August Non Farm Payrolls and Unemployment data
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