We are inching closer to a formal bailout plan for the Big 3 automakers and as previously suggested, regardless of the final outcome, the markets will cheer an end to the drawn out drama. The rally in equities this morning have driven major currencies higher against the US dollar and Japanese Yen, but it remains to be seen whether the improvement in investor sentiment will last. We are walking into a lot of potentially weak economic data on Thursday and Friday that could serve as a harsh reminder of the problems that the US economy faces. The PPI and retail sales figures should resurrect concerns that deflation and depression will hit the US.
The Treasury market is already pricing in the possibility of deflation and depression with yields in zero to negative territory for the first time since the Great Depression. Fed Fund futures are pricing in a 100 percent chance of a 75bp rate cut from the Federal Reserve next week. This would take US rates to 0.25%, making the US dollar the lowest yielding currency in the developed world. Although the greenback has remained weak against the Japanese Yen, if the Fed takes interest rates to zero, we could see the dollar fall to 13 year lows against the Japanese Yen.
In every major bear market, there are relief rallies and that is what we have seen today. The Dow Jones Industrial Average dropped more than 300 points during the US trading session before reversing violently to end the day up more than 550 points. The major turnaround in equities has forced the US dollar to give back its gains.
However as much as I would love to see the global unwind come to an end, the continued weakness in US economic data makes me really skeptical of this rally. Nothing is behind the move other than short covering. Therefore this could be more of mirage than a bottom for currencies and equities.
Ask Your Neighbor About Retail Sales
Jobless claims rose 516k last week to the highest level since September 2001 and it has a direct correlation with consumer spending. Retail sales are expected to contract for the fourth consecutive month. The recent bankruptcies and profit warnings confirms that US retailers are already struggling. Both ISCS and SpendingPulse reported a sharp decline in sales while various independent studies across the nation report that consumers are cutting back. The recent drop in oil prices means that gasoline receipts will fall as well. The average price of a gallon of gasoline has fallen close to 50 percent from its summer highs. We don’t expect consumer spending to recover until well after the holiday shopping season. Just ask your neighbor and he will probably tell you that he is cutting back his spending as well.
No V Shaped Recovery
The global unwind continues this morning with US equities, commodities and currencies taking another beating. The US dollar and Japanese Yen continue to outperform with the British pound hitting a fresh 5 year low.
The story is still the same, which is sell first and ask questions later. It is earnings season and the reports that we have seen so far are a harsh reminder of the growing problems in the US economy. Retail sales are due for release on Friday and the warnings from retailers indicates that consumer spending has slowed materially.
Best Buy cut its full year forecast today, DHL is shutting down its US operations and Circuit City became the 14th retail chain to go bankrupt, joining companies like Linen N Things and Steve and Barry.
We are in a global easing cycle and the market expects central banks around the world to follow the UK’s aggressive interest rate cuts.
Central Bank Meetings: What Do I Expect for December
Federal Reserve: 50bp cut
Bank of England: 75bp cut
European Central Bank: 50bp cut
Reserve Bank of Australia: 75bp cut
Reserve Bank of New Zealand: 75 to 100bp cut
Bank of Canada: 50bp cut
Bank of Japan Japan: no rate cut
Paulson’s comments aren’t helping either:
Retail sales dropped by the most since August 2005 as consumers cut spending on cars, furniture, electronics, clothing and sporting goods. Americans are even eating out less and only spending on the necessities – health care and gas.
With fears of a deep recession that may feel like the depression driving the dollar and equities lower, the latest consumer spending report suggests that GDP growth in the third quarter may be negative. Retail sales dropped every single month in the third quarter and since consumer spending is such a big component of GDP, we may finally see those recessionary growth numbers. Core producer prices increased but headline prices declined. Headline numbers have become just as important as the core numbers, which means that the data today gives the Federal Reserve an excuse to continue cutting interest rates.
Interest rates at 1 percent before the end of the year is a very real possibility. Given the way the futures markets are trading, there is a decent chance that we will see the Dow test 9000 today. This will weigh on USD/JPY and other carry trades. Over the past few weeks, the equity market has been sell-off positive for the dollar but negative for the Japanese Yen.
Here is the “In the Financial Papers Radio Broadcast” (Length: 5:04 minutes). The player should load automatically. Please let me know if you like it. Contact Kathy
Read my Daily report on DailyFX.com
In the Financial Papers:
Reserve Bank of New Zealand Cuts Interest Rates
German Business Confidence Hits 3 Year Low
UK Retail Sales Sees Biggest Drop in 22 Years
Jobless Claims Crack Above 400k – 2001 Levels
Crude and Food Falls Help Lift Equities
Oil in the Artic
Chinese Banks Told to Tighten Mortgages
Fed’s Beige Book Report Relects Caution
Amazon Profit Higher on Weaker Dollar
Housing Bill Will Extend Federal Role in Markets