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TRADE IDEAS
Euro appreciated against US dollar, while funding currencies showed low volatility.
• EUR/CHF demonstrated low volatility for the second consecutive week. Nevertheless, last week was completed by the slight appreciation of Euro against Swiss franc. I still remain bullish and my medium term target for this currency pair is 1.637. Moreover, I issue long recommendation at 1.589.
• Following the single European currency Swiss franc strengthened a little against British pound. However, GBP/CHF still fluctuated in a tight range (may be the first sign of the downturn completion). Good level for buying is still 2.1, because the pound is still extremely undervalued against franc. Targets have not changed. Medium term targets for this currency pair are 2.199 and 2.221, accordingly.
• GBP/JPY didn’t manage to break the support line last week and remains within the “triangleâ€. I focus on 214.1 and 217.1, which are the minimal and medium correction levels of the last six weeks downtrend (Dec 12 - Jan 22). At the same time Euro slightly appreciated against the main funding currency, Japanese yen. As a result my short term target (159.10) has been achieved. It was the medium correction level of the latest downtrend.
MAJOR ECO Events
US - Prices (released – Feb 20)
Core CPI on the High Side. In January headline CPI rose by 4.4% over year. Excluding utility services all other components of the CPI favored to the inflation acceleration. The main contributors were food, clothing and footwear, as well as medical services. Food and beverages showed 0.7% m/m increase and kept the growth rate of these goods prices at 4.8% over year. It has been the highest level during the last seventeen years. The main sources of acceleration were fruits, vegetables, meat, fish, dairy products and eggs. Dairy products have been the best performers by the growth rate among the components of the CPI during the last twelve months. Another source of CPI growth were clothing and footwear, as consumers spent 0.7% and 0.6% more on men’s clothing and footwear. The rise of some kind of clothing prices was caused by the completion of Christmas and New Year discounts.
After a solid increase in December medical care again became more expensive. Medical services and pharmaceutical items prices rose by 0.5% m/m and 4.9% y/y. The acceleration came out from 5.7% increase of hospital and related services prices. Gasoline prices growth rate decelerated second month in a row, as a result the transportation index rose only by 0.5% m/m. In particular, gasoline prices, which have the largest share in CPI, advanced by 1.1% m/m. Nevertheless, gasoline was 34.4% more costly compared with the same period of last year. The prices for public transportation have been rising for the second consecutive quarter, mainly thanks to a 0.8% increase of airline tickets. These increases were offset by a moderate growth of household services prices. Natural gas prices, one of the most important components of housing index, tumbled down by 2.2% m/m. Electricity also got more expensive. Nevertheless, the growth rate of housing component remains high. Among the components of housing index only rent of primary residence and household insurance have been an important source of inflation.
Core inflation, excluding food and energy prices, soared by 0.1% to 2.5% over year.
UK - MPC (released – Feb 20)
On 20 February the minutes of the Bank of England MPC meeting was published. Eight members of the Committee voted to cut repo rate by 25 basis points to 5.25%. The ninth member - David Blanchflower suggested reducing interest rate by 50 basis points.
In the Minutes the Committee members gave a special consideration to the widened spreads and increased yields of mortgage and asset backed securities. Subsequently it caused huge losses for many investment banks. They expressed their concern related to the aggressive actions of rating agencies, which lowered the ratings of thousands structured products and asset backed bonds. It contributes to the deepening of the crisis, as the banks started to sell (write off) securities, the markets of which has been “freezeâ€, due to very low or absence liquidity. It will be recalled that during the last years they readily provided high ratings to these instruments. In the end, it was impossible to finance “bad quality†mortgages by issuance of bonds backed by these loans. British Northern Rock actively treated debt market to finance his liabilities, therefore turned out to be on the verge of bankruptcy. Northern Rock management didn’t manage to find investors, in this connection the UK Government decided to nationalize this bank. However, compared with American banks the losses of British banks were much less during the second half of last year.
For mitigating the turmoil in financial markets major central banks realized coordinated intervention in order to provide short term liquidity. For that the Fed lent 40bln USD to the ECB for a month. This loan was meant for satisfying the needs of European banks in USD. The Fed, BOE and BOC didn’t confine to providing liquidity and cut base interest rates. The Fed acted very aggressively and lowered the federal funds rate by 125 basis points. It was the fastest cumulative reduction of interest rates during one month since 1990. Central banks actions, including BOE, have had a significant impact on the market, as short term forward rates dropped down below 5%. Moreover, most of the market participants are expecting one more cut in the second quarter of this year. Furthermore, yield curve shifted down during the last twelve months, mainly due to short term treasury bills. The latter’s price rise was related to the market participants expectations concerning the forthcoming reduction of interest rates.
The provisional estimate of GDP growth in the fourth quarter had been 0.6% q/q, which is close to post World War II average rate. As during the first three quarters of 2007 this indicator fluctuated between 0.7 - 0.8 percent, GDP rose by 3.1% in 2007. One of the primary sources of economic growth was consumer’s expenditure, thanks to relatively high personal income. However, consumer confidence index rapidly fell during the last months. In January this index fell further to its lowest level since December 1992. It was connected with deceleration of personal income and house prices growth rates. In particular, all house prices indices have been falling a few months in a row. It is important to note, that growing house prices ensured an increase of consumers expenditure during the last two years. The impact of real estate on consumer’s behavior is too high, because the residential and commercial property worth exceeded 4trln pounds. At that more than half of this wealth is residential property.
My forecast, related to the base rates reduction, proved to be correct. The Committee members voted to cut repo rate due to the crisis in the US Sub prime and Alt-A mortgage backed securities market, which had a negative impact on the UK real estate and mortgage markets. Due to this crisis many British banks had huge losses, while one of them was on the verge of bankruptcy. These developments pushed down real estate prices and reduced monthly mortgage payments. The latter’s contraction came out of relatively high mortgage rates and tighten credit conditions, which were caused in their turn by “freeze†mortgage backed bond market. It will be recalled that for mitigating the US real estate crisis negative effect Bank of England attempted several actions, including cutting of base interest rate, providing huge liquidity and directly supporting the big bank, which was on the verge of bankruptcy.
Despite the intensifying crisis in the real estate market oil prices are still at record high levels, since this sharp rises have a political character and came out of Iran’s nuclear project and recognition of Kosovo independence. Another source of inflation acceleration will be money supply (M4), which edged up by 12.9% y/y in January.
Nevertheless, inflation growth rate remains within 2% due to significant decline of natural gas and electricity prices. In respect to the medium term economic cycles the increase of workforce thanks to immigrants from Eastern Europe will also have a downward pressure on inflation. Therefore, in case the representatives of the BOE give the above mentioned negative factors a consideration,
it is possible that on May 2008 repo rate will be cut by 25 basis points.
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