Forex Investment and Currency Trading

Amid signs of an economy that struggles to remain afloat and rising price pressures, minutes from the March 18 FOMC meeting reveal the Fed’s concerns about the economic outlook, credit stresses and the importance of maintaining its inflation-fighting credibility. This week’s data releases on retail sales, housing and industrial production will show continued weak product demand and output, while reports on the CPI and PPI reveal significant increases in headline inflation.

The minutes from the March 18th FOMC meeting reveal the Fed’s concerns on many dimensions. They describe in detail how strains in financial markets had increased, and describe Fed initiatives designed to provide liquidity and restore order to financial markets, particularly the mortgage market. These initiatives include the Term Securities Lending Facility (TSLF), which allows primary dealers to swap Treasuries for a variety of investment-grade MBS collateral at a weekly auction that eventually will total $200 billion, the Primary Dealer Credit Facility (PDCF), which allows primary dealers to borrow directly from the discount window, and the Fed’s unprecedented $30 billion loan to JP Morgan to acquire Bear Stearns, with the Fed accepting collateral from Bear Stearns’ portfolio. Clearly, these credit stresses have significantly influenced the Fed’s economic outlook: the minutes state “many participants thought that some contraction in economic activity in the first half of 2008 now appeared likely.” The Fed anticipates that monetary easing and fiscal stimulus package will lift economic activity in the second half of the year. As such, the Fed anticipates that real GDP will grow in 2008. Nevertheless, it is very rare for the Fed to state publicly expectations that the economy may contract. Adding to these concerns, the FOMC minutes state “the recent information on inflation was seen as disappointing.” It mentioned higher commodity prices and the lower US dollar as contributors to higher inflation. While the Fed expects inflation to recede, the minutes emphasized the high premium the Fed puts on its inflation-fighting credibility. These concerns about inflation led two FOMC members, Plosser from Philadelphia and Fisher from Dallas, to dissent against the 75 basis point cut in the Federal funds rate to 2.25%; worrying that “inflation expectations could potentially become unhinged”, they urged easing policy less aggressively.

Even though the US trade deficit widened in February for the second consecutive month, in real terms it is projected to narrow further in Q1, contributing positively to real GDP growth relative to domestic demand. Exports rose in February by more than 1%, reflecting generally healthy economies overseas and the positive impact of the weak dollar that are generating continued high demand for a wide array of US goods and services. However, imports jumped 3.1%, lifting their January-February average 14.8% above their Q4 average. Looking forward, in real terms, exports are projected to outpace imports. These positive contributions to real GDP of the declining trade deficit are anticipated to provide a very important offset to further declines in residential investment.

The lower dollar, while helping to boost exports, is imposing mounting pressure on import prices. In March, import prices rose 2.8%, lifting the year over year rise to 14.8%. Prices of nonpetroleum imports rose 1.1% in March, and they are now up 5.4% year over year. Insofar as the lower US dollar has a lagged impact, expect further price pressures from imports. This trend represents yet another factor weighing heavily on the Fed’s concerns about keeping inflation in check and maintaining its inflation-figthing credibility.

US Economic Indicators

Retail Sales
Weak vehicle sales suggest that March’s headline increase in retail sales will only partially
retrace February’s 0.6% decline. Much of the non-vehicle sales rise will likely reflect the increase in gasoline prices. With credit conditions deteriorating, household wealth slipping and employment falling, between 0.5% and 1.0% annualized growth is projected in real consumer spending in 1Q, a marked slowdown from the 4Q advance of 2.3%.

Business Inventories
Both factory and wholesale inventories rose 0.5% in February, so total inventories likely
posted another increase.

Producer Price Index/Consumer Price Index:
With gasoline, fuel oil and natural gas prices advancing, the March headline inflation readings will largely reflect the energy price surge. This will push the headline CPI increase to an estimated 4.1% yr/yr. While lagged intermediate cost pressures will boost the core finished goods index, slowing economic activity will begin to put downward pressure on core consumer prices.

Housing Starts:
Housing demand remains weak as building permits, a leading indicator for housing starts, tumbled 7.3% in February. Declining single-family home sales, falling home prices and tighter mortgage lending standards by banks should constrain housing activity.

Industrial Production & Capacity Utilization:
The downturn in the ISM production index implies that manufacturing output slipped in March. Sharp advances in mining and utility hours worked suggest that output in these sectors rose and are likely to provide an offset.

Leading Index:
The Conference Board’s index of leading indicators is expected to post a gain of 0.1% in March as positive contributions from the money supply, vendor performance, steeper yield curve and the manufacturing workweek offset negative contributions from the stock market, initial unemployment claims and consumer expectations.