Commodities and currencies should continue mixed and sidelined

Turmoil in the credit markets and the ECB adds to woes by suggesting it will raise its key rate by 25 basis points at July’s meeting. Euribor interest rate futures promptly dropped 25 points, with the December 2008 contract pricing three-month Libor at 5.525%, dragging Sterling, Swiss and US money market contracts down too. Benchmark Schatz yields surged to 4.789%, higher than they have been since December 2000, ten-year Bunds to a one year high at 4.49%, but 30-year ones reversed sharply from 4.90% to end the week at 4.70%. The yield curve has inverted yet the ECB insists that a flat curve is a temporary phenomenon. Government bond yields in some Eastern European and Asian countries surged but UK and US ones remained mixed, easing late in the week on nasty US Unemployment numbers. Jobs lost were 49K, not as bad as some had feared but because of an increase in the pool of available workers Unemployment jumped half a percent to 5.5%. Some may dismiss this as college students trying to get summer jobs, but let’s not forget that it is one of the biggest monthly increases in years and years. Most equity indices ended the week a little lower, some testing fairly important support levels, Nikkei 225 the odd man out banks taking the rally to almost this year’s highest level. Currencies and commodities were mixed yet CBT Corn set a new record at 646 cents per bushel. Baltic Capesize, and Clean Tanker rates to Japan, soared.

Political and Economic Developments

US tax rebate cheques helped discount-type shops (Costco and Wal-Mart) but not car makers. Sales of American Sports Utility Vehicles slumped 28% in May, and no wonder with petrol at $4 a gallon; total sales 14.3 million units the lowest in ten years. Now, and not when they were coveted by some (why?), General Motors decides to sell its Hummer brand. A shift to lighter and smaller cars, as well as hybrids, helped Asian car makers sell, for the first time ever, more vehicles than America’s ‘big three’. UK April sales of 4X4’s dropped 18% (down 50% in Spain this year), probably because filling the tank costs £90.00. And those who are stuck with gas guzzlers are driving fewer miles and keeping them going for longer, helping car parts makers. In contrast Daimler’s ‘Smart’ car UK registrations were +147% Y/Y. Eurozone citizens got no handouts from governments so their retail spending dropped 2.9% in the year to April, the biggest decline on record.

Underlying Themes

Lots of talk about fighting the inflation demon and its ‘second round’ effects. EZ15 CPI has been above 3.0% since November, hitting 3.6% in March, and rarely has the ECB met its target of just under 2.00%. Their forecasts for 2008 and 2009 HICP are ‘markedly higher’, yet assume no upward pressure from wages and that food and energy prices will ease, so they have put themselves ‘in a state of heightened alertness’. To what one might ask. Like Mr. Trichet’s comments Fed chairman Bernanke also surprised by explicitly warning of US dollar weakness’ effect on inflationary expectations. Responsibility for the greenback’s value lies with the Treasury so these remarks, while stating the obvious, are unusual. Swiss National Bank’s Jordan was obviously singing from the same hymn sheet, saying inflation at 2.9% (highest in 15 years and above their 2.0% target) was ‘unpleasantly high’ and that central bankers have to be ‘extremely alert’. As opposed to asleep at the wheel?
Brazil raised its key rate 50 basis points to 12.25%, probably the highest real interest rate in the world, to counter price rises. Add this to its new investment grade status and the likelihood of speculative inflows explains why the currency (1.615) is stronger than it has been since January 1999’s devaluation.

What to watch for next week

Monday (holidays in Australia, China and Israel) Japan May Money Supply, Bank Lending, Economy Watchers’ Survey and a new Business Cycle Index for April, German Trade Balance, US Pending Home Sales, UK May PPI, and Eurozone June Sentix Index. Tuesday Japan April Machine Orders, UK Industrial Production, May BRC Retail Sales Monitor, April US Trade Balance and the Bank of Canada decides on interest rates (unanimously expected -25 basis points to 2.75%). Wednesday Japan final Q1 GDP, April Trade Balance, UK Trade, Average Earnings and May Unemployment, US Monthly Budget and the Fed’s Beige Book. Thursday the Bank of Japan starts a two-day rate-setting meeting (expected unchanged at 0.50%), the ECB’s Monthly Report is published, Eurozone April Industrial Production, US Business Inventories, May Import Price Index and Retail Sales. Friday the 13th (unlucky for some) Japan May Consumer Confidence, Eurozone Q1 Labour Costs and Employment, US May CPI, June University of Michigan Survey and G8 finance ministers meet in Osaka.

Positioning and Technical Analysis

Long-dated Treasury yields should drop, possibly very sharply, as equity indices break below retracement support levels. Eventually traders will realise that Libors need not necessarily move in tandem and front month Eurodollar interest rate futures may plunge. Credit quality is key and cash is king. The US yield curve should flatten and the Eurozone and UK ones invert further. Commodities and currencies should continue mixed and sidelined.