Singapore dollar revaluation

The government of Singapore decided on a modest revaluation of the Singapore dollar, which jumped a little over 1% vs. the US dollar and therefore to the strongest level since before the crisis hit in 2008. The move is seen as a response to stronger inflation readings in Asia as China’s commodity demand has seen prices for key commodities rise as much as 70% over the last year. The magnitude of the "revaluation" was not particularly great, but the Singapore authorities are clearly not against further appreciation of their currency as growth is expected to surge past previous expectations. The Monetary Authority of Singapore said it would seek a "modest and gradual appreciation" of the SGD against a basket of currencies. This pushed the USD a bit weaker in Asia, and commodity currencies a bit higher (is this a preview of the kneejerk reaction that awaits if the Chinese try to revalue?) but later the EURUSD was back lower, and the market must also consider the argument of whether less pressure on reserve diversification from trying to maintain currency pegs or managed floats is a Euro negative.

Risk rally

Of course, commodity currencies are stronger not just on the Singapore news, but also because risk appetite remains robust after the market liked what it saw from the key chip company Intel yesterday after the US equity markets closed. Sales, profits and guidance were all positive and Nasdaq 100 futures are trading at a new high for the cycle, having rallied almost 100 percent now from their lowest levels after the crisis, and even more remarkably, now only a little over 10% from the 2007 highs. Crude oil also survived a test of support below 84 dollars a barrel and Gold rebounded from its two-day sell-off. The kiwi was a reluctant participant in the commodity currency rally, since its retail sales numbers saw an ugly dip in February, against expectations for reasonably strong expansion.

Euro: renewed spread widening

The Greek debt spreads are at it again, and have now widened to the levels they were ate before the weekend’s bailout announcement. Perhaps worse, Portuguese spreads have also widened again and are at their widest since February. Investors are clearly beginning to second guess the situation and where it will lead. Fitch Ratings said that Greece may be forced to activate the loan packaged from the EU/IMF already this month. The director of Fitch ratings doesn’t believe that Greece wants to wait for a failure in the market place and that Greece may turn to the EU/IMF for help within a week or two. Not much evidence of pressure on the Euro in trading today, however, outside of a heavy EURGBP cross.

Disappointing US Confidence but strong US Retail Sales

It is very disappointing for the US jobs and recovery picture that the weekly ABC Confidence survey dipped back sharply lower, as it suggests the employment picture on the ground is not improving enough to dig this indicator out of the cellar. Robert Reich pointed out that we need to see +150k payroll improvements from the US every month just to track population growth in the US, so the employment picture is still very "bleak". On the other hand, the unconfident US consumer still seems willing to spend money, as the Mar. Retail Sales results came in stronger than expected and the Feb. data was revised higher as well, even ex Autos and Gas. The CPI came in lower than expected (core reading matched the lowest year-on-year reading since the mid-1960′s), and the bond market preferred to focus on the inflation data, so the bond market rally eroded support for the greenback that the retail sales might otherwise have given.

Latest Fed speak

The Fed’s Lacker said late yesterday that he would like to see the language removed that suggests the Fed will keep rates this low for a considerable period. "The recent data has made me think that it might be sooner rather than later that we would move that language. It depends on more data coming in." Mr. Lacker is not a voting member of the FOMC. Meanwhile, the Fed’s Fisher said that slack in the US economy translates into no threat of inflation for the US economy.

Looking ahead

It’s time for EURUSD to either stand or fall. Looking at the chart, one can argue that the entire sequence below the previous 1.3435 area low has effectively been rejected and that as long as we stay above there, the outlook is for a try at the 1.3800+ high at minimum and possibly even a go at the 200-day moving average way up above 1.4200. A move back below the old 1.3435 support area, on the other hand, would seem to cap the action for now and have the market focusing on whether the 1.3267 cycle low will eventually give way. We prefer a scenario in which the EURUSD remains below the 1.4000 area for now. And in the very short term here, the 55-day moving average is proving rather interesting.

Finally, the JPY response to the bond market seems to be less consistent of late: the strong bond rally in the wake of the US data would normally have been met with a kneejerk rally in the JPY – is the simultaneous equity market rally confusing the situation? This could be, since risk bulls love the combination of low inflation and positive data, the idea that the economy can grow plenty due to the slack built up in the system, without straining capacity. That’s the story the markets are trying to tell us at the moment, at least.

Up shortly, we have Bernanke testifying before Congress on the outlook for the US economy. Later we see the latest DOE crude oil inventory (massive inventories have not impressed the commodity bulls, USDCAD traders should note!) and the Fed’s Beige Book is set for release later in the day. In Asia, we’ll have a look at the Chinese growth figures for Q1 (whopping 11.7% YoY expected) and a raft of March data, data that is likely to feed the revaluation story further.

Be careful out there.

Economic Data Highlights

• US Weekly ABC Consumer Confidence out at -47 vs. -43 the previous week
• New Zealand Feb. Retail Sales out at -0.6% MoM and -0.9% MoM ex Auto vs. +0.2/+0.4% expected, respectively
• Australia Apr. Westpac Consumer Confidence out at 116.1 vs. 117.3 in Mar.
• China Mar. NDRC House Price rose 11.7% YoY vs. 11.4% expected and 10.7% in Feb.
• New Zealand Mar. Non-resident Bond Holdings fell to 63.6% from 64.2% in Feb.
• EuroZone Feb. Industrial Production rose +0.9 MoM and 4.1% YoY vs. +0.1/+2.8% expected, respectively
• US Mar. CPI out at +0.1% MoM and +2.3% YoY vs. +0.1/+2.4% expected, respectively
• US Mar. CPI ex food and Energy out at 0.0% MoM and +1.1% YoY vs. +0.1/+1.2% expected, respectively
• US Mar. Advance Retail Sales out at +1.6% MoM and +0.7% ex Auto and Gas, vs. +1.2/+0.6% expected, respectively

Upcoming Economic Calendar Highlights

• US Feb. Business Inventories (1400)
• US Fed’s Bernanke to Testify before Congress (1400)
• US Weekly DOE Crude Oil and Product Inventories (1430)
• US Fed’s Lacker to Speak (1500)
• US Fed’s Fisher to Speak on Financial Reform (1745)
• US Fed’s Beige Book (1800)
• New Zealand Mar. Business NZ PMI (2230)
• US Fed’s Sack to Speak (2300)
• UK Mar. Nationwide Consumer Confidence (2301)
• China Q1 Real GDP (0200)
• China Mar. Producer Price Index and Purchasing Price Index (0200)
• China Mar. Consumer Price Index (0200)
• China Mar. Retail Sales (0200)
• China Mar. Industrial Production (0200)

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Asian markets were firmer today after a lackluster performance in US equities. Concerns about debt laden Greece continue to weigh heavily on the euro while commodity currencies continue to gain on improving global economic outlook. Crude oil continued to climb, testing 17 month highs at $87-per barrel with gold bettering $1137.00 late in the Tokyo session. Copper prices hit levels not seen since August of 2008, topping $7990.00-per metric ton. The loonie and the aussie continued their assault on the dollar with the loonie breaking parity to .9983 at market open in London.

The Greek Contingency

Markets remain fixed on the Greek sovereign debt crisis, as mixed reports continue to weigh on the euro. Greek officials denied reports made yesterday about a potential amendment to the proposed EU aid package, excluding IMF involvement. Lack of clarity regarding how the Greeks will pay off maturing debt continues to fuel bearish sentiments. On one hand, the Greeks say they cannot continue to finance their debt at such high rates for long. The yield spread between Greek and German 10-year bonds reached their widest since the euro’s inception, peaking just over 4%. On the other hand, finance minister Giorgos Papakonstantinou stated yesterday that they had no intention of using the IMF backed aid package just yet. It is this uncertainty that has traders adding to shorts on the single currency. Targets are set at the 1.33 handle followed by 1.3280 and 1.3240. Subsequent floors are seen at the 1.32 figure, backed by 1.3130 and 1.3110 which represents the 61.8% Fibonacci extension taken from the Jan 13th and March 17th highs. Upside potential strengthens with a breach of 1.3450 with resistance levels eyed at the 1.35 handle followed by 1.3540 and the 1.36 figure.

Aussie Holds Gains

The aussie trade has played out well, reaching our limit at the 61.8% Fibonacci extension taken from the Feb 25th a March 26th lows at .9275, late in the US session. Positive economic data combined with the RBA’s recent rate-hike and climbing commodity prices will continue to provide support for the aussie. Resistance rests at the R1 monthly pivot just above the .93 figure and is backed by .9320. Additional targets are eyed at the .94 handle and at the 100% Fibonacci extension at .9450. Supply is seen at .9480. Short-term pullbacks could see the aussie test the .92 figure with subsequent support levels eyed at .9170, .9130 and .9090.

Today’s economic calendar includes PMI reports from the Eurozone, Germany, and the UK. Eurozone and German services PMI are seen to hold steady at 53.7 and 54.7 respectively with the UK seen slightly lower at 58.0 from 58.4. Later in the day, Eurozone PPI is seen to fall to 0.2% from 0.7% m/m and GDP is expected to hold at 0.1% q/q. From the US, MBA mortgage applications are scheduled to be released at 7am in New York with consumer credit expected to show a fall of some $700 million at 3pm. Canadian building permits and the Ivey purchasing managers index are both seen stronger m/m at 8:30am and 10am respectively. European markets are weaker across the board with US equity futures also pointing to a negative open early in London trade.

MG Financial Group
http://www.mgforex.com

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U.S. Review

Economic Recovery Continues, but is it Enough?

• Economic indicators this week suggested continued economic growth. Factory orders, the Institute for Supply Management manufacturing index and employment all suggest continued progress.
• Yet the pace of the recovery still presents several fundamental challenges. First, construction spending is disappointing and for a society that has put so much emphasis on housing, there is a disconnect between aspirations and reality. Second, the pace of growth will not likely solve the budget shortfalls in many states or at the national level.

Economic Recovery Continues, but is it Enough?

Three important economic indicators this week suggested continued economic growth. Factory orders, the Institute for Supply Management Index and employment all suggested continued progress on the economic front. Factory orders increased 0.6 percent in February and the gain reported for January was revised higher. Factory orders have gained in 10 of the past 11 months and are now more than a third of the way back to where they were at their peak in July 2008. Specifically, new orders for non-defense capital goods ex-aircraft are up nine percent (annualized) over the last three months, consistent with our expectations for 8 percent or more gains in real equipment & software spending for this year.

Meanwhile, the Institute for Supply Management manufacturing index rose to 59.6 and is consistent with a continued recovery rather than a double-dip recession. Orders, employment and production all suggest a positive growth outlook. Finally, employment rose in March and private sector employment has risen for the past three months. The breadth of the employment gains was also positive in March. There were gains in manufacturing and services with improvement in such cyclical areas as retail trade, leisure & hospitality and temporary help. One downside for jobs is that the mean duration of unemployment remains very high and suggests persistent structural unemployment. With that come concerns about consumer and housing credit.

Yet, the pace of the recovery still represents several fundamental challenges. Moderate economic growth alone does not solve several secular imbalances in the economy. First, construction spending is disappointing and for a society that has put so much emphasis on housing, there is a disconnect between aspirations and reality. Our expectation is that housing purchases will not rebound at a pace that will make many speculative housing starts economically viable. Second, the pace of growth will not solve the budget shortfalls in many states or at the national level. Political promises have outpaced the ability of the economy to deliver. For several years entitlement spending has outpaced the tax base that supports it. Finally, the longer-term budget deficits and our dependence on foreign capital to support them creates a delicate balance of supply and demand that is currently being tested by questions raised about the U.S. commitment to long-term deficit control.

Cyclical Recovery Still Leaves Structural Imbalances

Both public and private decision-makers are left with the reality that a cyclical economic recovery still leaves us with longer-run structural imbalances—many of which have been growing since the 1960s. Economic growth appears insufficient to generate the income needed to meet all the entitlement promises. The latest Congressional Budget Office report on Social Security emphasizes this point. For the private sector, the ability to generate jobs and earnings are being challenged in an economy with slower top-line sales and greater consumer caution. We may be out of the woods but it is still a long journey to Mordor.

U.S. Outlook

ISM Non-Manufacturing • Monday

The ISM Non-Manufacturing Index remained in expansionary territory for the second consecutive month in February increasing by 2.5 points to 53.0. With the exception of employment, all components of the composite index (business activity, new orders and supplier deliveries) contributed to the increase. The recent strength in service sector business activity is consistent with our view that an economic recovery is underway. The forward looking new orders index has been in expansionary territory for seven consecutive months and suggests continued strength in the service sector in the near future. The employment index rose 4.0 points to 48.6, the highest level since April 2008. The employment index will likely push into expansionary territory in March, which is consistent with underlying strength in private sector jobs.

Previous: 53.0 Wells Fargo: 53.5
Consensus: 54.0

Pending Home Sales • Monday

Pending home sales have fallen two out of three months with declines likely due to the weather and a payback from the jump in sales that occurred before the initial expiration of the first-time homebuyer tax credit (initially scheduled to end November 30th). While the extension and modification of the tax credit has yet to spur sales, we expect to see a boost in the months leading up to the second expiration (extended to April 30th for contracts to be signed). All four regions of the country saw declines in January with the West seeing the largest decline. We expect the index to continue to wane in February. The decline in mortgage applications in February supports the notion that pending sales will likely remain weak.

Previous: -7.6%
Consensus: -1.0%

Initial Jobless Claims • Thursday

Initial jobless claims for the week ending March 27th fell by 6,000 to 439,000, the second consecutive weekly decline. On a trend basis, the four-week moving average edged lower to 447,250. Consistent with our view that labor market conditions are stabilizing, we expect claims to continue to decline in coming weeks (especially with improving weather conditions in most parts of the country). While claims are moving in the right direction, the level is still too high to be consistent with sustained underlying strength in payroll growth. We expect temporary census hiring will likely help boost payrolls through May. Thereafter, we should see a retracement in temporary and government employment from June through September. By the fourth quarter, the effects of the census should be behind us and payroll gains should reflect underlying strength in the private sector.

Previous: 439K
Consensus: 433K

Global Review

Signs of Continued Global Recovery in Q1

• The Tankan index of Japanese business sentiment, which is fairly correlated with GDP growth, rose further in the first quarter, and manufacturing PMIs across Asia were strong in March.
• Monthly GDP data suggest that the Canadian economy continued to expand at a strong pace in the first quarter.
• Manufacturing PMIs in Europe also rose further in March. However, strength in “soft” data has yet to translate into robust “hard” data in most European countries.

Signs That Global Growth Strengthened Further in Q1

Data released this week suggest that the global economic recovery, which has been in place over the past few quarters, strengthened further in the first quarter of this year. In Japan, the Tankan index of business sentiment, which is fairly correlated with real GDP growth, rose to its highest level since the near collapse of the global financial system in the autumn of 2008 (see graph on first page). Sentiment among large manufacturers, who tend to be exporters, was the strongest among different sectors. However, the increase in sentiment was broad-based among both manufacturers and non-manufacturers, suggesting that domestic demand also strengthened in the first quarter.

Speaking of Japanese exports, survey evidence indicates that growth in some of Japan’s major trading partners in Asia remained strong in the first quarter. The manufacturing PMI in China rebounded in March after a brief dip during the previous month, suggesting that growth in Chinese industrial production remained strong (top chart). In India and Taiwan, manufacturing PMIs remained well within expansion territory in March.

A marked upturn got underway in Canada in the second half of 2009, and real GDP data for January indicate that the economy is on pace to register another strong quarter of growth in the first quarter (middle chart). In January, real GDP rose 0.6 percent relative to the previous month, which follows the 0.5 percent increase that was chalked up in December. Even if the economy stagnated in February and March, which we do not expect, real GDP in the first quarter will have risen at an annualized rate of about 5 percent. Although exports clearly have played an important role in the Canadian recovery, indicators of domestic demand have been strong as well recently. For example, retail sales in January were up 0.7 percent relative to the previous month, and employment in February stood 0.4 percent above its year-ago level. (By way of comparison, U.S. employment in February was down 2.5 percent on a year-over-year basis.)

Among the major regions of the global economy, recovery thus far has been strongest in Asia and weakest in Europe. However, the manufacturing PMIs for the euro-zone and the United Kingdom strengthened further in March (bottom chart). The PMI in the former jumped to a 40-month high and the index in the latter rose to its highest level since 1994. Service sector PMIs for March will not print until next week, but European and British indices are expected to remain well within expansion territory where they have resided since last summer.

Unfortunately, the apparent strength in the PMIs has not translated into strong economic growth, at least not yet. Real GDP in the United Kingdom rose only 0.4 percent (not annualized) in the fourth quarter, and it was essentially flat in the euro-zone. Although British consumer spending has rebounded somewhat, continental European consumers have no pulse at present. And we fear that the fiscal consolidation that is underway in some of the euro-zone’s former high-flying economies (e.g., Greece, Ireland and Spain) will keep growth in the overall euro area weak for some time.

Global Outlook

German Industrial Production • Thursday

The year-over-year rate of decline in German industrial production (IP) has slowed significantly over recent months due, at least in part, to base effects. German IP has risen 8 percent from its low last April, but remains 17 percent below its peak in early 2008. However, recent increases in survey data (e.g., the Ifo index and the PMI) suggest that German IP rose further in February. Germany also releases data on February factory orders and French IP data will print next week as well.

The European Central Bank holds its monthly policy meeting next week, and there is very little chance of a change in rates at the meeting. Rather, investors will look to the press conference for clues about ECB policy going forward. Due to the sluggish nature of the euro-zone recovery to date (see page 4), we believe that the ECB will keep rates on hold throughout the rest of the year.

Previous: 0.6% (month-on-month change)
Consensus: 0.7%

British Industrial Production• Thursday

As in Germany, the year-over-year rate of decline in British IP has flattened out in recent months. Unlike Germany, however, there has been very little bounce in British industry thus far. British IP is up only 2 percent from its low, and it remains 14 percent below its peak in early 2008. As discussed on page 4, the manufacturing PMI has risen sharply in recent months, so “hard” data should, sooner or later, start to firm as well. Indeed, the consensus forecast looks for a modest rise in IP in February. In addition, a widely followed index of monthly GDP is also slated for release next week.

Like the ECB, there is very little chance that the Bank of England will change rates at its own policy meeting next week. In our view, the upturn in Britain is not quite as tepid as the euro-zone recovery, and we look for a BoE rate hike by the end of 2010.

Previous: -0.4% (month-on-month change)
Consensus: 0.5%

Canadian Employment Report • Friday

Despite the occasional month of contraction, Canadian payrolls have been growing on trend since midsummer 2009. The gain in payrolls reported for February was driven by an increase in manufacturing jobs. Consensus expectations for March payrolls look for an even larger increase. Still, the employment component of the forward-looking Ivey purchasing managers’ index recently slipped to its lowest level since February 2009, suggesting the pace of the recovery in the labor market might slow somewhat in coming months.

Speaking of the Ivey index, we get our next look at that survey on Wednesday of next week. The overall index has been above 50 for eight of the last nine months. However the employment series has been below 50, signaling contraction, for the last several months. An improvement here could lift expectations for future jobs reports.

Previous: 20.9 K
Consensus: 25.0 K

Point of View

Interest Rate Watch

Canary in the Coal Mine

As expressed by Alan Greenspan, rising Treasury interest rates are the canary in the coal mine suggesting danger in the outlook for interest rates. In our December annual outlook for 2010 we posited a pattern of rising interest rates on the benchmark 5- and 10-year Treasury notes. In rebalancing the U.S. economy, we anticipated that both fiscal and monetary policy would have a significant influence on the pattern of interest rates this year. In recent weeks the pattern of fiscal policy has turned negative. First, recent estimates of the future fiscal integrity of Social Security have suggested that the system’s revenues would fall short of spending this year—much sooner than many anticipated. Second, the budget estimates for the healthcare plan do not appear credible to the markets. Future Medicare cuts are unlikely. While mandates have been raised and entitlements broadened, there is likely no reasonable method to pay for these.

Meanwhile for monetary policy, questions have arisen about the ease and extent of the Fed’s exit strategy. Both the composition and the size of the Fed’s balance sheet represent significant issues to the marketplace. Also the Fed’s real commitment to reducing the balance sheet has been in question as several members of the Federal Open Market Committee suggested that the Fed could reenter the market for mortgage-backed securities if problems arose. With the recovery in the first quarter and expectations for further growth, the flight to safety trade that favored U.S. Treasury debt became less attractive. Bond issuance for both high grade and high yield has grown sharply over the last three months. Equity markets have improved. Therefore, the opportunity costs have risen for continued investing in Treasury debt. For the rest of this year our view is that interest rates will continue to rise. We see that investor demand will decline as more attractive alternatives become available. Our concern is that the interplay of policy risks and diminished domestic and foreign demand may create more upside risks to the interest rate outlook than earlier anticipated.

Consumer Credit Insights

Mortgage Rates Still Low… for Now

The Fed’s mortgage-backed securities (MBS) and agency debt purchase programs have helped to keep mortgage rates low for the past year. Even though 10-year Treasury yields have rebounded by about 180 basis points from the December 2008 lows, 30-year conventional fixed mortgage rates have actually declined slightly. The average spread between 30-year fixed mortgage rates and 10-year Treasury yields over the last 15 years has been about 160 basis points, about 40 basis points higher than the current spread, which is still near the lowest in decades. The Fed’s mortgage purchase program however, came to an end this week on schedule and we have already seen some response in the MBS markets where securities declined in value and yields rose on Thursday. Buyers are likely on the sidelines waiting to see how the Fed’s exit affects markets in the coming days. In addition, with signs that the housing market is continuing to struggle and unemployment remaining high, investors are still concerned about mortgage defaults. This will continue to exert upward pressure on rates. Higher mortgage rates will add another headwind, or at least takeaway a tailwind, from a housing market that continues to struggle. In the coming months the housing market is also likely to lose the other major stimulus it has received with the first-time homebuyer tax credit scheduled to expire. The combination will likely hold down sales activity through the summer months.

Topic of the Week

Does Another Debt Crisis Await Argentina?

Argentina has been in the news once again as investors are worried that Argentina may default on its external debt. This speculation is a repeat of what happened during 2008 and 2009, and it seems to be more related to internal political fights than to the current condition of government finances, though government finances have continued to deteriorate. Argentina is still negotiating with holdout bondholders from the 2005 restructuring of its defaulted external debt. Argentina’s access to international financing markets has been closed since the default in 2001, and some investors holding about $20 billion in defaulted debt did not accept the debt renegotiation in 2005.

While we do not expect Argentina to default during the next several years, the seeds of a potential default are being planted today. First, the administration is using stocks to pay for what it owes instead of relying on its cash flow. Second, the government is tampering with inflation numbers to pay less in interest on some part of its current debt. Third, government expenditures are growing too fast for fiscal sustainability, especially if the economy does not make a strong recovery.

The administration has been moving to make a final offer to the 2005 holdouts from the 2001 debt default. According to the Argentine minister of economics, Amado Boudou, the holdouts should expect no more than 35 cents on the dollar. If the holdouts accept this offer from the government, the country will be able to access the international capital markets once again, and will likely be able to find financing rates close to the single digits, much better than today’s rates of 15 to 20 percent. However, if the government runs into trouble obtaining financing in the short- to medium-run, then we should expect a higher inflation tax, devaluation and more confiscatory measures against different productive sectors of the economy. The outcome of these measures will determine how close or how far away another debt default may be.

Wachovia Corporation
http://www.wachovia.com

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USD Mixed, House Prices Flat, Consumer Confidence Rises

• USD: Mixed, house price rebound slows, consumer confidence rises more than expected, stocks turn lower
• JPY: Lower, industrial production and household spending declined , unemployment unchanged
• EUR: Lower, France AAA debt rating at risk of a downgrade, Greek bond spreads widen
• GBP: Higher, GDP revised up, house prices rise, trade gap narrows
• CAD and AUD: AUD & CAD higher, RBA rate hike speculation, Canada’s raw material prices rise

Overview

The USD traded mixed Tuesday weakening against the GBP and commodity currencies and firming versus the EUR and JPY. GBP outperformed supported by report of an upward revision in UK Q4 GDP and higher UK house prices. EUR erased early overseas gains pressured by rumors that France may lose its AAA debt rating and in reaction to ongoing concerns about the Greek debt crisis as Greek bond spreads continued to widen. AUD was supported by RBA rate hike speculation and the JPY traded lower pressured by improving risk appetite and firmer equity market trade with additional selling pressure noted in cross trade to the GBP and AUD. CAD traded higher supported by report of an unexpected rise in Canada’s raw material prices. Risk appetite was supported by news from China about possible Yuan revaluation and US China tensions. Reuters reports of divisions in China over the Yuan value. Two PBOC advisors said that China should allow the Yuan to gradually appreciate but the Chinese trade minister said that the Yuan is not the cause of US China trade gap. US Chinese tensions may be easing in reaction to comments from President Obama that he wants to work with China to create balanced and sustained global growth. US economic data was mixed with the Case Shiller House Price Index unchanged last month. The rebound in house prices seen last fall has faded. Consumer confidence came in above expectations and USD edged higher rising to a fresh two month high versus the JPY. Focus turns to Wednesday’s release of the ADP employment report for March. Investors will be looking at the ADP for clues to Friday’s US unemployment report. March nfp is expected to post a gain of 200k.

Today’s US data:

January Case Shiller Home Price Index declined by 0.7%, a 0.8% decline was expected. March consumer confidence rose to 52.5, a reading of 49.5 was expected.

Upcoming US data:

On March 31st March ADP employment will be released expected at 20k compared to -20k last month. Also on March 31st March Chicago PMI and factory orders will be released. The Chicago PMI is expected at 61 compared to 62.6 last month and factory orders are expected to rise by 0.5% compared to a 1.7% rise last month. On April 1st initial claims for the week ending 3/27 will be released expected at 438k compared to 442k last week along with February construction spending, the March ISM index and March domestic auto sales. Construction spending is expected to fall by 1.1% compared to a 0.6% decline last month. The ISM index is expected unchanged at 56.5. On April 2nd the March unemployment rate and nonfarm payrolls will be released. Nonfarm payrolls are expected to rise by 200k compared to -36k last month and the unemployment rate is expected unchanged at 9.7%.

JPY

JPY traded lower pressured by improving risk sentiment, selling in cross trade and in reaction to mixed economic data. President Obama’s call for cooperation with China may help to ease US China trade tensions and contributed to an improvement in risk appetite. JPY traded lower in cross trade to the GBP with GBP supported by report of improving UK house prices and an upward revision in UK GDP.JPY traded lower in cross trade to the AUD with AUD supported by RBA rate hike speculation. EUR/JPY traded lower with EUR gains limited by rumors that France may face a credit rating downgrade and in reaction to ongoing concerns about the Greek debt situation as demand for Monday’s Greek bond auction was weak. Japan’s February unemployment rate was unchanged at 4.9%. Japan’s February industrial production declined by 0.9% and household spending dropped by 1.6%. These reports contrast with Monday’s release of strong Japanese February retail sales and paint a mixed picture for Japan’s economy. JPY traded to the days lows after the release of above expectation US consumer confidence. This week’s main focus will be the release of Japan’s tankan business sentiment Thursday survey and US March unemployment report Friday.

On March 31st February housing starts and construction orders will be released. Housing starts are expected to rise by 2% compared to 5.4% rise last month. Construction orders are expected at 9.1% compared to 15.7% last month. On April 1st March tankan survey will be released expected -16 compared to -24 last month with CAPEX spending expected -11.5% and -13.8% last quarter.

Key technical levels to watch in USD/JPY include support at 91.75 the March 25th low with resistance at 92.96 the March 25th high.

EUR

EUR traded lower erasing early overseas gains pressured by ongoing worries about the Greek fiscal outlook and rumors that France may see a downgrade of its credit rating. Monday, Greece auctioned a seven-year bond that was poorly received and Greek bond yields continued to widen. The poor reception for the Greek bond auction and widening of Greek bond spreads generates concern about the financing of Greek debt. EUR has been supported over the last couple trading sessions by last week’s announcement that the IMF and EU agreed to aid Greece if needed. EUR remains vulnerable to concern about sovereign debt risk in the EU with today’s focus on rumors that France may lose its AAA credit rating. Last week Portugal’s debt rating was downgraded and there is concern that the EU faces more sovereign debt risks with investors keeping a close eye on Ireland, Spain and Portugal. The Irish government announced today that it will take a bigger stake in the banking sector. EUR traded lower despite report of rising import prices in Germany. German February import prices rose by 1% a 0.4% rise was expected. If today’s report of higher import prices in Germany is the start of a trend towards higher EU inflation investors may begin to look for the ECB to shift to a more hawkish policy bias. Many analysts expect the ECB hold rate policy steady and delay rate hikes because of concern about the impact of sovereign debt risks on the EU recovery. EUR may see additional selling pressure as interest rate differential is moving in favor of the USD. Monday, three month USD Libor rate hit a six-month high in anticipation of an eventual Fed policy shift. In contrast EU Libor rates held at record low in anticipation of fresh liquidity add expected from the ECB Wednesday. This week’s release of US March unemployment report will be key to the outlook for the US recovery and interest rates.

On March 31st, German March unemployment will be released expected unchanged at 8.2% along with EU HICP for March expected at 1% compared to 0.9% last month. On April 1st EU March manufacturing PMI will be released expected 54.2.

The technical outlook for the EUR is negative as EUR trades below 1.3400. Expect EUR support at 1.3350 with resistance at 1.3537 the March 30th high.

GBP

GBP traded higher supported by report of an upward revision in UK GDP, firmer UK house prices and a narrowing of the UK current account gap. UK Q4 GDP was revised up 0.1% to 0.4% and February Nationwide Building Society house price index rose by 0.7%. These reports suggest that the UK recovery is gaining momentum. UK Chancellor Darling says that he expects to see a sustainable recovery in the UK. Darling went on to say that weaker GBP has helped to support the rebound in the UK economy. Q4 current account gap narrowed to 1.7bln from a revised 5.9bln in Q3 as exports rise. GBP was also supported by gains in cross to the EUR with EUR pressured by ongoing worries about the Greek debt outlook and fresh worries about a potential downgrade for France’s credit rating. Investors remain concerned about the UK debt outlook but in its pre-election budget announcement the UK forecast that the budget deficit will narrow in the years ahead and the latest UK election polls suggest that the Conservatives may gain a parliamentary majority. The Conservative party has pledged to take action to reduce the UK deficit. GDP direction will be linked to UK debt and election outlook.

On March 30th GFK consumer confidence will be released expected -13 compared to -14 last month. On April 1st March CIPS manufacturing PMI will be released expected at 56.8 compared to 56.6 last month.

The technical outlook for GBP is mixed as GBP traded above 1.5000. Expect near-term support at 1.5000 with resistance at 1.5329 the March 18th high.

CAD

CAD traded higher supported by rising commodity prices and by hope US China tensions are easing. Canada’s IPPI was flat last month and the RMPI rose by 0.4%. The IPPI was in line with expectations and the RMPI rose more than expected. A statement by President Obama that he wants to work with China to achieve stable and balanced growth generates hope that US and Chinese trade tensions may ease. US Chinese trade tensions are seen as a threat to the global recovery. CAD generally benefits from optimism about the global recovery. Equity markets are trading at an 18 month high adding to optimism about the global recovery. Crude prices traded above $82 a barrel and the price of copper was also firm. CAD price direction maintains a very close correlation to the price of crude. CAD traded higher last week supported by hawkish comments from BOC Governor Carney. Carney said that the Canadian recovery was faster than expected and he suggested that he was open to consideration of possible rate hike as early as June 1st. The BOC has pledged to maintain low yields through June of 2010 conditional on inflation remaining in check. Canada’s core inflation rate rose to its highest level in 16 months. Canada’s February CPI rose by 0.4%, a 0.3% rise was expected. The core inflation rate rose by 2.1%. The core inflation rate is above the BOC’s 2% inflation target. The above target CPI increases the risk of an earlier BOC rate hike. CAD has been outperforming supported by improving Canadian domestic economic outlook and speculation that rising Canadian inflation will encourage the BOC to make an earlier rate hike. Today’s report of an unexpected rise in Canada’s February raw material prices may increase pressure on the BOC to consider an earlier rate hike. CAD should remain well supported on breaks by speculation that the BOC will hike rates before the Fed. Focus turns to this week’s release of Canada’s GDP. The trade will be looking to the GDP for confirmation that the Canadian recovery is gaining momentum.

On March 31st January GDP will be released expected unchanged at 0.5%.

The technical outlook for CAD is positive as USD/CAD trades below 1.0100. Look for near-term support at 1.0062 the March 19th low with resistance at 1.0273 the March 29th high.

AUD

AUD traded higher supported by RBA rate hike speculation and speculation that China may allow the Yuan to gradually appreciate. RBA watcher McCrann said that it would be extraordinary if the RBA did not hike rates next week. McCrann’s comments follow yesterday’s statement by the RBA Governor Stevens that interest rates are too low and cannot remain at prior levels. His comments fuel speculation that the RBA will hike rates at the April RBA policy meeting. RBA’s Debelle said that rate policy will be tied to mortgage rates and home prices. Australian home prices have been rising. RBA assistant governor Lowe said last Thursday that interest rates will continue to rise towards normal and that waiting for improving global outlook to raise rates would be too late. The normal range for RBA rates is thought to be 4.25% to 4.75%. Australian financial markets are pricing a 70% chance that the RBA will hike rates 25 basis points to 4.25% next week .The RBA is expected to hike rates from the current 4% level to 5% by year-end. Next RBA policy meeting will be held on April 6th. AUD was also supported by Yuan revaluation speculation. PBOC advisor Bin says that China should let the Yuan gradually rise. Firmer Yuan could help to reduce global trade imbalance and improve Australian export demand. AUD gains were limited as US equities turned lower for the day and US bond yields rise in reaction to report of improving US consumer confidence.

This week’s Australian economic calendar includes the March 31st release of February building approvals expected at 3.5% compared to -7% last month along with February retail sales expected at 0.8% compared to 1.2% last month and February private sector credit expected unchanged at 0.4%. On April 1st February trade balance will be released expected at -1.63bln compared to -1.18bln last month.

The technical outlook for the AUD is positive as the AUD rallies above 9100. Expect AUD support at 9166 the March 30th low with resistance at 9253 the March 17th high.

By Michael J. Malpede

Easy Forex

Michael J. Malpede is Chief Market Analyst with Easy-Forex® and has previously been featured on Bloomberg TV, Bloomberg radio, Reuters, MarketWatch, Wall Street Journal, Chicago Tribune, Chicago Sun Times, Toronto Star and Nikkei press. In analyzing the markets, he draws from 29 years of Foreign Exchange Research as a Foreign Exchange Analyst.

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Weekly Economic and Financial Commentary

U.S. Review

Public Policy Grabs Center Stage

• Public policy dominated this week, with the passage of healthcare reform and confirmation the social security system would run into deficit this year contributing to disappointing Treasury auctions and higher bond yields.
• Advance orders for durable goods rose in line with expectations, but a large downward revision to January’s nondefense capital goods orders raises a red flag as to how strong capital spending will be in the first quarter.
• Sales of new and existing homes both declined in February, raising fears the incipient recovery in housing has faltered.

Strange Days in the Credit Markets

The bond market is the ultimate truth detector and its verdict on healthcare reform is the new law will be more costly than the Congressional Budget Office (CBO) estimated and budget deficits will be larger. The bond market was already on edge from the ongoing Greek debt saga and reports that Berkshire Hathaway and a handful of other businesses can now borrow more cheaply than the U.S. Treasury. The CBO confirmed the Social Security system would pay out more in benefits this year than it receives in taxes, something that was not supposed to occur until 2016. The Social Security shortfall means the Treasury will need to redeem the “special issue notes” issued to the Social Security trust fund, which will require the Treasury to sell real bonds, which has become more challenging in recent weeks.

The last few years have seen Treasury yields rise during the spring, triggering a whole new set of challenges. History looks like it will repeat itself this year, with the end of the Fed’s mortgage-backed securities purchases next week adding to the upward drift in yields. The supply of bonds coming to market will remain a challenge, with additional money needed to pay Social Security benefits and recapitalize Fannie Mae and Freddie Mac. Sovereign credit risk and worries about growing supply also extend to municipalities, which saw yields climb sharply recently.

Rising interest rates will make it hard for the housing recovery to gain momentum. The latest numbers are clearly troubling, although anecdotal reports from builders and Realtors are not nearly as pessimistic as February’s home sales were. New home sales fell to a new all-time low in February, falling 2.2 percent to 308,000. Builder sentiment also remains near all-time lows but builders are reporting some improvement in sales and buyer interest. On a net basis, housing is likely modestly stronger this year than last year. Supply remains a big issue, with a 9.2-month supply of new homes currently available for sale.

The harsh weather had less of an impact on existing home sales, which fell 0.6 percent in February. Single-family sales fell 1.4 percent, while condominium prices posted a slight increase. Maybe all that cold weather up North boosted the attractiveness of all those vacant condos in South Florida. The inventory of homes available for sale rose to an 8.6-month supply, as more homes are put up for sale in anticipation of the key spring home buying season and the expiration of the tax incentives.

The unusually prolonged drawdown in inventories has set off a strong cyclical recovery in parts of the factory sector. Advance orders for durable goods posted a 0.5 percent gain in February with January’s numbers being revised higher. Big gains in orders for machinery appear to be driving the overall increase. New orders for nondefense capital goods, excluding aircraft, rose 1.1 percent in February, but the previous month’s decline was a percentage point worse than first reported and now shows a 3.9 percent drop. The downward revision should cause forecasters to pull back their estimates for first quarter economic growth and may also signal a weaker trend for capital spending in general for 2010.

U.S. Outlook

Personal Income and Spending • Monday

Personal income is expected to advance at a moderate 0.2 percent pace in February. Aggregate income data from the February employment report proved disappointing, falling 0.2 percent on the month. This should continue to weigh on the wage and salary growth component of income. Personal consumption expenditures are expected to rise a more tepid 0.2 percent in February, after strong gains of 0.5 percent in January. Unit vehicle sales dropped 2.0 percent in February, which will be an important factor behind the somewhat slower trend in overall consumption spending. The chain PCE price index should continue to point toward slowing consumer inflation. Headline PCE is expected to be unchanged in February, reducing the year-0n-year growth rate to 1.8 percent. Fears of inflation forcing the Fed’s hand on interest rates appear overplayed at the moment.

Previous: 0.1 percent Wells Fargo: 0.2 percent
Consensus: 0.2 percent

ISM Manufacturing • Thursday

Regional manufacturing surveys for March suggest that manufacturing expansion remains firmly in place as we close out the first quarter. The rapid recovery in global trade, combined with the end of aggressive inventory cutting in the United States, is helping to boost manufacturing production at a healthy pace despite still-sluggish final demand growth from consumers and businesses. The March ISM index is expected at 56.7. This is a slight improvement from February’s 56.5 reading, but still below January’s 58.4, which marked the highest level since August 2004. The Chicago Business Barometer and Philadelphia Fed index both improved in March, though the Empire index moderated, suggesting a somewhat mixed picture on production gains in March. These ISM manufacturing levels are consistent with 6 to 7 percent industrial production growth on an annualized basis.

Previous: 56.5 Wells Fargo: 56.7
Consensus: 56.5

Employment • Friday

For March, we are finally expecting to see a positive net non-farm payroll print. The payroll report for February was encouraging in this regard: it revealed only a modest 36,000 net job loss in a month plagued by winter storms, suggesting the U.S. economy is on the verge of positive employment growth. A strong monthly boost from Census Bureau hiring should be the catalyst that finally pushes the payroll change into positive territory. The unemployment rate is expected to hold steady at 9.7 percent, though re-entering job seekers could still push the unemployment rate slightly higher in the months to come. Look for additional gains in working hours and hourly earnings to confirm the firmer labor market tone. Jobless claims remain stubbornly high, pointing to a weak underlying trend in private employment growth, and consumer confidence stumbled in light of labor market uncertainty.

Previous: -36 K Wells Fargo: 177 K
Consensus: 150 K

Global Review

The Argentine Economy Surprises on the Upside

• The Argentine economy grew by 2.6 percent during the last quarter of 2009 compared to the same period a year earlier, and by 0.9 percent for the whole year.
• The most important contributor to last year’s GDP performance for the Argentine economy was the collapse of imports.
• Government consumption increased by 7.7 percent during the last quarter of 2009 compared to the same period a year earlier, and rose 7.2 percent for the year as a whole.

The Argentine Economy Surprises on the Upside

According to the INDEC, Argentina’s statistical institute, the country’s economy grew by 2.6 percent during the last quarter of 2009 compared to the same period a year earlier. This result followed two consecutive negative quarters when the economy dropped by 0.8 percent and 0.3 percent in the second and third quarters, respectively. The fourth quarter growth helped the economy to avoid a negative performance during the whole of 2009 by posting an annual growth rate of 0.9 percent. Interestingly enough, the economy’s performance during the last quarter of the year was boosted by very strong personal consumption expenditures, which increased by 2.9 percent after dropping by 1.8 percent and 0.7 percent during the second and third quarters, respectively. However, personal consumption expenditures increased by only 0.5 percent during the whole of 2009.

The most important contributor to last year’s Argentine GDP performance was the collapse of imports. Imports of goods and services plunged by 19.0 percent in real terms during the year, while exports of goods and services dropped by only 6.4 percent. Thus, the strong drop in imports helped the economy prevent a deeper recession during the year as imports are a subtraction to GDP. On the other hand, the second most affected sector during 2009 was gross fixed investment, which dropped by 10.2 percent during 2009, the worst performance since the 2001-2002 financial crisis when gross fixed investment collapsed by a cumulative 52.1 percent in real terms.

Another contributor to growth during the year was strong government consumption. Government consumption increased by 7.7 percent during the last quarter of 2009 compared to the same period a year earlier, and rose 7.2 percent for the year as a whole. Thus, the Fernández-Kirchner administration continued to support economic growth through very strong fiscal policy at a time when fiscal revenues continued to dwindle due to the effects of the worldwide recession. Government consumption during 2009 was stronger than during the previous year even though the Argentine economy grew by 6.8 percent during 2008.

This is one of the reasons why many analysts are wondering if this policy is sustainable, considering that the Argentine government has been an international “pariah” and has not had access to international capital markets since the country’s default back in 2001. Many are wondering how long will it take for the country to default on its debt again if it cannot continue to finance its increased expenditures.

So far the administration has been able to “find” domestic financing through several measures that have captured increased revenues, but the situation is getting tougher, fundamentally because the government has lost the majority in the Argentine Congress and it is becoming more difficult to bypass the institution to continue the spending spree.

Global Outlook

German Unemployment • Wednesday

Despite the deep German recession – real GDP contracted nearly 7 percent between early 2008 and early 2009 – the unemployment rate in Germany has barely risen. However, the unemployment rate understates the weakness of the German labor market because many workers have been put on “short shifts” (i.e., hours worked have been reduced). The consensus forecast anticipates a small increase in the number of unemployed workers in March when the data print on Wednesday. Preliminary CPI data for March are expected to show few inflationary pressures in Germany at present.

Other data will offer further insights into the current state of the Euro-zone economy. Italy releases unemployment and CPI data as well next week. In addition, the sizeable increases in the Euro-zone PMIs that were reported in March are expected to be confirmed by final data next week.

Previous: 8.2%
Consensus: 8.2%

Canadian GDP • Wednesday

Like its large neighbor on its southern border, the Canadian economy has grown for the past two quarters after enduring a painful recession. Canada is alone among major countries that provide GDP data on a monthly basis, and data that are slated for release on Wednesday are expected to show the economy continued to expand at a strong pace in January. If the consensus forecast is realized, then the Canadian economy would be on pace to register an annualized growth rate in excess of 4 percent in the first quarter of 2010.

Data on raw material and industrial prices are also on the docket next week. Although prices of raw materials have risen significantly over the past year, the Bank of Canada is not likely to raise rates anytime soon because the core rate of CPI inflation remains very benign (i.e., only 1.3 percent in January).

Previous: 0.6% (month-on-month change)
Consensus: 0.5%

Japanese Tankan Index • Thursday

The quarterly Tankan survey that is conducted by the Bank of Japan is widely watched by investors. Not only does it contain a treasure trove of data on the Japanese economy, but the “headline” index, which measures sentiment among large manufacturers, is fairly correlated with real GDP growth. If, as expected, the “headline” index rises further, then investors will infer that the year-over-year growth rate in GDP in the first quarter rose into positive territory for the first time in two years.

Monthly data for February will offer further details about the present state of the Japanese economy. The consensus forecast looks for a small drop in industrial production last month, which, if realized, would be the first decline in IP in a year. Data on retail spending, the labor market and housing starts are also on the docket next week.

Previous: -24
Consensus: -14

Point of View

Interest Rate Watch

Cyclical Rise in Rates Reinforced by Structural Deficits.

Over the last few weeks the typical cyclical pattern of rising interest rates has become more obvious. Improved economic activity tends to be associated with rising credit demand. With each economic recovery, the demand for credit tends to increase as firms raise their expectations for stronger final sales. Meanwhile, on the credit supply side, the opposite pattern starts to emerge as the Federal Reserve begins to withdraw liquidity. For now, many investors appear to anticipate that the Federal Reserve will maintain its accommodative policy for the rest of this year. This may be true for the politically sensitive federal funds rate but behind the scenes the risk is that the cost of funds is likely to rise while longer rates will also rise as the Fed reduces its role in the Treasury and mortgage backed security markets.

Structural Deficits Reinforce the Cycle

In the last two weeks the long-run outlook for U.S. fiscal deficits has deteriorated for two reasons: Social Security and healthcare. Recent estimates suggest that the Social Security fund will experience spending outflows in excess of revenue inflows this year – much earlier than prior estimates. This suggests the entitlement problems that were anticipated with the retirement of the baby boom generation are coming earlier than many expected.

Meanwhile, the budget implications of healthcare have become more visible. First, there is lots of skepticism on the ability of future Congresses to really enforce cuts in Medicare. Second, there are very few elements in the healthcare bill to control costs.
Research done at the Federal Reserve suggests that it is expected future federal deficits that influence interest rates today. Financial markets are forward-looking and the outlook is not good. This outlook is reinforced by the understanding that much of the Federal deficit in the last year has been purchased by the Fed and Asian buyers – two buyers that the markets are less confident about going forward.

Consumer Credit Insights

ABS Slowdown May Hinder Spending

During the credit boom, issuance of asset-backed securities (ABS) soared, peaking at $1.2 trillion in 2006. Since then, ABS issuance has fallen off a cliff, with a mere $177.4 billion being issued in 2009, a whopping 86 percent decline from the peak. While the year-to-date total through March 2010 of $27.9 billion is 42 percent above the same period in 2009, issuance through the rest of the year will have to largely match the last nine months of 2009 in order for 2010 totals to surpass 2009.

Unfortunately, that may not happen. After rebounding from a scant $600 million in October 2008 to $26.4 billion in September 2009 as investors’ risk appetite returned, ABS issuance has slowed to just $9.2 billion in March 2010 as investors have turned cautious again. Following the cash-for-clunkers surge in fall 2009, auto ABS issuance has been cut in half. Credit card issuance has fared even worse as no securities have been issued in two of the last three months, leaving the three-month moving average at just $370 million versus about $8.0 billion last summer. Furthermore, the Fed’s assistance is waning as ABS holdings via the TALF have actually declined since December.

Over the last couple years, consumer spending growth has been closely linked to ABS issuance, lagging it by about six to nine months. Thus, the recent slowing of ABS issuance suggests consumer spending growth could remain sluggish as we head into the summer.

Topic of the Week

A Few Brief Comments on Healthcare Reform

The financial markets appeared to have already priced in passage of the healthcare bill before last weekend. Our early assessment is that, while there is a great deal of cost shifting taking place, the bill that passed was less onerous than many had feared. Unfortunately, the history of massive social spending programs is that they tend to grow larger and larger over time. Moreover, the scoring by the Congressional Budget Office (CBO), which shows the program costing $940 billion and reducing the deficit $138 billion over the 2010 to 2019 period, was based on a strict interpretation of the bill as it was written. The costs will likely be higher than the CBO estimate and the budget deficit will also likely be larger. Savings from Medicare cutbacks will likely be harder to achieve. Moreover, the extended phase-in of the program will likely lead to incessant political pressure to expand benefits and scale back the tax hikes. The healthcare bill will have relatively little impact on economic conditions over the near term as most of the provisions will not take effect for a couple of years.

There is little evidence the new healthcare law will hold down the price of healthcare. Healthcare costs have been rising faster than the overall inflation rate for about as long as can be remembered. The driving force for this increase has been the aging population, which has resulted in increased demand of healthcare services and a lack of market discipline in the healthcare marketplace. Most costs are paid indirectly either by insurance companies or the government. This leads to over-consumption and little to no price sensitivity.

The higher tax rates on investment earnings will draw more investment dollars into tax avoidance projects and lead to modestly lower investment throughout the economy. Likewise, the new tax on medical devices and pharmaceutical companies could lead to reduced profitability and thus less innovation and product development.

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The Week Ahead

Highlights

• Greek denouement looms
• RBI hikes, more coming from others
• SNB pulls the rug out from under EUR/CHF
• March 24 UK budget will be critical in pre-election positioning
• CAD–To parity and beyond
• Key data and events to watch next week

Greek denouement looms

FX markets continue to fluctuate broadly in recent ranges, turning with every twist in the ongoing Greek drama. Risk saw higher in the beginning of the past week as EU leaders appeared to be in agreement on a plan to provide an aid package to Greece. Then the German government indicated it could not legally support such a plan and that Greece should seek aid from the IMF, sending EUR/USD and most other risk assets lower into the end of the week. Then on Friday, EU Commission President Barroso confused matters further by advocating a standby financial aid mechanism of coordinated bilateral loans from Euro-area countries. The immediate Greek drama may be entering the final act, though, as next week’s EU summit is likely to see a definitive resolution one way or the other. If European leaders fail to reach an agreement, it will look very bad for Euro-area cohesion, exposing the fiscal vulnerabilities of other members now seen to be on their own, and likely see the Euro suffer as a result.

In the end, Greece will be bailed out, whether by the EU, the IMF, or some combination of the two, and we think the risk of a Greek debt default remains remote. Even though its last bond auction was well oversubscribed, Greece is facing unsustainably high borrowing rates and a package is needed to lower Greece’s borrowing costs and give the austerity plan time to work, otherwise a high cost debt-spiral would ensue. Once an aid package is resolved, we would expect some of the tempest to subside and for the EUR to stabilize and potentially recover. Given that EUR/USD has moved back to the lower end of the recent range, we would prefer to be buyers of EUR/USD while its holds above the key 1.3430/50 level. A daily close below that level, however, would suggest that the market was not in agreement with us and we would have to reckon with weakness down to 1.3200/50 initially.

From the charts, this past week’s price action mostly highlights downside potential ahead. Attempts to rally in EUR/USD, GBP/USD, XAU/USD and AUD/USD, all look to have been rejected, and the US dollar index has posted a weekly bullish engulfing line. But until the ranges break, fading the ranges (buying dips/selling rallies) still seems the most viable trading strategy.

RBI hikes, more coming from others

The Reserve Bank of India caught markets flat-footed on Friday with an inter-meeting rate hike of 1/4%, its first rate hike since July 2008, and the RBI indicated it would need to do more. The move itself was not unexpected, just the timing. But it should serve as a reminder that central banks globally are in the process of monetary tightening for those doing well (emerging markets mostly, maybe Canada–see below) or removal of extraordinary liquidity measures for those limping along (the G7). The PBOC, China’s central bank is widely expected to raise again its required reserve ratio, further restricting credit in China and potentially undercutting the global recovery. The Fed is also expected to further normalize (raise) the discount rate again before its next meeting. In most cases, such moves should only lead to short-term setbacks for risk appetites, and these may be sharp at times. However, we generally prefer to use such dips as a buying opportunity on risk assets.

SNB pulls the rug out from under EUR/CHF

SNB board member Jean-Pierre Danthine shocked markets by suggesting that the Swiss need to be prepared for higher rates and an eventual exit from accommodative policies. The CHF strengthened sharply on indications that the SNB was stepping back from its efforts to rein in CHF strength, and EUR/CHF plunged to essentially the all time low around 1.4315/20. Danthine later tried to put the cork back in the bottle, saying that the SNB will continue to counter excessive FX gains, but the markets were too busy unloading EUR/CHF to hear. We think the risk of intervention remains and we would not be surprised to see the SNB in the market sometime early next week. The fundamental flows, however, favor the CHF, especially if there is an EU impasse on Greek aid, so we would prefer to be sellers on the approach to 1.4500 should the SNB step in. SNB Chairman Hildebrand will be speaking on Tuesday morning in St. Gallen and he may stir things up. For those who anticipate a positive resolution to the Greek situation or believe the SNB is not done yet, it may be worth trying small longs in EUR/CHF, but with a highly disciplined stop loss below at around 1.4270.
March 24 UK budget will be critical in pre-election positioning

The March 24 budget will provide the incumbent UK government with a make or break opportunity to lay out its stall ahead of the general election. The release of better than expected public finances data for February will have put a small spring back in the step of Chancellor Darling. With just one month to go until fiscal year end the February data suggest that Darling will be able to announce that public sector borrowing this year is likely to be between GBP5 bln and GBP 10 bln less than forecast.

In essence this appears to be good news, but it requires qualification. Firstly, the February numbers may be better than expected but they are a far cry from good data. In the fiscal year to February net borrowing stands at GBP 131.9 bln. At this stage last year the borrowing requirement was around half the size at GBP66.5 bln; meaning that public finances are very much still in a shockingly poor condition. Not only that but there is risk that Chancellor Darling will use the news that the borrowing requirement is set to come in under his (very high) GBP 177.6 bln target to announce some pre-election sweeteners on March 24. The huge UK budget deficit (around 12.9% of GDP) is already a nasty thorn in the side of sterling, additional spending would not be welcomed by investors.

The recent falls in the value of the pound vs the US dollar are correlated with the fear that the general election (expected on May 6) will provide a hung parliament. The optimal outcome from the election as far as the markets are concerned would be a clear majority for the Conservative party insofar as this is more likely to bring a quicker resolution to the worries surrounding the huge UK budget deficit. Recently, there were signs that the Conservative party’s lead in the poll could again be increasing (albeit by probably not enough to win a clear majority) and this brought some support for the pound. Sterling also posted gains on the news that the February borrowing requirement data were better than expected. However, these gains proved to be short-lived. Further losses for the pound would be likely if the Labour party picks up more votes as the result of a pre-election giveaway at the March 24 budget. In the absence of clear evidence on March 24 that the incumbent government is committed to tackling the budget deficit cable could also see lower. The risks surrounding the pound suggest potential for a deeper decline. Below the GBP/USD1.4960/00 level may see towards USD1.4870.

CAD–To parity and beyond

Despite what has been a massive run-up of late, we maintain that the Canadian dollar still has considerable upside in the short/medium term. Rate hike expectations for the Bank of Canada (BOC) continue to increase, economic data in Canada remains robust and market positioning has yet to reach an extreme. These factors should help drive USD/CAD though parity and beyond.

Bank of Canada rate hike expectations continue to be nudged higher and the latest inflation report north of the border only increases the probability of a rate hike occurring sooner rather than later. Core consumer prices (excludes food and energy) jumped to an annual rate of 2.1% in February and this was well above the 1.7% run-rate expected. Remember that in their March statement, the Bank of Canada noted that core inflation had been "slightly firmer than projected" and the fact that it is now above their 2.0% target puts some pressure on the bank to potentially raise interest rates before their "end of 2Q 2010" line in the sand. We will have to see just how much of this pricing power at the retail level was due to the winter Olympics, but regardless, the trend in inflation remains decidedly higher and could force the bank’s hand. We may get an update from BOC Gov. Mark Carney next Wednesday (Mar. 24) when he delivers a speech and holds a press conference.

Canada also continues to outperform compared to the majority of the G-10 when it comes to economic growth. Not only have gross domestic product, international capital flows and housing starts come in better than expectations, but the all-important retail sales report (released just this week) blew away the consensus. Retail sales jumped 1.8% month/month in January and this was significantly better than the 0.5% market projection. The number in February is likely to be even stronger given the aforementioned impact from the winter games. This will continue to put Canada on better relative footing than most of the developed world and should continue to help attract capital to its shores.

Finally, while there has been much talk about the so-called overextended long position in the Canadian dollar, we must keep in mind that it is still well below the recent record. The non-commercial net position currently sits long 62,123 contracts and while this is quite elevated by historical standards, it remains nearly 30% below the 2007 highs when USD/CAD was making its 0.9058 low. In other words, there is plenty of room left to run here. Traders are now watching the 1.0050 level, where ostensibly a major option barrier lurks. Below there should see parity in no time.

While the Canadian dollar has the ability to rally on its own due to exceptional fundamentals, moves in other markets could help drive the move through the 1.00 level and beyond. In terms of what the CAD has been best correlated with since the beginning of the year, oil and stocks jump out. Loonie has moved in tandem with US equities 92% of the time in 2010 thus far and 85% of the time with oil. The relationships suggest that 1180 on the S&P 500 and/or $86 oil would translate to USD/CAD at parity.

Positive top-line 4Q earnings in the US coupled with massive amounts of flows out of money market funds suggests the upside in stocks remains in place. In terms of oil, the commodity is in what we would call a seasonal sweet spot. Looking back at the last 20 years, oil prices have rallied more than 10% on average from March through June – just in time for a Bank of Canada rate hike!

Key data and events to watch next week

The calendar lightens up in the United States in the week ahead. The under-the-radar Chicago Fed National Activity index kicks off the action on Monday. Existing home sales are due Tuesday while durable goods and new home sales are up on Wednesday. Initial jobless claims highlight Thursday while the final cut of 4Q gross domestic product and the University of Michigan sentiment index round out the week on Friday. Look out for a Bernanke testimony on Wednesday as well – these always have the potential to move markets.

It is also not very busy in the Eurozone. Consumer confidence starts off the week on Monday while French business confidence is due Tuesday. PMI indices, industrial new orders and the German IFO surveys are due Wednesday. French consumer spending is up Thursday while Friday has German consumer confidence due up. It will be a busy week in Brussels ahead of the EU summit on Thursday and Friday; expect a lot of headlines.

It is extremely light in the UK. Consumer prices are up on Tuesday, UK budget release on Wednesday, retail sales are due Thursday and business investment is scheduled for Friday.

Ditto for Japan. The BOJ meeting minutes kick things off on Monday, international trade is up on Tuesday while consumer prices are expected Thursday.

Canada is ultra-light, with leading indicators on Tuesday the only noteworthy release.

Don’t look down under for much excitement either. Australia has leading indicators on Thursday while New Zealand sees gross domestic product on Wednesday and trade numbers on Thursday.

Forex.com
http://www.forex.com

DISCLAIMER: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase of sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.

Overbought Test Of Resolve

Gbp/Usd moved 100 pips higher during the European session after reports from the U.K. labor market hit the newswires that were better than expected. The minutes from the recent Bank of England rate meeting revealed that nothing much had changed from the previous month, and that CPI and inflation reads were as much to do with a weaker pound than instigated by internal growth.

The MPC minutes suggest that interest rate increases are just as far away in the U.K. as any other major region, with the exception of Australia. This news had a positive effect on the major currencies, but the pound is the only pair to make a substantial breakout.The euro had a shy attempt to break the 1.3800 area during the London open, but the move was quickly retraced, and the pair spent the rest of the European session trading in a tight range. Unless the infamous Greek problems are actually solved, rather than jawboned, there seems to be much more upside potential for the Aud, Cad or even the Gbp than the Eur. The two commodity currencies, the Aud and the Cad continued their march against the Usd.

The global market place is once again trading on light momentum, signaling that investors may be reluctant to invest fresh capital, especially around such vital values, and now that global equity markets have moved into deeply overbought territory. It will need a fresh fundamental reason to instigate the next long move if it is to be ahead of a reversal to support.

Every global asset (except the Usd) is currently trading in an overbought state on the 4-hour timeframes, and the same on most Daily chart reads, which raises some questions whether this non-stop buying can continue during the next few sessions. S&P traders have moved 80% of the last 30 sessions into the green, but a point to note is that the vast majority of that buying has been put in place by futures trade; the cash sessions have been weak in comparison.

The major currencies are also overbought, in a move that forced the dollar index lower, to hit the 79.50 area in intra-day trade, which is a price area not seen in a while, and a previous swing point of note that may get the major currencies snagged up on in intraday trade.

Global Risk Impacts Usd Ahead Of PPI

Dollar Index

The Usd is being sold in-line with the move to risk, away from Bonds (read Usd based Treasuries) ahead of the 8.30am ET U.S. PPI read on inflation at the factory gate. Price action around red-flag releases is creating strong volatility. The Fed confirmation of rates on hold for extended periods has impeded long-Usd plays. Momentum is strong. Favor a straddle (Long and Short near term plays).

S&P Futures

Global risk markets are being bought, and stocks are through 2010 highs. Positive news on low interest rates means equities move higher in the near-term, with very little selling now that global expansion is expected through 2011. Market participants are focused on the positives right now, with nothing able to block the upwards view. Equity index numbers are holding at their highest valuations since Sept 08. Momentum is building. 12-month 96% correlation to Aud and Cad moves. Favor a pull-back to support.

Crude Oil

The energy and the entire commodity market saw strong upside action over the last two days of trading. This comes as the Fed continues to maintain its pledge for low interest rates, which reduces the value of the U.S. dollar, but also provides an important prop to the demand side of the economy. Favor a pull-back to support.

Gold Bullion

The gold trading pattern is hard to characterize, as most of the time the precious metal seems to be driven by the market’s aversion to risk. Some view gold as the only asset that is actually worth holding, while other say that gold has no real value in the fiat currency world. Intra-day traders should seal themselves from both camps, and focus on its price action.

Written by TheLFB Trade Team, © 2007-2008 LFB Services, LLC. All rights reserved. http://www.TheLFB-Forex.com

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U.S. Review

Upbeat, Downbeat or Simply No Rhythm

• Economic news continues to come in mixed, with positive reports on retail sales and the trade deficit being offset by disappointing reports on small business optimism and unemployment claims.
• Revised employment data for states show larger job losses during the recession and cast some doubt on January’s drop in the national unemployment rate.
• Stronger retail sales and declines in imports led to surprising drops in inventories at retailer and wholesalers in January. Inventories rose slightly at manufacturers, however.

Still on Pace for a Modest Economic Recovery

February’s retail sales report was easily the best economic news released this week. Overall sales rose 0.3 percent during February, with strong gains reported across nearly every major category. Sales excluding gasoline, building material and automotive dealers, which is a category that tends to track the personal consumption data, rose 0.9 percent in February, following a 0.6 percent gain in January. The strong back-to-back gains suggest consumer spending will rise at a 2.2 percent pace or better during the first quarter, which is in line with our forecast, published earlier this week.

One complicating factor in the retail sales figures is that retailers have done a really good job at bringing inventories in line with sales and are discounting much less than they did in prior years. As a result, the better numbers reported for January and February may not reflect as much volume as they first appear. The lack of discounting is also apparent in the Consumer Price Index, which has shown larger price gains for core good prices. Prices for core goods are currently up 2.9 percent over the past year, which is their largest gain since the early 1990s.

One of the more disappointing reports released this week was the Small Business Optimism survey conducted by the National Federation of Independent Business. The survey fell 1.3 points in February and showed little to no improvement in most of its key components. Small businesses remain pessimistic about the near-term economic outlook and relatively few feel that it is a good time to expand their operations or hire additional staff.

The lack of improvement in small business optimism does not come as much of a surprise to those that follow the sector. Small businesses are often firms that are usually privately owned and the owners are intricately involved in the operations of their business. The owners likely hired the vast majority of the workers they currently employ, work side by side with them, and many had to let some of their workers go over the past couple of years. Most owners also have a great deal of the personal net worth invested in their business and are understandably cautious about putting their life’s work at risk. To further complicate matters, credit is harder to get for many firms, particularly those tied to the housing sector.

There were three key reports on the labor market this past week. One was slightly positive, while the other two pointed to continued trouble. The Job Openings and Labor Turnover Survey reported a sizable increase in job openings during January, with the job openings rate rising to 2.1 percent. The increase brings the number of job openings to 2.7 million. The ratio of unemployed to job openings fell a record 0.6 during the month to 5.5 workers per job opening.

The better unemployment rate data for January, which saw the nation’s jobless rate fall 0.3 percentage points to 9.7 percent, may have overstated the pace of recovery. Newly revised state data show the unemployment rate moving in the other direction, with increases reported in January for every major Census region.

U.S. Outlook

Industrial Production • Monday

Industrial production rose 0.9 percent in January, the seventh consecutive monthly increase. The string of gains dating back to July is consistent with our view that the recession likely ended in June. Both manufacturing and utility output contributed to the gain. Cold weather will likely continue to boost utility output in February. The headline ISM manufacturing index came in at 56.5 in February with new orders and production still solidly in expansionary territory. With inventory levels still relatively lean, the difference between new orders and inventories suggest further gains in production are likely in coming months. Capacity utilization, which peaked in 2006 at 81.2 percent, will likely continue its gradual upward trajectory, but is rising from very depressed levels. Consequently, pricing power will remain minimal.

Previous: 0.9% Wells Fargo: 0.2%
Consensus: 0.0%

FOMC • Tuesday

The Federal Reserve is expected to keep its federal funds target rate at its current level at the March meeting. Economic conditions including “low rates of resource utilization, subdued inflation trends, and stable inflation expectations” that have continued to warrant “exceptionally low levels of the federal funds rate for an extended period” are still in place. Our outlook continues to suggest that resource utilization should remain low through the end of 2010 with the unemployment rate peaking at around 10.1 percent. Moreover, the fed has historically not raised rates while the unemployment rate is rising. Further, inflation trends as measured by the core PCE deflator remain well within the Fed’s comfort zone at 1.4 percent year over year. Finally, one measure of inflation expectations, the TIPS spread, is a little more than 2 percent, suggesting inflation expectations are contained.

Previous: 0.25% Wells Fargo: 0.25%
Consensus: 0.25%

CPI • Thursday

The Consumer Price Index (CPI) rose 0.2 percent in January. The overall CPI is now up 2.6 percent year to year, while the core CPI is up just 1.6 percent. With housing in obvious oversupply, rent and owners’ equivalent rent should continue to moderate in coming months keeping core consumer prices relatively tame. Goods prices, however, are continuing to rise faster than services prices. Goods prices were up 2.9 percent over the past year in January, the largest increase since the early 1990s. Core goods prices are being pulled up by stronger global economic growth, while weak domestic demand continues to restrain core services prices. Higher retail gasoline prices will likely also push the headline higher. We expect headline CPI to increase 2.3 percent year-over-year in February and core CPI will likely register a modest increase of 1.4 percent.

Previous: 2.6% (Year-over-Year) Wells Fargo: 2.3%
Consensus: 2.3%

Global Review

Brazilian Economy Surges on Domestic Consumption

• The Brazilian economy surged during the last quarter of 2009 on the back of personal consumption expenditures and government expenditures. Given the faster-than-expected rate of recovery, we will likely raise our forecast for 2010 GDP growth.
• For the full year, the economy slipped 0.2 percent in real terms during 2009 after growing 5.1 percent in 2008.
• Our primary concern in Brazil going forward is inflation.

Brazilian Economy Surges on Domestic Consumption

The Brazilian economy expanded substantially during the last quarter of 2009 on the back of personal consumption and government expenditures. Personal consumption expenditures jumped 7.7 percent during the fourth quarter of the year compared to the same period a year earlier, while government consumption posted a 4.9 percent growth rate over the same period. The growth in private and public consumption was largely engineered by the administration through very specific fiscal programs as well as a very accommodative monetary policy by the Brazilian central bank.

The economy dropped 0.2 percent in real terms during 2009 after growing 5.1 percent during 2008. It is clear that the Lula administration had to put some type of domestic package together during the year because exports remained very weak even as the world economy recovered. Exports of goods and services dropped by 4.5 percent year over year in the last quarter of 2009 and by 10.2 percent during the whole of 2009 after a decrease of just 0.7 percent during 2008.

After three miserable quarters for gross fixed investment, there was a welcome turnaround in the fourth quarter. This is an important dynamic because fixed investment spending is going to provide some sustainability to the current recovery, especially as the external sector comes back. Gross fixed investment grew by 3.6 percent during the fourth quarter of the year compared to the same quarter a year earlier but dropped by 9.8 percent for the whole of 2009 compared to the previous year.

Our main concern going forward is Brazilian inflation. The Lula administration will have to scale down government programs put in place during the last two years if it does not want to suffer another bout of accelerating inflation, especially during an election year, which is normally a very difficult time for inflation expectations.

Even though the country has advanced considerably in terms of productive infrastructure, it still needs to invest more to reduce productive bottlenecks that occur once the economy is growing at a fast pace. Thus, gross fixed investment will have to keep advancing at a much faster pace than it is today to help relieve some of the pressure on the supply side of the economy.

Given the faster-than-expected rate of recovery, we will likely raise our forecast for 2010 GDP growth. That said, there are still some risks attached to this forecast, and the fundamental risk is renewed inflationary pressures. We have already seen the first signs that inflation is coming back, and if domestic consumption continues to remain as strong as it is today, then the problems will worsen as the external sector continues to recover. Thus, the central bank will have to move sooner rather than later, and this could slow down growth during the second half of the year. For this reason, our forecast is likely to remain below the consensus forecast of almost 6 percent for 2010.

Global Outlook

Japanese Machine Tool Orders • Monday

The Japanese economy surprised markets by posting a very strong 4.6 percent rate of growth during the last quarter of 2009. Early indications point to a very strong number for Japanese machine tool orders next week, which could point to relatively strong growth during the first quarter of this year.

However, these expectations will have to deal with the blow coming from the automobile industry where Toyota has continued to face production slowdowns and stoppages as well as reputation hits that have severely affected the company’s performance. Thus, while the economy seems to be on the mend, it is still too early to gauge how serious Toyota’s problems will be for the overall economy. So far, the news coming form Japan seems to point to a somewhat negligible effect, but we will not be surprised if this changes during the next several months.

Previous: 67.8
Consensus: N/A

U.K. Unemployment Rate • Wednesday

While the U.K.’s unemployment rate remained at 7.8 percent during the last quarter of 2009, there is plenty of evidence that the employment situation has continued to deteriorate during the first quarter of this year. Production measures like the industrial production index have remained in negative territory even as other countries’ indices have rebounded strongly during the last several months.

The weak employment situation is clear when looking at the unemployment claimant count. This measure, which shows those workers seeking unemployment insurance, increased by 23,500 in January to 1.64 million, the highest level in 13 years, and was up by 381,800 compared to January of last year. Thus, while the U.K. economy is recovering from the recession, the pace of this recovery is still very weak.

Previous: 7.8%
Consensus: 7.9%

Canadian Retail Sales • Friday

The rebound in Canadian economic activity has been significant, and next week’s retail sales activity could confirm the recovery in domestic demand, which was also prey to the global economic downturn during the last two years. Retail sales in December of 2009 posted a very strong growth of 6.7 percent, and we should expect that trend continued during the first month of 2010 as the economic recovery gained momentum.

Meanwhile, commodity prices have increased considerably over the last several months, and this is giving the external sector and the economy as a whole some more ammunition to continue its current expansion. Petroleum prices are once again on the way up, and this is very good news for the Canadian petroleum sector and for domestic consumption.

Previous: 0.4% (Month-over-Month)
Consensus: 0.5%

Point of View

Interest Rate Watch

Fed Exit Strategy

We are skeptical. This perfect strategy sounds too much like the British invasion of Gallipoli. Seldom have we had so much policy easing in so many new and untried ways, and now we are looking at getting out with no problems? Effective communication is the way we have heard it expressed but already we have the Treasury SPF program announcement with some confusion about what is the purpose of this rebuild of the program from $5B to $200B over the next two months. The Fed’s announcement of the discount rate hike did catch many observers by surprise. Certainly we do not expect the Fed to have a perfect plan that will be laid out so that everyone will know exactly what to expect at all times and we have already seen two examples where actions that entail credit markets effects have not been perfectly anticipated. Why would we expect future actions to be perfectly anticipated? Instead our expectation is for short-term rates to be more volatile and drift upward over the next six months. There is uncertainty about the commitment of the Fed to drop further intervention in the mortgage backed security (MBS) market. Without the continuation of the Fed’s significant buying over the last six months our expectation is that mortgage rates will drift up as growth and inflation expectations rise with the economic recovery while the Fed drops out as a major buyer of MBS. Much uncertainty remains among investors that the Fed can remain out of the mortgage market due to the political pressures to support the economy and housing. Yet any Fed return to intervention in the MBS market would suggest that the Fed’s balance sheet is not going to be reduced and that growth, not inflation, is the goal. In this case the Fed’s inflation-targeting credentials will be tarnished—especially in an election year.

Our outlook is that both short and long-term interest rates will rise this year as the economy continues to recover. However the rise in rates will limit the gains in housing and consumer durable purchases this year. Rebalancing the consumer balance sheet does require less spending.

Consumer Credit Insights

Rebalancing the U.S. Consumer

One of the key drivers for the pace of the recovery will be the actions of the U.S. consumer. If the consumer does shift toward higher savings and paying down credit/debt obligations we will see a slower pace of growth in the short run. Yet if the consumer returns to old ways then leverage will drive spending again.

This week’s Flow of Funds data from the Fed suggested that households are downshifting on debt and raising that saving rate. Household total liabilities (debt) fell for the fifth straight quarter. Liabilities declined for both home mortgages and consumer credit. Meanwhile, the personal saving rate came in at four percent and is off the sub-two percent range that characterized the 2005-2008 period.

On the asset side, homeowners’ equity as a share of household real estate has begun to recover and we expect this recovery will continue for several years. Household net worth also continues to recover although it remains beneath the 2007 peak.

Our outlook is for consumer spending growth to remain subpar in 2010 and 2011 compared to the 2004-2007 period. Both housing starts and light vehicle sales will therefore remain significantly below the pace of that same period. With more modest consumer spending comes more modest economic growth and thereby continued stress on state and local sales tax revenues.

Topic of the Week

State Finances Face a Tough Road Ahead

Even with the recovery finally taking hold, the outlook for state finances remains bleak. The exceptionally weak labor market, with high and unusually long-term unemployment, continues to restrain personal income tax receipts, while falling home prices and disappointing retail sales are hitting property and sales tax collections. State lawmakers already closed a cumulative budget gap of $158.5 billion earlier in fiscal year 2010, but new gaps have emerged as revenues have failed to keep pace with spending. Midyear budget gaps bring the total shortfall for fiscal 2010 to $196.2 billion.

Revenues are expected to decline further as state tax collections traditionally lag trends in the overall economic recovery. In the previous recession, tax revenues lagged nearly a year following the end of the recession. The extended drag on revenues is due to the weak labor market, which weighs on personal income, consumption and corporate profits growth. State tax revenues were down nearly 11 percent on a sequential basis in the third quarter and are 33 percent below the peak reached in the second quarter of 2008. Preliminary figures for the fourth quarter from The Nelson A. Rockefeller Institute of Government showed continued weakness with total tax revenues declining 4.1 percent. Declines have moderated, however, reflecting fewer layoffs, a slight increase in hours worked, and a slightly better-than-expected holiday shopping season.

Many states have already projected huge budget gaps for fiscal 2011 with estimates of $103.5 billion. Provisions in the proposed federal budget for fiscal 2011, however, will likely not be enough to offset growing budget concerns. With many states having already scaled back many nonessential services and boosted taxes and user fees, there are few easy alternatives left. The drag from state and local government will continue to be a drag on GDP growth, further slowing an already modest economic recovery.

Please visit our website for the full report.

Wachovia Corporation
http://www.wachovia.com

Disclaimer: The information and opinions herein are for general information use only. Wachovia Corporation and its affiliates, including Wachovia Bank, N.A., do not guarantee their accuracy or completeness, nor does Wachovia Corporation or any of its affiliates, including Wachovia Bank, N.A., assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or any foreign exchange transaction, or as personalized investment advice. Securities and foreign exchange transactions are not FDIC-insured, are not bank-guaranteed, and may lose value.