German Consumer Confidence fell in September; French manufacturers remain upbeat

French President Nicolas Sarkozy and German Chancellor Angela Merkel at a press conference on Sept 10,2007.

The high level of the German consumer climate index in the summer months has not been sustained in September, according to the Gfk monthly survey of German consumer confidence. Meanwhile, France's national statistics office Insee said today that a survey of French manufacturers showed that they remain upbeat despite the ongoing credit market turmoil.All three main indicators of the German consumer mood are slightly down. Due to the most recent developments of the consumer climate, GfK has decreased its forecast growth of private consumption from 1.0 to 0.6% for 2007 as a whole. Following the revised 7.4 points in September, the consumer climate forecast for October is 6.8 points.

As was already evident in August, the positive consumer mood has been affected by the rather more gloomy conditions of late. Above all, the credit crisis in the USA and rising food prices are responsible for the somewhat less euphoric consumer attitudes. In addition, increasingly critical comments mean higher skepticism amongst consumers who anticipate a slight glitch in the German economic upswing as a result of the strong euro, high energy prices and a weak economic outlook in the USA. In light of this, buying propensity, which managed to withstand last month’s negative effects, is somewhat weaker this month.

Market News Update: Euribor 3-month rate hits almost seven-year high

Bank credit risk has risen in Europe and the 3-month Euribor rate, a key inter-bank lending rate, has risen to the highest level since December 2000.

JPMorgan Chase & Co says that credit-default swaps on the iTraxx Financial Index of subordinated debt, a measure the cost of protecting the bonds of 25 European banks and insurers against default, rose 4 basis points to 48 basis points. The rise in the index comes as hopes of an early end to the credit crisis has abated..

The Financial Times reported today that Northern Rock Plc has borrowed £8 billion pounds from the Bank of England - equivalent to a third of its deposits prior to its recent financial crisis. It's also reported that Canadian lenders are also encountering ng difficulties refinancing in the money markets, Bank of Montreal Chief Financial Officer Karen Maidment said on Thursday.

The Libor, London interbank offered rate that banks charge each other for three-month loans in euros is at 4.79 percent, 79 basis points more than the European Central Bank's benchmark rate and the highest since May 2001, according to the British Bankers' Association.

Global forex volume surges

The Bank of International Settlements just released the results from its first survey of Central Banks in over three years, and the results were startling. Forex volume rose 71% to $3.2 trillion per day, cementing the status of forex as the world's largest market. Trading in forex derivatives also surged, to an average of over $2 trillion per day. While the role of the USD has slipped somewhat, it remains the world's reserve currency as evidenced by the fact that it represents over 40% of all forex volume. FinFacts reports:

"A significant expansion in the activity of investor groups including hedge funds" as well as individual investors also contributed to the increase."

dollar & yen continue to strengthen

Despite the effects of US subprime mortgage troubles on the rest of the world, investors have scaled back risky ventures and increased the value of both dollar and yen. While this result may be inadvertent, it is much appreciated by those who have lost major funds in the stock market recently. The future doesn't look any brighter for US mortgage, either. According to Hemscott:

Housing starts sank 6.1 pct in July to a 1.381 million unit annual rate, the lowest since January, while building permits -- a more forward-looking indicator -- fell 2.8 pct to a 1.373 million rate, the lowest since October of 1996.

Canadian Dollar reaches a 30-year high

The Canadian Dollar is making a run at forex history, having reached a 30-year high against the USD this week. The currency has appreciated by over 50% since 2002, and is up 9.4% this year alone. The Loonie is surging on a combination of high commodity prices and attractive interest rates. It is no coincidence that the price of oil has more than tripled over the five year period that the Loonie also appreciated in value. In addition, the Bank of Canada is expected to raise interest rates two more times in the near-term which would bring its interest rate levels close to parity with US rates. The last time the Canadian currency, itself, stood at parity with the USD was in 1976. While it now seems inevitable that the currency will soon return to that marker, there are still hurdles that need to be cleared. Bloomberg News reports:

“A strengthening currency has started to adversely affect the country's growth, especially the manufacturing sector, which may raise concern the BOC needs to keep rates on hold.”

commentary: what to do about the chinese

The Chinese Yuan refuses to die as a topic of conversation among forex speculators. In theory, the currency is among the world’s most prosaic; since its famous “revaluation” by the Chinese government nearly two years ago, the Yuan aka RMB has appreciated at a leisurely pace, roughly equivalent to 3% per year. Last week, the CCP took a step further in liberalizing its currency system by widening the band in which the Yuan is permitted to fluctuate, to .5% daily.

However, this did little to appease foreign diplomats and American politicians, who contend that the Yuan remains vastly undervalued, and that the Chinese government is guilty of currency manipulation. Two American Senators, Lindsey Graham and Charles Schumer, are still threatening to introduce a latent piece of legislation into Congress, which would slap a 27.5% tariff on all Chinese imports, unless the CCP promptly increases the value of the Yuan. (The 27.5% represents an average of the high and low estimates, 40% and 15%, respectively, of the extent of the Yuan’s undervaluation relative to the USD.) For its part, China maintains that not only is the currency fairly valued, but also that it will not be pressured into hastening the Yuan’s rate of appreciation. So, two questions need to be answered: Is the Yuan undervalued and if so, should China allow it to appreciate at a more rapid pace?

The first question is probably the trickier of the two to answer. Economists use admittedly crude techniques to value currencies. One method involves a calculation of purchasing power parity (PPP), which dictates that currencies should adjust in value relative to each other in inverse proportion to their respective price levels. In the case of the Yuan, PPP analysis suggests that the Yuan may be undervalued by as much 50%. However, this is to be expected; since income levels in China are vastly lower than in the US, one would expect prices to be lower, irrespective of exchange rates. Other methods used to estimate the fundamental value of the Yuan involve sophisticated statistical analysis, producing estimates of undervaluation ranging from 0% to 50%. In short, it appears as though the Yuan remains marginally undervalued, but the extent of which remains guesswork.

Upon concluding that the Yuan is undervalued, should China be expected to allow the currency to fluctuate more freely (i.e. appreciate)? It depends on who you ask. American officials argue that the revaluation of the Yuan represents a crucial piece of the drive to reduce the burgeoning US trade deficit. However, upon closer examination, this notion is revealed to be false since most of China’s exports to the US are themselves repackaged products from other parts of Asia. Further, a sudden revaluation of the Yuan would likely result in the relocation of Chinese production to facilities to other low-wage countries, thus doing little to stem the US trade deficit. From China’s point of view, its economy is helped by an artificially cheap currency in that its export sector receives an indirect subsidy. However, it is constrained in its ability to conduct monetary policy as well as in its need to accumulate massive forex reserves, both of which would be relaxed in the event of a revaluation.

Not withstanding that China’s stubbornness mean it will not be bullied into appreciating its currency, it is probably in everyone’s best interest if it capitulates. My prediction, for what it’s worth, is that China will ultimately allow the RMB to appreciate at a slightly faster pace against the USD, probably somewhere in the neighborhood of 5% a year.

bank of england raises rates

The Bank of England raised interest rates for the second time in as many months yesterday, to 5.75%. As a result, the UK has widened its lead over the US as the country with the highest interest rates in the industrialized world, after New Zealand. Moreover, the UK is becoming an increasingly viable alternative to the US as a target for risk-averse investors. The British Pound is hovering around a record high against the USD, which can probably expect to suffer prolonged decline against the world’s majors if it falls behind in attracting risk-free foreign capital. The Financial Times reports:

“The statement accompanying the rate hike gives few firm clues as to future interest rate movements, with the Bank of England…concluding that the risks to the inflation outlook are still tilted to the upside.”

central banks

The U.S. Central Bank voted unanimously to hold interest rates steady on Tuesday, resisting pressure from Wall Street calling for an rate cut. The federal funds rate has now been at 5.25% for over a year. The Fed feared that a rate cut would only do more damage to the USD, which is already weak overseas. According to the Chicago Tribune:

About the only consolation for financial markets was the fact that the central bank at least mentioned these concerns in a statement after its meeting. That acknowledgment gave Wall Street faint hopes of an interest-rate cut later this year if credit conditions continue to deteriorate.
Tightening credit, combined with a continuing housing correction, have slammed stock prices over the past weeks. A high level of volatility has signaled to many that the bull market is over and that the credit crunch could be worse than believed.

how to value a currency ?

With the US government doggedly clinging to the notion that China is manipulating its currency and insisting that the communist country be punished accordingly, it bears asking “how can we determine that a currency (in this case the Yuan) is in fact undervalued, and if so, by how much. One notable economist has laid out three general techniques for “valuing a currency,” which may prove useful to all of you amateur economists.
First, there is the concept known as “purchasing power parity,” which suggests that a pair of currencies should fluctuate in value relative to each other based on changes in their respective interest rates and inflation. Second, there is the notion of a “sustainable” or “fundamental equilibrium” exchange rate which brings a country’s current account into balance- neither deficit nor surplus. Third, historical exchange rate data can be regressed against various economic indicators (productivity, employment, etc.) in order to distill the select few that had the most direct effect on the currency in the past. The most current economic data can then be plugged into the resulting equation and tested against actual exchange rates. However, while economists agree that these techniques are the most theoretically sound, they ignore the fact that currencies today seem less tied to the laws of plain economics than they do to financial economics- capital flows.

fed holds rate steady

The U.S. Central Bank voted unanimously to hold interest rates steady on Tuesday, resisting pressure from Wall Street calling for an rate cut. The federal funds rate has now been at 5.25% for over a year. The Fed feared that a rate cut would only do more damage to the USD, which is already weak overseas. According to the Chicago Tribune:

About the only consolation for financial markets was the fact that the central bank at least mentioned these concerns in a statement after its meeting. That acknowledgment gave Wall Street faint hopes of an interest-rate cut later this year if credit conditions continue to deteriorate.
Tightening credit, combined with a continuing housing correction, have slammed stock prices over the past weeks. A high level of volatility has signaled to many that the bull market is over and that the credit crunch could be worse than believed.