The concurrent rally in the U.S dollar and U.S. equities implies good news relating to the U.S. economy. But unfortunately the price action is misleading, because this morning's U.S. housing market numbers were mixed, and according to the Federal Reserve's Beige Book report, there are more signs of slower economic activity in the 12 Fed districts. For the Federal Reserve, which uses the Beige Book to decide if monetary policy changes are needed, there was nothing surprising in today's report.
While growth in some parts of the nation is slowing, other parts of the country are still growing at a moderate to modest pace. With this in mind, however, 3 of the Fed districts reported slower growth compared to only 1 in the previous report. This means that the U.S. economy worsened in June and if the Fed wants to this trend to change, they will need to stimulate the economy further. Yet the Fed Chairman is very hesitant about resorting to a third round of stimulus. In Day 2 of his semi-annual testimony on Capitol Hill, Bernanke admitted that there is a theoretical limit to QE as the Fed can only buy Treasuries and agencies. The problem for the Fed is that they did not expect such a dramatic and sustained slowdown in job growth and since this wasn't anticipated, they are not sure how enduring the slowdown will be. Incoming economic data has been mixed, providing the central bank will very little direction.
According to the Beige Book report, the areas surrounding New York, Philadelphia and Ohio saw economic growth slow. This represents deterioration from the previous month when only Philadelphia reported weaker economic activity. Manufacturing and retail demand also softened while job growth improved at a tepid pace in most districts. Businesses remain cautiously optimistic but there were signs of improvements in loan demand and housing market reports were "largely positive."
This morning's U.S. economic releases showed housing starts rising 6.9% in June and permits dropping 3.7%. The trend in both starts and permits has been rather volatile, which isn't particularly surprising considering that a housing market recovery always lags the broader economic recovery. The Philadelphia Fed Survey, Existing Home Sales and Leading Indicator reports are scheduled for release on Thursday along with the weekly jobless claims report.
EUR: Concerns About Europe Return
The euro ended the North American trading session unchanged against the U.S. dollar, but its earlier weakness and rise in Spanish 10 year bond yields tell us that concerns about Europe have returned. In our end of day note yesterday, we warned that it is a mistake to assume that the focus on QE from the Fed means that Europe's sovereign debt crisis has gone away. This morning's weakness in the EUR/USD was tied to fresh concerns about stability in the region.
With the memorandum of understanding for Spain's bank bailout plan scheduled to be signed on Friday, terms for Spanish aid are being hashed out right now. A spokesman for the German Finance Minister said the Finns needs to make concessions if they want a special guarantee for their part of Spanish aid. Ten year Spanish bond yields rose 13bp this morning to 6.85%. Comments from European Central Bank Executive Board member Joerg Asmussen about Eurozone stability certainly hasn't helped the euro as well as talk of a possible Austrian sovereign downgrade.
Europe's debt crisis is back in the headlines and with it, the weakness in the euro. No major economic reports are expected from the Eurozone on Thursday but Switzerland will release its trade numbers, which should tell us whether the intervention efforts of the Swiss National Bank have helped to improve trade activity. With the euro extending its losses against many major currencies, the SNB has undoubtedly stepped up intervention efforts to keep EUR/CHF above 1.20. If the June trade numbers show continued weakness in exports, intervention will need to continue.