Prague Twin

Saturday, June 10, 2006

Weekly Economic Report

Fed Chairman Bernenke all but plainly said that the short term lending rate would go to 5.25% citing inflation concerns. His "ramaining vigilant" quote will probably become one of his catch frases for raising rates. This had a devestating effect on the equity markets (DJIA down over 3%). The most worrisome day, ironically, was Thursday which ended in positive territory, but high volume and volatility pushed the Dow momentarily below 10,800. This represents a nearly 1,000 point drop in 29 days. This hard of a drop has not been seen in over 3 years. The main difference between now and then, was that then, the market was in a mode of stabilizing after some of the most volatile swings ever seen after the dot-com crash and 9/11.

Simply put, investors are diminishing their risk, which is why we also see gold spiking lower to nearly $600. This means they are pulling their money out. Investors are hoping that we have hit a bottom. Personally, I am surprised it went down this fast, so I expect to see a bounce next week. The downward action is looking quite shocking on the long term charts. A perfect funnel down. A bounce will probalby be followed by more downward action until this pattern of decline can be broken.

Three weeks ago I said that the USD/EUR rate would stay between $1.30 and $1.26 for some time. Well, for 3 weeks it has. Anyone range trading on this basic priciple over the last three weeks has made a fortune. This week we saw the perfect example of this as the high point was $1.2976 and the low point was $1.2597. The drop was mostly due to Bernanke's statement. When the pair hit this $1.26 level, on better than expected US trade deficit news, it immediately bounced up to $1.2680 and has now settled in for the weekend at $1.2639. I expect that $1.26 will hold but there is still a chance of that correction to $1.25 or lower.

HIgh volatility in all markets, with a sharp drop in equity markets and strong gains for the dollar: A typical reaction to hawkish comments from the Fed.

Look for a slower week next week. Or, rather, hope for one. I expect that equities will be more volatile than currencies in the comming week, with the Dow seeing a bounce off Thursday's bottom by weeks end, and the dollar consolidating around $1.2750.

3 Comments:

  • praguetwin,

    it's good to have you back. I missed your market/financial analysis during this topsy-turvy week for the markets.

    Wasn't Thursday an insane day for the Dow? I saw it down 172 early in the day, yet by the time I got home in the afternoon, it was finishing up. Amazing. And still the Dow gave up 300 points for the week.

    I assume this week could be just as volatile if the producer's price index or consumer's price index come in either over or under expectations.

    If the ppi or cpi spooks markets on the inflation front, how do you think they'll react? And conversely, if the numbers are good, will the Dow take back the losses from this week?

    It seems to me as an unschooled observer that the Fed is definitely raising rates no matter what. So even if the cpi and/or ppi numbers are a little better than expected, Wall Street can't read that as a hedge against a June rate increase, can they?

    BTW, you're Moscow post was great.

    By Blogger reality-based educator, at 7:04 PM  

  • Reality-based,

    Thanks for the warm welcome. I probably would have had to chime in early on this week, because as you say, it was wild. Especially after the last 3 years of relatively steady growth and low volatility, this one-two punch of sharp declines and volatile swings is highly significant.

    Thursday is probably an indication of things to come. Regardless of the data, you will see more volatility as the long term investors lower risk and short-term investors and day traders try to capitalize on the rebounds (which is what happened thursday).

    After Bernanke's comments, the market now has a rise to 5.25% priced in. It would take much higher CPI and PPI data than expected to make a large impact. However, lower CPI and PPI data than expected could lead to another round of overenthusiasm which would eventually come to call (as the last round is now).

    I imagine that the numbers will be in line with expectations, but look for consumer confidence numbers (especially retail sales on tuesday) to make an impact this coming week.

    I've been thinking the Fed will continue to rise no matter what. The Fed looks at ALL the numbers, not just the ones that the market focuses on.

    My feeling is that with 5% GDP growth, rates are going to continue to rise as this is too hot for the U.S. economy. The market likes to fantasize, and they have been doing a lot of that lately (i.e. prior to Bernanke's comments there was a 50% chance that the Fed would raise which is laughable). Now it is like 84%.

    So in answer to your questions, yes, if the nubers are good, you will see a bounce as the market foolishly considers lower than expected CPI and PPI numbers as an indication that the Fed will pause.

    They will be wrong, of course, but the market lives in a fantasy world all it's own.

    By Blogger Praguetwin, at 8:01 AM  

  • I just came home to see the Dow fell almost a hundred today and the Nasdaq is now in a full-fledged correction, having fallen 10 percent since May 8.

    Yikes, the volatility continues. Tomorrow should be an interesting day. I'll watch for those retail numbers tomorrow.

    By Blogger reality-based educator, at 11:50 PM  

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