Rethink Foreign Exchange

September non-farm payrolls are due for release on Friday and now more than ever the level of job losses could determine whether the Federal Reserve will cut interest rates this month and by how much. The US dollar hit a one year high against the Euro this morning, but has remained weak against the Japanese Yen. This divergent price behavior has been primarily due to the market’s adjustment of ECB interest rate expectations. However should non-farm payrolls be particularly bad, it would

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Non-farm payrolls dropped by 159k last month, 50 percent more than the market expected. Even though there was a minor upward revision to the August data, the Fed will have no choice but to cut interest rates at the end of the month. Fed fund futures are pricing in a 50bp rate cut by the Oct 29 meeting but we believe that the number is not bad enough to cut by 50bp because the central bank will want save some ammo for the remainder of the year in case the bailout plan fails to stimulate the

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The value of total construction put in place remained unchanged in August. For the first time since March 2007, residential construction actually increased – up 0.3 percent. The slower economy coupled with tighter lending requirements, however, will continue to put downward pressure on construction spending in the coming months.

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Overview: The ISM manufacturing index was unchanged in April at 48.6. Although contracting moderately, the recent months of data suggest that the manufacturing sector continues to hold up quite well compared to other parts of the economy. Again the survey sent a message of continued significant price pressures in the production pipeline.

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• Spending on goods fell, but services continued solid • Non-residential investment deteriorated significantly, signaling a future broad based deterioration • We maintain our forecast of 1% GDP growth in 2008 GDP growth remained at a sluggish 0.6% in 1Q08. This was 0.4 pp less than our estimate. On a year-over-year basis, real GDP growth was 2.5%, similar to that of 4Q07. Private consumer expenditures (PCE), government spending, net exports and private inventories added to growth. This was

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Overview: The April labour market report proved stronger than generally anticipated. The data revealed a job loss of 20,000 persons in April (consensus: -75,000, DB: -40,000) and a drop in the unemployment rate to 4.95% from 5.08% (consensus and DB: 5.2%). Prior months saw a mild net revision of -8,000 persons. Today?s report is consistent with an economy which has come close to a standstill, but has not slid into a recession.

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Although CPI excl. fresh food in March was in line with expectations, increasing core inflation and the preliminary April CPI figures for Tokyo both indicate that inflation in Japan is increasing faster than expected. Hence we have increased our inflation forecast.

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What?s new? There was mixed data today with Euroland PMI weaker for manufacturing, but the German PMI was still quite strong with a robust improvement in the Service sector. Belgium business confidence data was also released today, and surprised strongly to the downside strengthening the case for a slowdown in Euroland manufacturing. The Belgium business confidence index fell from 1.2 to -7.9 (consensus 0.5). As can be seen in the chart below, the correlation between Belgium confidence and ifo

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Overview: The German IFO index disappointed in April and fell stronger than expected. The decline was broadly based across sectors and reflected lower expectations as well as assessment of current condi-tions. We have been puzzled about its strength in the past few months, but we may now start to see the slowdown in growth feeding through to IFO. The decline was not a total surprise as markets got a warning from the steep decline in Belgium business confidence yesterday.

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Contraction, although modest, continues in manufacturing. The ISM index of manufacturing activity came in at 48.6, below 50 for three of the last four months. Orders, production and employment led the weakness. These components suggest continued weakness in the second quarter for output and personal income. Prices are an issue.

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