Domestic Economic Conditions
Current economic conditions will likely foster a disinflationary environment, at least in the short run. The first quarter annualized GDP was down 6.1%, which was much weaker than the median estimate of a 4.7% decline. This was the first time since the 1974 - 1975 period that GDP has declined for three consecutive quarters. Keep in mind that only two consecutive quarters of negative GDP growth is the classic definition of a recession. Much of this weakness in the nation’s output was attributed to substantial declines in business inventories and exports. The business inventories portion of the report collapsed by almost 38%, while exports contracted by 30%. This decline in exports was the largest since 1969. One encouraging part of the report was consumer spending, which increased by 2.2%, against an estimate of a .9% improvement. The April consumer confidence index also was encouraging at 39.2, which compares to a guess of 29.9.
There is a mixed to bearish picture for the housing industry. March new home sales were 356,000, when 337,000 were anticipated. Partially offsetting this improvement was news that a record 19.1 million homes were unoccupied in the first quarter. March housing starts were not very encouraging either. March housing starts were 510,000, against a guess of 540,000 and permits were 513,000, which compares to an estimate of 549,000. The permits portion of the housing report is widely thought to be a leading indicator of the housing industry because it reflects signed contracts, as opposed to the actual home construction that can take place months later. In addition, it looks as though restrictive lending rules and home price declines may keep many buyers out of the housing market for now. Also, we continue to hear that a majority of U.S. banks have made it more difficult for consumers and businesses to get credit in the last six months. This continues to be the situation even though financial institutions have received large injections of taxpayer funds. It does appear rather ironic that U.S. banks have received billions of dollars from the government and are actually making fewer loans.
The most recent employment reports have shown weakness, but they have not been much worse than the analysts’ guesses. March nonfarm payrolls were down 663,000, when a 660,000 decline was anticipated. The February figure was left unrevised, but the January figure was changed to down 741,000 from a previously reported 598,000 decline. The unemployment rate was 8.5%, which was the median guess. Manufacturing payrolls were down 161,000, which compares to expectations of a drop of 162,000.
Global Disinflationary Forces
International inflation rates are moderating as the global economy has yet to show much response to the various economic stimulus plans. It appears as though it will take more time for all of the international governmental efforts to improve economic conditions. There continues to be talk that more of the major central banks will eventually drop their key short term interest rate targets to near zero percent.
There are plenty of disinflationary forces at work in the euro zone, which is prompting many analysts to believe that the European Central Bank will lower their benchmark interest rate again when they meet on May 7th. The current key interest rate in the U.K. is at its lowest level since the Bank of England was established in 1694. Since the British economy remains under pressure, it is anticipated that the U.K. will be forced to provide additional incentives in order to maintain their extremely accommodative interest rate policies.
The deflation problem that Japan experienced several years ago and the brewing disinflationary/deflationary concern in the U.S. both have their roots in losses in real estate investments. Presently there is a minority view that the U.S. could be facing the same disinflationary or potentially deflationary pressures that plagued Japan’s economy several years earlier.
EURODOLLAR FUTURES - WEEKLY CONTINUATION
Higher Futures Prices at the Short End of the Curve
We are seeing more signs that the current period of economic weakness will continue into the third quarter of 2009 and may be the most severe in the last 25 years or more. The multitude of stimulus packages, bailout plans and “bad bank” proposals, at least in the short run, will not be sufficient to offset the destruction of wealth that has taken place as a result of the subprime mortgage related write downs. Even though the Federal Open Market Committee lowered interest rates by 75 to 100 basis points to a range of zero percent to 25 basis points at their December 16, 2008 meeting, it appears to not have been enough to quickly revive the U.S. economy. It now appears that more stimulus, other than just zero short term interest rates is needed. It also appears that the major central banks of the world cannot lower interest rates fast enough to offset the disinflationary and potentially deflationary impact of wealth lost as a result of the international economic crisis. This bullish influence on the short term interest rate markets will probably last at least through the third quarter of this year, before the expansionary impact of all the world’s interest rate cuts and stimulus packages begin to take effect. Over the next two quarters we can expect Eurodollar futures to continue to trade higher. It is likely that the December 2009 Eurodollar futures contract will be able to take out the 98.885 contract high that was established in mid January of this year.
If you have a question or comment about this article, please contact Alan Bush at 1.800.243.2649 or send an email to alan.bush@archerfinancials.com.
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