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RESEARCH NOTE: Beige Book Preview
Brian Dolan, Chief Currency Strategist
Jacob Oubina, Currency Strategist
Tomorrow (Wednesday, July 23) at 1400ET/1800GMT the Fed's Beige Book will be released in advance of the August 5 FOMC meeting. The Beige Book is supposed to form the basis of the FOMC discussion at the meeting in two weeks time. The Beige Book is one of the timeliest updates on the US economy and is prepared based on contributions from the 12 regional Federal Reserve District Banks. The District banks in turn compile their updates based on surveys with local firms and business contacts. As a result, the Beige Book holds significant potential to move investor sentiment and market prices, including the USD against other major currencies, based on changes to expectations of US interest rates and the US economic outlook.
Outlook summary: We expect the Beige Book to retain a similar sluggish tone for the near-term US outlook as the economic data trends since June have remained on the weak side in most cases, while inflationary pressures have increased. At the same time, however, the rate of deterioration in US economic data appears to have slowed to a significant extent. This highlights the risk that the Beige Book notes such signs of stabilization and leads to a more positive impression that the US downturn will not be overly severe. If that tone should emerge, and along with increased price pressures, we would expect markets to increase expectations of a Fed rate hike for the September FOMC meeting, currently at about a 45% likelihood of a 25 bps increase, up from 21% just a week ago. We think this would support the USD, but potentially undermine the current stock market recovery, which may lead to setbacks for the carry trades (long JPY-crosses, like EUR/JPY or GBP/JPY). We think the risks are skewed to a more USD-positive outcome, but the central expectation remains that of a sluggish US outlook against a backdrop of higher price pressures. Also, keep in mind, the report will be contrasted with, and possibly overshadowed by, Fed Chair Bernanke's rather bleak semi-annual economic outlook delivered just last week.
Below are our expectations for the key components of the Beige Book:
Lending: Mortgage rates are slightly higher than they were during the last survey, with 30-year fixed rates up about 20 bps since early June. Weekly mortgage application data suggests applications for both purchases and refinancing stopped declining and posted modest gains toward the end of the current survey period, potentially suggesting some leveling-off of mortgage lending declines, but the July NAHB index pointed to a continued deterioration in the new home segment. On balance, lending activity may have improved slightly, but with greater regional discrepancies, and is still mired at reduced levels due to ongoing credit reduction efforts by banks. The typical seasonal pick up in mortgage lending may present a silver lining.
Inflation (Wages and prices): Headline inflation rose significantly since the last survey period, driven by record price increases in underlying commodities. The survey is likely to note that consumer prices rose less than producer prices and that corporate profit margins were consequently squeezed. Recent sharp commodity price declines since the current survey period ended are likely to cloud the inflation outlook that the FOMC will be confronting when it meets, likely leading markets to discount the inflation comments somewhat. Average hourly earnings (YoY) held largely steady between the two surveys, keeping the consumer outlook weak against the backdrop of rising prices.
Consumer Spending: We expect the characterization of consumer spending to not have changed much since the prior Beige Book. The last report showed that "consumer spending slowed" as consumers "were pinched by rising energy and food prices." Monthly chain-store sales growth has decelerated to 1.2% through mid July from 1.9% in the period covered by the last Beige Book, according to Redbook data. Meanwhile, gasoline prices have increased more than 3% since then, to well over $4 per gallon. That said we look for little market reaction on a better than expected assessment, given that much of the increase in spending is being supported by the fiscal stimulus package and thus markets continue to look at the elevated numbers with caution.
Labor: The assessment on the labor market is likely to be that it remains soft overall. Indeed, the latest employment report showed that the unemployment rate remained at a cycle high 5.5% in June. Meanwhile initial jobless claims averaged about 380k from the beginning of June through mid-July, higher than the 367k average for the period covered by the last Beige Book. The risk here is that the labor market is noted as "stabilizing" given the sharp declines in claims that we have witnessed in the first two weeks of July. In such a case, the market would view this as very positive for the US economy and the US dollar.
Residential Real Estate: The appraisal of US residential real estate activity probably remained downbeat. In the last go around, residential real estate markets were characterized as "generally weak across most of the nation." We expect not much has changed on this front. The National Association of Home Builders (NAHB) survey, which covers new homes, saw its present home sales component continue to slip through July to a new all-time low of 16. Meanwhile, the future sales component tumbled to just 23 after a 28 print in May, suggesting confidence in future sales continues to crumble as well. On a positive note, however, we have seen a pickup in weekly mortgage application activity to an average growth of around 1% per week in the period since the last Beige Book release. This compares with an average weekly decline of -3% for the period covered in the last report. Thus the risk on the residential real estate front is also that we get a better than expected assessment. This would be a welcome sign as markets would begin to believe that the bottom in housing is coming sooner rather than later, and the buck would surely be bid.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
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Overview