Forex European Preview 08.28.2009

A revision of the second-quarter UK Gross Domestic Product is set to confirm that the economy shrank 0.8% in the three months to June to bring the annual growth rate to -5.6%, the worst in at least 53 years. Barring an unexpected, large revision in the headline figure or any of the key components (in particular the Private Consumption reading), the outcome is unlikely to produce much of a reaction in the currency markets having already been priced into the exchange rate. Indeed, the market seems focused more on the Bank of England’s dovish posture despite surface-level improvements in economic data: a trade-weighted index of the Pound’s average value topped out on 08/05, the day before the last rate decision, and has been trending lower ever since; a Credit Suisse index gauging traders’ 1-year BOE rate hike expectations (as derived from overnight index swaps) topped out on the very same day.

Turning to the continent, Euro Zone Consumer Confidence is expected to rise for the fifth straight month to print at -21 in August, up from -23 in the previous month. The metric closely tracks a Morgan Stanley index of Euro Zone stock performance; indeed, the correlation now stands at a formidable 97.7% and has registered above 80% since October 2005. Equities listed on Euro Zone exchanges have added 5.7% so far this month, bolstering the case for an improvement in sentiment. The Euro Zone Business Climate Indicator is likely to follow a similar trajectory: this metric is 95.1% correlated to stock performance in the currency bloc. While these results will offer little by way of new insights, they may offer some additional near-term fuel to continue feeding the rebound in risky assets that began late into the New York trading session. The longer-term outlook is far more ominous, however: unemployment stands at 9.4%, the highest in a decade, while loans to Euro Zone businesses and households grew just 0.6% in July, the lowest since records began in 1991. Clearly, private demand can’t grow without the ability to earn or borrow money, making any rebound beyond the fleeting effects of government stimulus a distant prospect.

Asia Session Highlights

Japan’s labor market continued to disappoint in July as the Jobless Rate rose to a greater-than-expected 5.7%, a 33-year record high, while the ratio of available jobs to seeking applicants unexpectedly dropped to a fresh all-time low of 0.42. Looking ahead, a survey of economists conducted by Bloomberg suggests the pace of job losses will continue to accelerate at least through the second half of next year. This points to continued weakness in consumer spending as layoffs weigh on disposable incomes. Indeed, Household Spending fell -2.0% in the year to July, four times worse than forecast.

The economic outlook for the world’s second-largest economy was made all the more ominous as the Consumer Price Index fell -2.2% in the year to July, marking the sixth consecutive month in negative territory and threatening to send Japan spiraling back into another “lost decade” of deflation-fueled stagnation as consumers and businesses expecting lower prices in the future delay spending and investment, encouraged to perpetually wait for the best possible bargain.

In the UK, GfK Consumer Confidence disappointed in August, holding flat at -25 to show that pessimists among those polled for the survey outnumbered the optimists by the same margin for a third consecutive month, upsetting expectations of an improvement to -24. Expectations of economic conditions for the next 12 months and the propensity to commit to major purchases both deteriorated; the former for the first time since April. On the other hand, a gauge of saving intentions rose for the seventh consecutive month. A statement accompanying the release noted that, “While UK consumers are still cautious about the economy, they are less pessimistic than this time last year.”

The Bank of China Ltd, the country’s third-largest lender by assets, said it plans to slow credit growth in the second half of the year. The news reinforces the government’s efforts to rein in lending and may weigh on risky assets considering the market’s recent focus on China as the poster-child of recovery from the global downturn.

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The World's Largest Economy Contracts Less than Expected in the Second Quarter!

The U.S. economy continued to contract during the second quarter of this year for a fourth consecutive quarter, however the pace of contract eased drastically from that of the first quarter, as conditions started to improve and several sectors around the economy started to show signs of stabilization.

The U.S. Commerce Department released the Gross Domestic Product Preliminary estimate for the second quarter of this year, GDP contracted by 1.0% inline with the prior contraction of 1.0% reported in the Advanced estimate and better than median estimates of a 1.5% contraction, while the GDP Price index was flat in the second quarter marking a downward revision from the prior estimate of 0.2% and below median estimates.

Moreover, personal consumption declined in the second quarter by 1.0% better than the prior and expected estimates of -1.2% and -1.3% respectively, while Core PCE, the Feds’ favorite indicator for inflation rose in the second quarter by 2.0% inline with the prior and expected estimates.

The economy contracted by 3.9% on a yearly basis, as personal consumption shed 0.69% from GDP, while gross private domestic investments shed 3.20% from GDP, meanwhile the housing sector continued to cut from growth after shedding 0.66% from GDP, inventories shed 1.39% from growth, while net exports contributed with 1.60% to GDP, and governmental consumption added 1.27% to GDP.

The U.S. economy is still on the receiving end of this crisis, however signs of improvement continue to show over the outlook, which suggests that the economy will be able to return back to growth over the course of the third and fourth quarters of this year, however economic growth should remain subdued over the upcoming period, as conditions are still rather challenging.

Rising unemployment, tightened credit conditions, and diminishing households’ wealth continue to weigh down on economic growth in the world’s largest economy, and accordingly the economy is still expected to continue its weakness, as the recovery process just started and it will take some time before the economy returns back to its long term growth potentials.

The U.S. economy will continue recovering, however the recovery will be rather slow and gradual, as economic activity though improving recently yet it needs time, especially as unemployment is still elevated, unemployment is now standing at 9.4% and will probably continue to rise over the course of this year.

Unemployment continue to weigh down on personal income and accordingly consumer spending, and knowing that consumer spending accounts for nearly 2/3 of economic activity in the United States, we should expect economic activity to remain weak until companies start hiring again.

The U.S. Commerce Department released the Initial Jobless Claims for the week ending August 22nd, jobless claims dropped by 10,000 to 570,000 from the prior revised estimate of 580,000 and worse than median estimates of 565,000, while continuing claims dropped to 6.133 million from the prior revised estimate of 6.252 million.

The labor market is still on the receiving end of the worst recession since WWII, as this is the first time the economy had contracted over four consecutive quarters ever since records began back in 1947, and this alone signals that this recession is not your normal recession but was rather close to a depression and the only thing that prevented that from happening was the extreme and rather ingenious measures adopted by the Federal Reserve Bank, so we should give them and their Chairman Ben S. Bernanke the credit they deserve…

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Where The Money, News and Action is

American International Group, Inc. is in the news, posting huge market gains and rightfully positioned at the center of multiple controversies. On Monday, investors welcomed new CEO Robert Benmosche as AIG continued its powerful rally closing +1.56 or +5.76%. In the past week, the stock has doubled in value and scored some rather ominous headlines along the way.

U.S. taxpayers own an 80% share of AIG. With $180 billion of taxpayer money, AIG is under the gun to divest itself of losing entities and overcome the public’s perception of mismanagement, scandal and stupendous bonus rewards for poor performance.

Interim CEO, Ed Liddy, whose annual salary was $1.00 for his 11 months of service turned over the reins but the AIG controversy appears to be heating up again.

On August 6^th, former AIG CEO, Hank Greenberg, agreed to pay $15 million to settle allegations about bookkeeping misrepresentations at the world’s largest insurer. Greenberg chaired AIG for 38 years and may still face civil charges. Greenberg also agreed to pay $1.5 million to the SEC for other fraudulent misrepresentations.

On August 7^th, AIG announced its first profitable quarter in almost two years.

On August 9^th, questions were raised as to the relationship between former U.S. Treasury Secretary Henry Paulson, his former employer Goldman Sachs, and the AIG bailout.

On August 11^th, Taiwan’s Cathay Financial seemed released an announcement with tie to the company’s plan to acquire AIG’s Taiwan Insurance unit.

Meanwhile, the ongoing dilemma at AIG is rooted in the Financial Products unit’s staggering $99 billion loss in 2008.

Standard & Poor’s Catherine Seifert offered the following analysis; “Results were better than we expected and reflected positive mark-to-market gains, not strength in underlying operations. We believe that the turnaround in Q2 book value may not be sustainable and that the risk/reward for common equity holders is not attractive.”

Liddy Issues Warning

On his last day at AIG, Ed Liddy hoisted cautionary flags indicating that accounting revisions could lead to severe swings. The strategy is to wind down unprofitable units, sell other units and do whatever is necessary to raise $80 billion to retire the first installment in a series of taxpayer loans.

AIG’s second quarter profit was $1.8 billion, which represented a significant year-over-year improvement. Second quarter 2008 losses were $5.4 billion. Adjusted profit was $2.57 per share, well above analyst projections of $1.33 per share.

With the August 7^th release, AIG shares jumped 20% to $27.14. In the four days preceding the release, shares jumped 70% as the improved results pressured short sellers to become buyers to cover their positions.

AIG has yet to deal with $1.1 billion in 2009 retention bonuses. When bonuses were issued in March, Liddy came under heavy fire from Congressional leaders and taxpayer groups.

In 2009, small asset sales of AIG entities have resulted in $2.6 billion returned to the Federal Reserve. A government directed sale of AIG’s largest life insurance units should net another $25 billion for taxpayers.

AIG’s general insurance operations have suffered a 19% decline in new premium issues as premiums to the company’s life insurance retirement account dropped 15% to $8.1 billion.

Paulson & Goldman Sachs

Goldman Sachs was one of the biggest benefactors of the AIG bailout. Not only did Goldman Sachs receive $10 billion in taxpayer funding, but the company captured $13 billion in AIG counter-party payments as a result of the AIG bailout. Meanwhile Former Treasury Secretary Hank Paulson spoke with Goldman’s CEO, Lloyd Blankfein, on more than two dozen occasions during the tense period following the collapse of Lehman Brothers.

To facilitate the conversations, Paulson requested a waiver from White House attorneys. The waiver enabling Paulson to speak with his former employer was executed on September 17^th. Records indicate that Paulson had an inordinate number of conversations with Goldman Sachs.

Paulson and his Goldman Sachs successor spoke three times prior to the waiver and five times on the day the waiver was finalized. These conversations have led lawmakers to suggest a conflict of interest existed between Paulson and Goldman Sachs.

Taiwan Companies Vie for AIG Division

With Cathay Financial’s announced intention to raise $600 million, Taiwan’s largest financial holding company seems ready to enter the bidding war for AIG’s Taiwan division. Previously, Cathay’s biggest competitor, Fubon, announced plans to raise $900 million for the acquisition.

The sale of Nan Shan Life should reap $2 billion for ailing AIG. Every AIG payment is welcomed by U.S. taxpayers, who have a dim view of the company and former CEO Hank Greenberg’s business practices.

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