The US dollar is trading at its best levels for the week. Two factors seem to be behind the firmer tone. The first is technical. The lack of follow through dollar selling after last week’s poor close is prompting some position adjusting. Second, disappointing Chinese data (trade and bank loans) renews fears that the world’s second largest economy has not yet bottomed and this fanned the risk-off.
This is also evident in the equity markets, which are finishing the week on a down note. The MSCI Asia-Pacific Index was off about 0.5%, though foreign buying of Korea and Taiwan equities have helped those markets buck pressure and outperform today and this week. European bourses are paring this week’s gains. The Dow Jones Stoxx 600 is off about 0.3% near midday in London. Although all sectors are lower, financials are among the best performers. Spain and Italian yields are slightly higher in both the short and long ends, but largely consolidating the recent sharp decline in yields seen in anticipation of official action next month.
There are a few developments to note today. The most important is the Reserve Bank of Australia’s Monetary Policy Review. Although we had been looking for it earlier this week, today the RBA finally expressed concerned about the strength of the Australian dollar (it would constrain growth). This coupled with the Chinese data sent the Aussie down about a cent from the NY close yesterday. Bids were found just below $1.05.
The UK reported benign PPI figures and construction investment was revised higher. The latter reinforced ideas that Q2 GDP may be tweaked slightly higher next week. Nevertheless, sterling, which has recorded higher lows for five consecutive sessions, was pushed through yesterday’s lows. The midweek low near $1.5570 offers initial support.
Lastly, to the extent that the European debt crisis is also partly a function of a competitiveness crisis, the fact that Italian inflation continues to outstrip German inflation is troublesome. Using harmonized data, Italian inflation is running at a 3.7% year-over-year rate, while German inflation is nearly half as much as 1.9% pace.
The most important US economic report today is not July import prices, even though it may help forecast next week’s PPI report. In fact, the most important report today is unlikely to be found in most calendars for the capital markets. It is the US Department of Agriculture’s crop estimate (8:30 am EST). Last month the USDA cut its corn harvest forecast by 12%, which was the largest cut in more than 20 years. Given the drought, that has been the widest in at least half a century, many expect the USDA to save its estimate by another 5-7%. In anticipation, corn prices have reached new record highs. Soybeans set record highs a few weeks ago and wheat is near 4-year highs.
There are seven dimensions of the issue that are important for financial investors to appreciate.
1. The pace of the move has been simply breath-taking. Since the middle of June for example, corn prices have soared 63% and soybeans by a quarter.
2. The drought caught participants wrong footed. As recently as early June, the USDA was forecasting record harvests.
3. The weather problems are not limited to the US. Russia and Australia (key wheat producers), for example, are also experiencing weather shocks. On the other hand, Argentina, Brazil and Canada appear to be poised to benefit.
4. As one might expect, low income countries and people spend a greater percentage of their income on food than do high income countries and people.
5. The effect of the combination of drought and heat is having knock-on effects on other parts of the economy, including natural gas drillers, who are intense water users, and producers that use water as a coolant, which includes some nuclear generators.
6. The crop destruction could hit farm income, but that impact is mitigated by the fact that about 85% of the US crop is insured.
7. It seems clear that the rise in agriculture prices is being driven by a supply shock induced by the weather. However, with the many central banks point to ease monetary policy, some observers argue that the fear of inflation and the debasement of money is encouraging a demand shock. Yet that explanations does a poorer job with the timing of the rally and the particular commodities involved, and the fact that gold has gone essentially no where in more than two months.
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