Dollar increases due to CPI report

Friday, December 14, 2007

ECONOMIC DATA / NEWS

Rate cut optimists were dealt another blow today as consumer inflation showed signs of heating up in November.  Overall CPI was up .8%, naturally related to gas prices spiking.  However, core CPI, which factors out food and energy was up .3%, the largest single month increase since February.  It’s interesting that retailers would be raising prices during the holiday shopping period when there is so much talk about this being one of the weakest holiday seasons in years.  However, it seems to suggest that perhaps the additional costs from oil, which affects production and transportation costs, could finally be forcing businesses to raise their prices.

Although the Fed funds futures market is starting to price in a potential hold on rates in January, the inflation figures could actually lead to a necessity to cut rates.  The economy is already in slowdown mode, and Alan Greenspan told NPR that he feels the chances of a recession are “clearly rising.”  Higher prices are just going to make it that much more difficult for consumers to spend money, which will bring down economic activity even further.  Something has got to give, so either consumer prices are going to come down in order for businesses to move inventory, or the economy is going to head toward recession as businesses lose profits on weaker spending.  Either way, the opportunity, and perhaps the necessity, will be there for the Fed to continue cutting their rate.

Industrial production picked up in November by .3%, following the .7% decline the previous month.  But, capacity utilization slowed to 81.5%, which actually could be a plus for lower inflation.  Even though the industrial production improvement was very mild, it was one more reason for those who are easily shaken to worry that the Fed may not cut their interest rate again.  A lot of it was related to automobiles, which normally are in greater production around this time with the new models coming out.  So, it really wasn’t a very strong result at all.  But even it is considered strong, it should be one more reason for the stock markets to celebrate, rather than mourn.

TECHNICAL ANALYSIS

The FNMA 30-year 6.0% is down 6bp at 100.94.  It has reached a critical point now, because it is touching the upward trend line.  A bounce higher would indicate MBS traders’ determination to push prices higher.  However, if prices break below the downward trend line, it could set off chain reaction selling, pushing prices drastically lower in a hurry.

Despite declines in the stock market, Treasuries have not benefited.  In fact, it seems that at the moment, the two markets are on completely different wavelengths.  Treasury traders are probably more intently focused on the higher inflation, which automatically detracts from the value of the fixed payments that bond holders receive.  Furthermore, the yield broke above the 38.2% Fibonacci retracement line, which had been acting as a strong resistance.  Now it is testing the 50-day moving average around 4.28%.  It has bounced off this ceiling once already, but traders refuse to bring the yield back under 4.20%.

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