Fannie and Freddie: Not a far away problem

What a weekend! Sure the test match was a jaffa and the Goodwood Festival of Speed satisfied one’s need for noise, excitement and risk but even so something more dangerous and damaging to the UK than Lewis Hamilton ploughing into a hay bale was revving up across the pond. Fannie Mae and Freddie Mac sound a lot like folksy, old friends; friends who sit on the stoop and wax lyrical and attempt to set the world to rights. Well the world is now listening.

The 2 companies are in control of over $6 trillion, roughly half, of the US mortgage market. They are owned by shareholders but have government sponsorship; a situation which is bound to increase. So what happens if these guys do bite the dust?

There certainly will be an overflow from the US to the UK and Europe in the form of falling confidence and tightening liquidity. Business and consumer confidence is already shot to pieces with our own mortgage crisis and liquidity is still choked. The movement of money from acting as liquidity to stabilising Fannie and Freddie will not go unnoticed and banks and other financial institutions will suffer as a result.

As these companies were seen as the backbone of financial America shareholders are as diverse as an X factor casting call. We have been hearing for years that China and India were huge investors in the US economy; guess where some of their investments were made?

Fannie and Freddie can simply not be allowed to collapse or show any more weakness or we could all be in serious trouble. I’m confident that between the White House, Fed and Treasury Department that we’ll come out of this ok.  I’ll don my sandwich board advising that ‘The End of the World is Nigh’ but with the caveat that ‘nigh’ is an acronym for ‘Nonsense, It’ll Get Healthier’.

Moving away from the doom and gloom of the US we have a fairly big day tomorrow for sterling. The UK’s main inflation figure, CPI, is due for release and is forecast to rise to 3.6%. The inflation picture has not changed at all since the previous reading or indeed the MPC decision last week however doubts over the effectiveness and accuracy of the CPI measure are being cast.

After the recalculation by the Government which saw council tax and housing costs CPI has stayed fairly level. Sir John Major, on BBC’s Sunday AM programme, said he thinks real inflation is nearer 10% if we include these factors; needless to say this is not a pretty picture. Even if the figure is north of 3% we will not see a letter from Mervyn King as the last buys him 3 months grace.
 

The week ahead

It’s been a busy weekend for the dollar and there will be no let up over the coming week. PPI and CPI figures are due for release and both are expected to increase although core prices should be fairly steady. Ben Bernanke will also be in the spotlight a couple of times this week with primarily his semi-annual testimony to Congress but also the Fed minutes release.

The German ZEW survey will probably be the highlight of a dull Eurozone week. Forecasts show it heading lower as global financial turmoil and rising inflation in all member states.

Currency Rates  Low  High   Current

GBPEUR    1.2468  1.2653  1.2505

GBPEUR had to take a back seat last week to movements and news flow from across the pond although the single currency managed to strengthen against the GBP and the embattled USD.

We and the market were looking for bolshy comments from leaders of EU member states after this month’s interest rate increase however this proved to be unfounded. Comments from ECB officials remained firm but not overly hawkish which suggests that the decision makers are happy with the effect that a single hike will have.

European data was fairly thin on the ground however manufacturing figures released by Germany, France and Italy were all poor and support the belief that the EU economy will start to shrink in the coming months.
 

GBPUSD “Cable”  1.9646             1.9960         1.9835

Cable volatility continued last week as everything from Iranian missile tests to major shocks in the US financial sector gave the markets an air of fear. The cross weakened towards technical lows at the beginning of the week however as more poor news filtered through a move back towards 2.00 was seen.

The relationship between the dollar and the price of oil continued unabated. Missile tests by Iran and hints towards an Israeli retaliation saw the atmosphere sour and the price pressures increase with Thursday seeing another record on futures trading at the NYMEX.

Strong economic data was hard to come by with weakness seen in both the housing and unemployment markets. Home sales were down by 4.7% in May casting doubt on signs of a recovery as the number of mortgage foreclosures also rose. The weekly jobless claims figure was also poor as the 60k fall in claims is more likely down to seasonal factors than a situational improvement.

The main clouds that hung over the dollar however were that of Fannie Mae and Freddie Mac. The 2 companies are said to be responsible for half of the $12 billion US mortgage market and have seen close to half of their respective share prices wiped out since Thursday.

Commodity currencies  

                    Low        High      Current

GBPAUD   2.0462   2.0780  2.0494

Following their Board Meeting on July 1, the RBA acknowledged that there had been ‘tentative signs of an easing in labour market conditions.’  However Thursday’s employment data for June seemed to contradict that, with the ABS reporting a large 29,800 increase in June, more than reversing the 25,600 fall in May. 

Recent employment figures have been very volatile, with a range of -37k to +30k in the past three months.  If we look beyond the recent monthly volatility there are some signs that the labour market is slowing. In trend terms, total employment rose by just 8,500 in June 2008, well down from the 20-30k trend monthly growth seen through 2007.

The prospect of higher unemployment is certainly a contributory factor for the RBA to keep interest rates on hold for now.  Many economists also believe that the next move they make will be a cut in the cash rate. However the RBA is unlikely to cut interest rates until we see the unemployment figures pick up.  In the current climate this could well take until the middle of next year by which time there could be enough room for the RBA to move.

The week ahead is a quiet one for the economic calendar in Australia.  The main features are the release of the RBA minutes (due Thursday) and RBA Governor Glenn Stevens’ speech updating us on the outlook for the Australian economy (Wednesday).
 

GBPNZD   2.5747    2.6343  2.6090

Last week’s NZIER’s Quarterly Survey of Business Opinion (QSBO) for the June quarter illustrated that businesses in New Zealand are feeling the strain and the economy is heading backwards, but inflation still remains high.

A net 18 percent of firms reported their own activity contracted over the past three months – the weakest level since 1998. Firms’ expectations for the coming three months were also fairly negative, with a net 18 percent expecting activity to fall – this is the lowest levels since March 1991.  Not only does it suggest that the negative GDP quarter for Q1 was not an aberration, but a contraction in Q2 is likely (if not worse than in Q1) and Q3 is also looking negative.

This leads us on to the big event of this week, namely the Q2 CPI release due Tuesday 15th July.  It is being viewed by many as the make or break for whether the RBNZ decides to cut interest rates as soon as next week or not (they meet on the 24th July to decide).   CPI is expected to grow 1.4%q/q, taking annual inflation to 3.8%.

While the CPI release may have a reasonable influence on the RBNZ’s OCR decision next week, there are other factors involved, and the recent run of negative reports across all sectors in NZ (including today’s May retail sales figures -1.2% versus -0.2% expected) have put the chance of a cut to the Official Cash Rate at the end of July up to 50%.  Analysts are also suggesting that a July cut maybe the first of three before the end of the year.

Despite the doom and gloom on the domestic front in New Zealand it is worth looking at things in a broader perspective – the aforementioned predicament facing the RBNZ of high inflation and negative growth is one faced by the majority of the worlds leading economies so it is not alone in its current problems.

GBPCAD   1.9897  2.0201  2.0049

CAD has continued to trade in and around the parity level with its US counterpart over the past week as poor domestic news hinders any attempt to strengthen against the USD.

Housing starts took a slight stumble in May, 218k down from 228k previously although we and the market are optimistic that the Canadian home loan arena is in a better position than the US’s or UK’s for example. Other data was cautiously optimistic but upside is limited as fears of a global slowdown continue to weigh.
 

GBPZAR   15.1394     15.4687  15.1348

News flow and comment, mine included, has pointed towards a fall of in ZAR and a probable recession in South Africa by the end of the year. The Treasury however hit back last week with is beliefs that the economy will continue to remain strong and that fears that GDP will fall below the 4% target are unfounded. So let’s consider the facts. Consumer and business confidence is shot, sales growth is weak and credit market turmoil is continuing to impinge on consumers’ buying power.

Investment is however up. This could point to a ‘rebalancing’ of the economy away from one dependent on consumption to one based around investment. This is obviously a long term play but in the mean time we are still looking for ZAR weakness.