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August Forecast: Finding Neutral Ground

Reports and Expiration Notices

August 2nd, 2006 — Issue #338

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August Forecast: Finding Neutral Ground

by Erik Gustafsson, TradeTheNews

July injected the markets with new uncertainties to contend with, as the surprise incursion and rocket barrage launched by Hezbollah into Israel has driven energy prices back toward record highs, and leaves the world worrying about a wider war. Apart from the turmoil in the Middle-East, markets will be watching an array of economic release and corporate earnings this month, as well as monitoring the Fed and other central bankers as they hold court.

As earnings season comes to a close, a handful of important names will report this month. Dell (8/17) which slashed earnings guidance a few weeks ago, has rebounded since that warning, but may come under pressure again as investors look for more favorable guidance. Dow Jones Industrial Average components Verizon (8/1), Disney (8/9), Wal-Mart (8/15), and Hewlett-Packard (8/16) are also slated to report this month.

Corporate earnings quality was somewhat eroded this quarter as elevated energy prices have begun to seep into corporate balance sheets. Natural Gas has traded up 40% in the last two weeks as a heat wave stretches across the US. Fed Chair Bernanke showed crude oil was on his mind, recently noting that any $10-15 oil rise would have significant consequences for inflation. The threats to the oil market are, obviously, the ongoing conflict between Israel and Hezbollah, and the nuclear issue in Iran. As its self-imposed deadline for responding to the Major Powers' proposal approaches (Aug 22), the UN Security Council has relented and extended its deadline to August 31st, after which time the Council will "consider" sanctions. Meanwhile, Israeli officials say the offensive in South Lebanon will continue for several weeks—each day adding to the danger that a stray Israeli missile or Hezbollah rhetoric will draw Syria in to the conflict. The terror attack that killed over 100 people in India last month and two homegrown, and Al-Qaeda inspired plots recently foiled in Canada and the US have also rekindled worries about terrorist attacks.

Economic releases to watch in August include the payrolls and the homebuilding data. The Non-farm Payrolls number (8/4) got a lot of extra attention last month after the ADP Employment reading (8/2) predicted a much larger than expected increase in payrolls...only to be contradicted when the government number came in below estimates that were ratcheted up by the ADP release. If ADP's credibility is still intact, its index could again exercise some influence over the analyst estimates this month, and create an opportunity for another surprise.
Housing data will continue to be of interest as home equity growth, the fuel for the strong consumer economy, will likely continue to show moderation. Leading the housing data lower, the NAHB Housing Market Index (8/15) has slid from a six year high of 72 last June to last month's 39 reading. Housing Starts (8/16) are also sharply off the record highs hit in January, and Building Permits (8/16) have been spiraling downward since last September, hitting a three year low last month.

Ahead of this month's FOMC meeting (8/8), Fed speakers have been taking note of the slowdown indicated by the data. The Fed's Poole, speaking about the global economy on July 31st told reporters that he sees a 50-50 chance of further rate action at the August meeting. That same morning San Francisco Fed President Janet Yellen stated that inflation is above her comfort zone and needs to moderate, but also said she goes into the FOMC meeting without a predetermined policy stance. In addition, newly installed Treasury Secretary Hank Paulson will make his first public address on August 1st, taking on the topic of the US and global economic outlook (note he will also appear on CNBC that morning as he tours the NYSE). This speech will likely set the tone for Paulson's tenure, demonstrating whether he will be an Administration votary like his predecessor John Snow, or more of a maverick like former Secretary Paul O'Neill.

All eyes will be on the Fed this month, as July's data confirmed pace of economic growth has slowed. In his Senate testimony two weeks ago, Fed Chairman Bernanke seemed to take a more dovish tone, driving the equity indices sharply higher. Following the weaker than expected 2Q Advanced GDP number, Fed Funds Futures now predict only a 35% chance of a rate increase in August, and many economists have gotten behind the notion that the Fed will start cutting rates before the year is out. The Fed has seen the evidence of the expected cooling of the economy, and has reiterated it is aware that there is a lag in the effect of rate hikes. With that said, its seems clear the FOMC will likely pause at this meeting, either leaving the rate at 5.25% or raising another 25 basis points and averring "no more, for now." Minutes of the FOMC meeting will be released on August 29th, giving market watchers a clearer picture of the rate decision, and more Fed commentary to mull over.

Despite the bets that the US Fed will pause or signal a pause at its August meeting, rate pressure is still to the upside overseas. On August 3, the ECB is expected to raise its benchmark interest rate 25 basis points to 3%. ECB members have made it clear they believe the rate is still accommodative, and after ECB head Trichet made the surprise move of calling a physical meeting in August (rather than the usual teleconference during Europe's prime vacation month), the rate hike seems all but assured. The Bank of England will also announce its rate decision that same morning.

Thus, the question for the near future seems to be how markets will react to a neutral policy. Once the Fed pause is officially in place, how will market react? Will equities rally as the Fed goes neutral, or will rising rates overseas and Middle-East hostilities keep traders cowed?

Disclaimer:

Trading commodity futures and options involves substantial risk of loss. The recommendations contained in this letter is of opinion only and does not guarantee any profits. These are risky markets and only risk capital should be used. Past performances are not necessarily indicative of future results. This is not a solicitation of any order to buy or sell, but a current futures market view provided by Cannon Trading Inc. Any statement of facts herein contained are derived from sources believed to be reliable, but are not guaranteed as to accuracy, nor they purport to be complete. No responsibility is assumed with respect to any such statement or with respect to any expression of opinion herein contained. Readers are urged to exercise their own judgment in trading!

Economic Reports and Expiration Notices

Source: Moore Research Center, Inc.

* Please note that the information contained in this letter is intended for clients, prospective clients, and audiences who have a basic understanding, familiarity, and interest in the futures markets.

** The material contained in this letter is of opinion only and does not guarantee any profits. These are risky markets and only risk capital should be used. Past performances are not necessarily indicative of future results.

*** This is not a solicitation of any order to buy or sell, but a current market view provided by Cannon Trading Inc. Any statement of facts herein contained are derived from sources believed to be reliable, but are not guaranteed as to accuracy, nor they purport to be complete. No responsibility is assumed with respect to any such statement or with respect to any expression of opinion herein contained. Readers are urged to exercise their own judgment in trading!