Where will EURUSD be heading???

We are seeing increased volatility in currency markets due to growing worries in Eurozone and unsettling harmony between G-20 nations. Last week G-20 summit failed to reach agreement on currencies, at the same time China, Japan and Germany criticised US of devaluing its currency by printing more money.

Earlier this month Fed decided to print $600Bn over next several months in anticipation that it will likely to aid US economy. Most analyst are worried that these dollars will trickle through to emerging economies and cause asset bubbles, appreciate their currencies and increase inflation.

EURUSD this week is going to be affected by decision from Ireland if they are going to need help from EU to deal with debt issue. Other EU countries are insisting on Ireland to accept bailout to increase confidence.

Looking at weekly charts EURUSD dropped sharply from Weekly upper trendline last week and looking to head lower. If Ireland refuses to accept help then EURUSD could fall below 1.3500 and find support at 1.3300

Mother of Spike for EURUSD - about 100 pips in one minute

Global Forex Market

AT the Group of 20 nations meeting, finance ministers from industrialised and developing economies acknowledged a “fragile and uneven” global economic recovery and pledged to avoid employing competitive depreciation of currencies.

Nonetheless, discussions on maintaining sustainable levels of trade balance, a major determinant of exchange rate levels, concluded with ministers agreeing only to “indicative guidelines” with the IMF chosen to be the referee.

With respect to rebalancing the global economy, IMF is set to release specific critiques of countries’ policies at the upcoming Seoul Summit on Nov 11 and 12. Without enforceable mechanisms, many Asian countries were seen reverting to capital controls and currency interventions during the week. Bank of Korea, for instance, highlighted that measures to mitigate capital flows may be “useful”, while China’s Central Bank set CNY’s reference rate level at 6.6912 against USD, the weakest level since September.

On another note, emerging markets were allocated a bigger voting and financial stake, with Europe ceding two of its nine seats on the 24-member IMF board.

Federal Reserve of New York surprised markets by prompting bond dealers to estimate the size of asset purchases, leading investors to believe that the next quantitative easing measure would be in line with market expectations.

The Wall Street Journal’s survey of economists revealed that the Fed is poised to purchase about US$250bil per quarter, and may continue until Q2 2011, totalling to US$750bil in all. The expected amount pales in comparison to the US$1.75 trillion deliberated during the financial crisis. Fresh optimism resurfaced during the week, following a series of better-than-expected economic data.

Durable goods orders reversed a previous decline, rising by 3.3% in September, indicating that companies are likely to remain on an expansionary mode.

In the same month, housing sector posted gains, with new home sales rising by 6.6% over a month ago, compared to 1.1% in August.

Australia’s CPI rose by 2.8% (y-o-y) in the third quarter, lower compared to 3.1% in the previous quarter. Moderating inflation pressures spurred expectations that the Reserve Bank of Australia may keep the key interest rate unchanged, prompting AUD/USD to plunge by 1.3% during the week.

Growth in Asian economies seems to be moderating, following recent appreciation in the region’s currencies. South Korea reported a Q3 GDP growth of 4.5% (y-o-y) from 7.2% in Q2, with the slowdown attributed to declining export levels. In Taiwan, industrial production growth halved to 12.2% over a year ago, the slowest growth rate in 11 months.

On another note, in a move to address global economic rebalancing, China’s vice-commerce Minister indicated that the nation’s trade surplus would “definitely” be narrower compared to levels in 2009.

Price Movement analysis for EURUSD

Private bankers advise: "just say no to gold"

Reuters) - Gold is all the rage as investors flee uncertain markets and worry about inflation, but some bankers to the very rich do not take a shine to the precious metal.

Gold prices have spiked 22 percent this year, with investors sending gold futures to record highs of more than $1,337 on Tuesday. The weak dollar, volatility in currency markets and deficit worries boosted demand for the metal as a safe store of value.

Private banking executives, say gold's glittering price tag is or should give their wealthy clients pause.

"We're not really recommending gold right now, just because it's at a level where there are things driving it beyond the types of things (where) that we can add a lot of value," U.S. Trust President Keith Banks said at the Reuters Global Private Banking Summit in New York.

Instead, Banks said gold prices may reflect the surge in demand for gold exchange-traded funds, listed shares that purchase physical gold, and broader worries about government spending leading to rapid price inflation.

"So what exactly is leading to gold at the levels it's at? Your guess is as good as mine," said Banks, who runs the Bank of America (BAC.N) private bank unit.

The SPDR Gold Trust ETF (GLD.P), which lets retail investors more easily bet on gold, has surged 21 percent this year to a record high of 130.71. The fund shares are up more than 50 percent since the end of 2008.

Wealthy families are more interested than ever in owning commodities such as metals and energy, assets that do not move up and down in step with stock and bond prices. They also offer a hedge against inflation, since their values rise with prevailing prices.

There are many critics who warn gold is the latest frenzy and is doomed to collapse.

"With gold being over $1,300 an ounce now, you have people who are asking whether, first, 'Is it another bubble?' and then, 'How far can I ride that bubble?,'" Credit Suisse Americas private banking chief Anthony DeChellis said.

Bessemer Trust Chief Executive John Hilton said his New York wealth management firm allocated a single-digit percentage of its real return fund into gold.

For some clients, he acknowledged, that was not enough.

"We have clients who have made very large individual purchases of gold. Sometimes they'll just say they're doing it, and they'll ask us if we can hold it for them, but we haven't made any large purchases of gold directly for our clients," said Hilton, whose firm manages about $56 billion.

U.S. private bankers, to be sure, also told the Summit they do recommend investments in a range of commodities.

"We have been a proponent of having an exposure to commodities. The bank is optimistic about the economic recovery, and commodities is a way to play global growth," said U.S. Trust's Banks.

U.S. Trust formed its Specialty Asset Management group, which buys hard assets on behalf of its wealthy clients -- anything from real estate, timberland and farmland to oil and gas properties. U.S. Trust will buy and sometimes hire people to operate these assets.

The business, which manages about $16 billion of assets, is seeing strong interest from clients, he said.

"These are assets that I think people can feel good about, that are probably not going to track the more typical areas, and it's just a unique opportunity," Banks said.

(Reporting by Joseph A. Giannone. Editing by Robert MacMillan)

Economic Calender

House passes bill aimed at Chinese Yuan

By Doug Palmer and Paul Eckert

WASHINGTON | Wed Sep 29, 2010 7:59pm EDT

(Reuters) - The House of Representatives on Wednesday passed legislation to pressure China to let its currency rise faster, fanning the flames of a long-running dispute over trade and jobs.

The bill passed by a vote of 348-79. Both Democrats and Republicans, speaking just over a month ahead of mid-term elections in which the economy has taken center stage, said it was time to take action to support U.S. jobs.

The House vote, with about 100 Republicans joining Democrats to pass the bill, cleared the legislation for action in the Senate.

However, any vote in the Senate won't come until after congressional elections on November 2 when the U.S. political landscape could be greatly changed, and odds have appeared to be against passage in the Senate.

The bill treats China's exchange rate as a subsidy, opening the door to extra duties on Chinese goods entering the United States, some of which are already subject to special levies.

"China's persistent manipulation of its currency contributes to the outsourcing of American jobs and poses a very serious problem that requires real action," said House Ways and Means Committee Chairman Sander Levin.

Daily Calender of Events

U.S. yuan raid idea is fascinating but flawed

A top think tank has advised Washington to declare a currency war on China. The proposal from the Peterson Institute to force up the value of the yuan sounds fascinating, but a direct attack may be hard to pull off in practice. Beijing is likely to respond better to multi-lateral persuasion.

Peterson has called for a U.S. raid on the forwards market for the yuan, which it believes has to rise at least 25 percent against the dollar. The timing is good. U.S. lawmakers are already threatening to slap tariffs on Chinese imports, and the 1.5 percent rise of the yuan in the past two weeks hardly looks enough.

Targeting China’s currency directly goes to the heart of the problem, whereas duties only address exports from China on a product by product basis. Foreign traders can’t buy yuan in large quantities because of China’s strict capital controls, so the next best thing is “non-deliverable” forwards.

These forwards, where no yuan actually change hands, don’t directly impact the exchange rate. But a big rise in their value could give China a headache. If forwards seemed to price in strong appreciation, it could attract speculative inflows and make China’s asset bubbles worse.

While this idea is fascinating, the execution would be tricky. The size of the forwards market is just $1 billion on a volatile day. The United States could not intervene in such a small market without being noticed. That would risk inviting counter-trades by arbitrageurs, who might sell forwards even as the United States buys.

Beijing might also inflict losses on would-be raiders. If it resolutely fixed the yuan below the forward price, the trader would make a loss. Washington may thus struggle to find investors willing to do its bidding. Unlike Beijing, it doesn’t control its financial institutions, so can’t tell them to carry out unrewarding trades.

The biggest problem with Peterson’s idea, though, is that Washington can’t really justify manipulating the yuan when it is blaming Beijing for the same thing. Two wrongs don’t make a right. Transparent, multi-lateral pressure looks a better way to call for change.

Japan intervenes to weaken yen

Japan's bold strike to weaken its currency on Wednesday sent the yen tumbling more than 3.0 percent against the U.S. dollar, but unsettled allies who feared the unilateral move may complicate efforts to restore balanced global economic growth.

Japan unleashed waves of yen selling, estimated at more than $20 billion (12.8 billion pounds), which spread from Tokyo through New York trading. The sales, conducted alone without help from its Group of Seven partners, are expected to continue in the days ahead, Japanese news agency Nikkei reported.

Japan's first intervention in global currency markets in six years was not a complete surprise given that officials had tried to talk down the currency in recent weeks after it hit a 15-year high against the dollar.

But the timing and go-it-alone approach drew criticism. A top European official said coordinated action was a more effective means of adjusting exchange rates. And as the U.S. Congress began hearings on China's currency policy, a U.S. lawmaker called Japan's move "deeply disturbing."

DOUBTS REMAIN

Doubts remained though about how effective Japan's unilateral yen selling spree might be. A 15-month solo effort by Switzerland which ended earlier this year did little to tame the Swiss franc.

Like Japan, most advanced economies are grappling with slow growth at home, making exports an economic imperative. Japan's move heightened concerns that countries would launch a round of competitive devaluations to give their own exporters an edge.

U.S. lawmaker Sander Levin, who chairs the congressional committee examining China's currency policy, blamed Beijing for Japan's "deeply disturbing" intervention. Levin and many other U.S. lawmakers say China keeps the yuan artificially low, boosting its exports at the expense of U.S. companies.

"What's happening is that China's actions have affected Japan, and now Japan's actions affect us," he said.

Andrew Busch, global currency strategist at BMO Capital Markets in Chicago, said Japan's move would make it more difficult for Congress to get its message through to China.

"How can the Japanese get a pass to intervene when the Chinese are being criticized for essentially the same activity?" he said.

Some emerging markets were also wary of losing out in a beggar-thy-neighbour round of devaluations. Brazilian Finance Minister Guido Mantega said he would not sit on the sidelines "watching the game" while other countries weakened their currencies at the expense of Brazil.

"We're going to take appropriate measures to stop the real from appreciating," Mantega said in Rio de Janeiro.

FLYING SOLO

The EU offered some sympathy for Tokyo's plight, saying too rapid yen appreciation could threaten economic recovery, but a top official said coordinated action would have been better.

"Unilateral actions are not the appropriate way to deal with global imbalances," Jean-Claude Juncker, chairman of the Eurogroup of euro-zone finance ministers, said when asked about Japan's intervention.

U.S. officials at the Federal Reserve, White House and Treasury declined to comment.

After this week's victory in a party leadership contest, Japanese Prime Minister Naoto Kan appeared to be stepping up efforts to wrench the country out of deflation by targeting the yen's strength which has weighed on stock prices and corporate profits.

The Japanese Prime Minister told reporters that Wednesday's intervention had some effect but the government was watching foreign exchange moves with a sense of urgency.

Aside from apparently acting alone, Japan faces the stiff task of trying to weaken the yen while other major central banks such as the U.S. Federal Reserve mull more steps to ease monetary policy, which could weigh on their currencies.

The dollar rose to 85.72 yen from its 15-year low beneath 83 yen, its biggest daily gain in nearly two years. It was last up 3.1 percent at 85.60 yen.

MAKING FRIENDS

The Japanese currency's rise had brought it closer to its record peak of 79.75 per dollar set in 1995, squeezing exporters' profits, but Wednesday's yen drop helped push Tokyo stock market's Nikkei average up 2.3 percent.

It also pleased Japanese exporters, many of whom had expected the yen to average 90 per dollar this fiscal year.

"We applaud the move by the government and the Bank of Japan to correct the yen's strength," Japan's No. 2 automaker Honda Motor Co said in a statement.

Honda has pencilled in 87 yen per dollar in its estimates for the fiscal year to March 2011.

Billionaire financier George Soros said Japan was right to act to bring down the value of the yen.

"Certainly, they are hurting because the currency is too strong so I think they are right to intervene," Soros said at a Reuters Newsmaker event.

Japanese Finance Minister Yoshihiko Noda, who will reportedly keep his post after a cabinet reshuffle, indicated Tokyo acted alone. Noda said he was in contact with authorities overseas, and analysts expected Japan to be spared international criticism.

Unlike previous forays, the Bank of Japan will not drain the money flowing into the economy as a result of the yen selling, sources familiar with the matter said.

That indicated the central bank plans to use the sold yen as a monetary tool to boost liquidity and support the economy.

Authorities that sell their own currencies to weaken them often issue bills to "sterilise" the funds and keep the excess money from becoming inflationary. In Japan's case, it wants to promote inflation since the economy has been dogged by deflation for much of the past decade.

(Reporting by Tokyo newsroom; Additional reporting by Tara Joseph Hui in Hong Kong, Doug Palmer and Paul Eckert in Washington; Writing by Kevin Plumberg and Emily Kaiser; Editing by Mike Peacock and Neil Stempleman)

China's forex reserve growth rate slows down

China's foreign exchange (forex) reserve expanded by US$417.8 billion last year, $44.1 billion less than in 2007, the People's Bank of China (PBOC) said yesterday (January 13).


The central bank also said the supply of money and loan growth picked up in December, reflecting the government's effort to boost the economy through proactive fiscal and moderately loose monetary policies.
The country's forex reserve increased by less than $45 billion in the fourth quarter to $1.95 trillion by the end of 2008, a PBOC report said.

The reserve growth slowed over the months last year. The total reserve was up 27.34 per cent over 2007, the lowest rate since 2001.

The growth rate from January to September was 32.92 per cent and that from January to June 35.37 per cent.
The fall in the growth rate is the result of a shrinking trade surplus and a possible slowdown in the inflow of "hot money", analysts said.

But despite the slowing of the reserve growth for the whole of last year, the monthly reserve for December increased $61.3 billion, up $30 billion year-on-year, the PBOC said. The fourth quarter's reserve, though, dropped compared to the same period in 2007.

Guo Tianyong, a Central University of Finance and Economics professor, said expectations that the yuan would weaken and extraction of capital from the domestic market to help stabilise the supply of capital in the West were major factors that caused a year-on-year drop in the fourth quarter reserve.
December saw a sharp rise in the reserve as the Central Economic Work Conference vowed early that month to keep the yuan stable--at a reasonable and balanced level--he said. That reversed expectations of a weaker yuan.
The government has been worried over "hot money" being brought into the country by businesses and individuals speculating on the continuous rise of the yuan. It fears that it would create asset bubbles and increase the pressure for the yuan's revaluation, making the domestic financial system vulnerable.
The flow of "hot money" into the country, however, began to dry up after some developed countries de-leveraged their financial markets to overcome the global financial crisis, the analysts said.
Money supply

As the money supply picked up in December, M2, which includes cash and all types of deposits and indicates overall liquidity in the financial system, increased 17.8 per cent year-on-year. It had risen 14.8 per cent in November.

Banks extended 772 billion yuan in new loans in December, compared to 476.9 billion yuan in November. That helped the annual loan growth to accelerate to 18.76 percent in December, up 2.66 percentage points year-on-year.

The annual growth of money supply including cash in circulation and demand deposits, or M1, was 9.06 per cent in December compared to a 6.8 per cent in November.

The growth suggests the recent aggressive cuts in banks' reserve requirement ratios have helped improve liquidity, said Jing Ulrich, chairman of China equities at JPMorgan.

The PBOC has cut interest rates five times, totaling 2.16 percentage points, since September. It has reduced the amount of deposit that lenders have to set aside to boost liquidity, too.
Earlier, policymakers said the government would try to ensure a 17 per cent M2 growth this year despite the economic slowdown.

The moves, the analysts said, are expected to encourage banks to issue new loans, which are crucial for the government to deliver the $586-billion stimulus package.

But some economists fear that increased lending could lead to a spurt in bad loans because returns from infrastructure projects are less predictable than what they were a decade ago. Ten years ago, the government began building a wide network of highways and other infrastructure as part of its fight against the Asian financial crisis.

"The boost to the economy is obvious in the short term," said Ha Jiming, an economist with China International Capital Corporation. "But we need to keep an eye on the risk for lenders."

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Giant FX market now $4 trillion gorilla

Global foreign exchange has always been one of the biggest markets in the world but its exponential growth keeps accelerating. The triennial survey by the Bank for International Settlements shows global foreign exchange market turnover leapt 20 percent to $4 trillion, compared with $3.3 trillion three years ago.

The increase in turnover was driven by growth in spot transactions, which represent 37 percent of FX market turnover.  Turnover was driven by trading activity by “other financial institutions” — a category that includes hedge funds, pension funds and central banks, extending a trend seen in the past several years where buyside firms are increasingly trading currencies themselves, via prime brokerage, rather than turning to interbank dealers.

Also notably, emerging market currencies are gradually increasing their share in the marketplace. Turnover of the Russian rouble has increased its share in total turnover to 0.9 percent of 200 percent (FX is double counted as transaction involves two currencies), up from 0.7 percent three years ago, while the Brazilian real rose to 0.7 percent from 0.4 percent. The Indian rupee’s share rose to 0.9 percent from 0.7 percent. The dollar keeps its dominance, although off its 2001 peak, with its share standing at 84.9 percent.

Fed stands by to boost U.S. growth

NY (FT) -- Ben Bernanke, Federal Reserve chairman, said on Friday that weaker-than-expected consumer spending growth and a "depressed" housing market had slowed the pace of the US recovery and promised that the central bank was ready to take "unconventional" steps to stimulate the economy if needed.
In a speech at a gathering of central bankers in Jackson Hole, Wyoming, Mr Bernanke acknowledged that the pace of economic growth had been "less vigorous" than the Fed was expecting and that the pace of the labour market's recovery had been "painfully" slow.
Mr Bernanke's remarks came after a sharp downward revision to second-quarter gross domestic product, which was held back due to a surge in imports. The Fed chairman said that the US central bank was surprised by the "sharp deterioration" in the US trade balance, but discounted it as the result of temporary and special factors.
The Fed chairman defended the central bank's surprise decision earlier this month to keep the size of its balance sheet constant and said the Fed was prepared to take "unconventional" measures to stimulate the economy if the outlook darkens.
Outlining other ammunition the Fed could use, Mr Bernanke pointed to additional purchases of long-term securities, changing the language of the Fed's statements and reducing interest paid on excess reserves.
Mr Bernanke said there was no support within the Fed to increase its medium-term inflation goals above levels consistent with price stability.
"Such a step might make sense in a situation in which a prolonged period of deflation had greatly weakened the confidence of the public in the ability of the central bank to achieve price stability, so that drastic measures were required to shift expectations," Mr Bernanke said.
In the short term, Mr Bernanke said that pre-conditions for a pick-up in growth in 2011 "appear to remain in place".
By Alan Rappeport, FT.com August 27, 2010 -- Updated 1812 GMT (0212 HKT)
© The Financial Times Limited 2010

Euro slumps

The euro dropped for a second week against the dollar to a five-week low as weaker economic data and calls by a European Central Bank official for more economic aid damped investor appetite for higher-yielding currencies.

The 16-nation currency reached a seven-week low against the Swiss franc after ECB council member Axel Weber Aug. 19 told Bloomberg Television the central bank should assist financial institutions to prevent year-end liquidity tensions. The dollar and yen rose against most of their major counterparts as data indicated the global economic recovery may be faltering. The Japanese finance minister is set to meet the prime minister this week to discuss the nation’s currency.

“The exceptionally weak numbers in the last couple of days in the U.S., that has weighed on risk appetite,” said Richard Franulovich, a senior currency strategist at Westpac Banking Corp. in New York. “In the euro, Canadian dollar and Australian dollar, the price action is very disappointing, the initial bias would be to sell these currencies and for more dollar strength.”

The euro fell 0.3 percent to $1.2712 in New York from 1.2754 in the five days ended Aug. 13. It touched 1.2673 yesterday, the weakest since July 13. Japan’s currency dropped 1 percent to 108.83 per euro from 109.92 last week in New York, after reaching 108.31, the strongest since July 1. The euro sank 2 percent to 1.3143 francs from 1.3408 francs a week ago, after touching 1.3140 francs. The yen rose 0.7 percent to 85.62 per dollar.

The Canadian dollar rose 0.4 percent to C$1.0475.

Stocks Fade

The Standard & Poor’s 500 Index fell for the second week, declining 0.7 percent. The Stoxx Europe 600 Index retreated for a third week, dropping 1.3 percent, and crude-oil futures for September delivery fell 2.6 percent.

“Most of these discussions about the continuation of the exit I think will be focused on the first quarter,” Weber, who heads Germany’s Bundesbank, said in an interview with Bloomberg Television in Frankfurt yesterday. “It’s clear that we need to re-embark on a normalization procedure.”

The euro accelerated its decline and the yield on Germany’s 30-year bond fell to a record low yesterday as Weber’s comments suggested the ECB will support the region’s banks for longer than some investors expected.

“Regional worries about peripheral eurozone debt have also resurfaced in recent weeks,” Samarjit Shankar, a managing director for the foreign-exchange group in Boston at Bank of New York Mellon, wrote in a note to clients. “We are seeing steady net inflows into German bunds, which offer relative safety and liquidity in the region.”

Currency Flows

Cumulative inflows to German debt this week totaled one- and-a-half times the average amount compared with the previous year, according to iFlow data from BNY Mellon, the world’s largest custodial bank, with more than $20 trillion in assets under administration.

“Weber indicating that he thinks it’s necessary to continue unlimited funding until the end of the year was a real red flag to the market,” said Jessica Hoversen, a Chicago-based analyst at the futures broker MF Global Holdings Ltd. “You have a lot of event risk over the weekend: the Australian election, the possibility of a conversation on the yen.”

Current Prime Minister Julia Gillard and opposition leader Tony Abbott will face off in an election that may result in a hung parliament. Demand for Australia’s dollar was limited as polls ahead of the election showed voters almost evenly split between Gillard’s Labor Party and opposition Liberal-National coalition.

Australia’s currency fell 0.1 percent to 89.39 U.S. cents this week.

Slower Growth

Revisions to U.S. economic growth next week will probably indicate the pace of the expansion slowed even more in the second quarter, to a 1.4 percent annual rate from the 2.4 percent in a preliminary report on July 30, according to a Bloomberg survey. Japan’s export growth slowed to 21.8 percent in July from 27.7 percent in June, and the Ifo institute’s German business climate index slid to 105.5 in August from 106.2 the previous month, separate surveys showed before the Aug. 25 data.

The Dollar Index, which IntercontinentalExchange Inc. use to track the greenback against the currencies of six major trading partners, rose 0.1 percent to 83.057 It reached 83.283 yesterday, the strongest level since July 22.

Claims Rise

U.S. initial jobless claims rose by 12,000 to 500,000 in the week ended Aug. 14, Labor Department figures showed in Washington. Claims exceeded all estimates of economists surveyed by Bloomberg News and compared with the median forecast of 478,000.

Speculation has mounted the Japanese government will take steps to curb the currency’s rally. The yen has gained 14 percent this year, the best performance among 10 developed-world currencies, Bloomberg Correlation-Weighted Currency Indexes show.

“If the yen becomes considerably volatile or breaks 80, chances for an emergency meeting would become high,” said Hideo Kumano, a former Bank of Japan official who is now chief economist at the Dai-Ichi Life Research Institute in Tokyo. “The impact of further accommodative steps may be limited; it would mainly be aimed at preventing the yen from becoming excessively strong.”

The yen’s climb to a 15-year high of 84.73 against the dollar on Aug. 11 has stoked concern that exporters’ earnings could weaken and deflation might deepen. Finance Minister Yoshihiko Noda said today he will meet with Prime Minister Naoto Kan next week to discuss the economy and currency.

Japan hasn’t intervened in the currency market since March 2004, when the yen was at about 109 per dollar. Central banks intervene in the foreign-exchange market when they buy or sell currencies to influence exchange rates.

To contact the reporter on this story: Catarina Saraiva in New York at asaraiva5@bloomberg.net

Housing led the U.S. out of seven of the last eight recessions

Housing led the U.S. out of seven of the last eight recessions. This time, it may kill the recovery.

Home sales collapsed after a federal tax credit for buyers expired in April. Since then, the manufacturing-led expansion, which began in the second half of 2009, has been waning, with jobless claims rising and factory orders falling.

“If foreclosures continue to mount and depress home prices, that could send the economy back into a recession,” said Celia Chen, an economist who tracks the industry for Moody’s Analytics Inc. “The housing market and the broader economy are closely intertwined.”

Spending on home construction and items such as furniture and stoves accounted for about 15 percent of gross domestic product in the second quarter, according to West Chester, Pennsylvania-based Moody’s Analytics. Real estate also can influence consumer spending indirectly. When values soared in the mid-2000s, people used the boost in equity to pay for cars and vacations. After prices fell, homeowners lost that cushion and curbed spending.

A report tomorrow by the Chicago-based National Association of Realtors will show July sales of existing homes plummeted 12.9 percent from June, the biggest monthly loss of 2010, according to the median estimate of economists surveyed by Bloomberg.

New-home sales, which account for less than a 10th of housing transactions, stayed at the second-lowest level on record last month, economists predict Commerce Department data will show on Aug. 25.

Housing in ‘Doldrums’

“Housing continues to be stuck in the doldrums,” said Jeffrey Frankel, a member of the business-cycle dating committee at the National Bureau of Economic Research, the arbiter of when U.S. recessions begin and end, and a professor at Harvard University in Cambridge, Massachusetts.

With 14.6 million Americans out of work, homeowners are struggling to hold onto their properties. One in seven mortgages were delinquent or in foreclosure during the first quarter, the highest in records dating to 1979, according to the Washington- based Mortgage Bankers Association. Foreclosures probably will top 1 million this year, said RealtyTrac Inc., an Irvine, California-based data company.

Federal efforts to help have had little success. Of 1.31 million loan modifications started under the Obama administration’s Home Affordable Modification Program, 48 percent were canceled by the end of July, the Treasury Department said Aug. 20. More than half of all modifications defaulted again within 12 months, the Office of the Comptroller of the Currency said June 23.

Sidelined Buyers

Shadow inventory, or the number of homes repossessed or in default that eventually will be offered for sale, stood at 7.3 million in the first quarter, according to Laurie Goodman, an analyst in New York at mortgage-bond broker Amherst Securities Group LP. As those properties hit the market, prices will come under pressure and buyers will wait for better deals.

Those sidelined house hunters include Marion and Jim Lasswell, who said they spend most weekends looking at homes for sale near Raleigh, North Carolina. His engineering job at iRobot Corp. is secure, the couple’s credit is good and they have saved enough for a 20 percent down payment, Marion Lasswell said. The problem: they don’t think the market has hit bottom.

“We’re still watching prices drop,” Lasswell, 38, a registered nurse, said in a telephone interview. She said they won’t buy “until there’s an awesome deal.”

GDP Weakens

Home prices tumbled 33 percent from their July 2006 peak to the low in April 2009, according to the S&P/Case-Shiller 20-city index. They may drop another 20 percent by 2012 if the economy slips back into a recession, according to Chen, the Moody’s Analytics economist.

Gross domestic product increased less than 1.5 percent in the second quarter, the slowest rate since the recovery began, according to the median forecast by economists in a Bloomberg survey. That’s down from the 2.4 percent rate initially reported by the Commerce Department last month. Growth may ease to 1.3 percent by the first quarter of next year, according to the New York-based Conference Board.

Consumer spending rose 1.6 percent in the second quarter, down from 1.9 percent in the previous three months. Purchases of home furnishings and appliances fell 1.7 percent to an annual pace of $256.5 billion in June from a 2010 high in April, according to the Bureau of Economic Analysis.

“There is an epidemic of thrift,” said Nariman Behravesh, chief economist at IHS Inc. in Lexington, Massachusetts. “Households and businesses are super-cautious right now. Sometime in the next 6 to 12 months, we’ll start to see more movement on home and car purchases and greater willingness on the part of businesses to hire.”

Fed Steps In

Federal Reserve policy makers on Aug. 10 made their first attempt to shore up the recovery by pledging to keep their holdings of securities and prevent money from draining out of the banking system. They said the economic expansion probably will be “more modest” than earlier anticipated. The Fed has held the target for its benchmark lending rate near zero since December 2008 and purchased $1.43 trillion worth of debt to keep rates low and bolster housing.

“Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth and tight credit,” the Fed said in a statement.

Buying Plans

The average U.S. rate for a 30-year fixed mortgage dropped to 4.44 percent in the second week of August, the lowest recorded by McLean, Virginia-based Freddie Mac, the second- largest mortgage buyer. A July survey by the Conference Board found 1.9 percent of the respondents planned to buy a home in the next six months, near December’s 27-year low of 1.7 percent.

A sustained economic recovery depends on the job growth required to boost consumer spending, said Behravesh of IHS. The unemployment rate may average 9.6 percent this year, based on the median estimate of economists in a Bloomberg survey. That would be the highest annual rate since 1983.

Home construction and property sales led the way out of the previous seven recessions going back to 1960, according to PMI Group Inc., a mortgage insurer in Walnut Creek, California. New- home sales improved an average of eight months before the beginning of economic growth, and single-family housing starts improved seven months before recovery.

That didn’t happen in the last recession. Sales of new houses fell in five of the eight months before economic expansion began in 2009’s second half. Housing starts fell in two of seven months.

While the Lasswells in North Carolina said they’ll keep spending their weekends looking at homes, they aren’t in a hurry to buy. “I don’t see things getting better,” Marion Lasswell said. “I expect prices to be flat for a long time.”

To contact the reporters on this story: John Gittelsohn in New York at johngitt@bloomberg.net; Bob Willis in Washington bwillis@bloomberg.net

The Fed’s Treasury Purchase Plan is Just Further Proof That It’s in the Denial About the Dollar

This week's decision by the U.S. Federal Reserve to buy Treasuries in an effort to prop up borrowing is further proof that the economy is worse off than policymakers would have us believe. But more than that, the Fed's Treasury purchase plan is just one more reason for investors to anticipate inflation and take steps to protect their money from it.

In case you missed the news, here's what happened...

The Federal Reserve on Tuesday announced that instead of allowing proceeds from maturing mortgage bonds to disappear from its balance sheet, the central bank would take the "modest" step of using them to invest in new Treasuries.

In plain English, that means that the Fed is reinvesting into U.S. Treasuries the money it would otherwise bank from maturing mortgages.

Its goal is very simple: to keep long term interest rates from rising.

Many economists have pointed out that the consequences of the Fed's Treasury purchase plan will be minimal. And I agree. A mere $200 billion or so in such securities - out of the Fed's $2.3 trillion portfolio -mature yearly as homeowners pay off or retire their mortgages. So we're only talking about 8.69% of the total here.

But it's the Fed's read-between-the-lines implication that is really scary.

By taking this step, U.S. Federal Reserve Chairman Ben Bernanke hopes to reassure global traders, and presumably the American public, that he is prepared to take even more drastic steps should the recovery grind to a halt. Chief among the Fed's options would be to buy more mortgage debt, which Bernanke believes would help keep down inflation.

Bear in mind, though, that at the height of this financial crisis, the Fed purchased a staggering $1.42 trillion in mortgage securities and some $300 billion in Treasuries to prop things up. And mortgage rates fell less than half a point. So much for that theory.

Something stinks here.

Bernanke either knows something about the state of the recovery that he's not telling the public, or he's trying to telegraph something he believes is inevitable.

Maybe it's both. But this isn't good news either way.

I have got to believe that it's finally dawning on Helicopter Ben that deficit spending and the Keynesian formula for consumer stimulation - upon which the Fed has based its entire recovery plan - don't work. (Something I argued in a recent report to Money Map Report subscribers - click here to sign up and get your copy.)

The housing market still stinks, mortgage rates are still falling despite being the lowest they've been in decades, and consumers have no money. Furthermore, the consumers that do have money are facing tighter credit standards and don't want the debt.

Frankly, I think that's actually a good thing because it represents a huge psychological change in our nation's reckless spending habits. However, from the Fed's point of view, it's a problem because its policies presuppose that government spending makes up the difference in consumer demand until demand can once again overpower the deficits induced in the effort.

But here's the real problem with the Fed's policy: By propping up the mortgage market, and by implication Treasuries, the Fed is only temporarily staving off inflation, while further selling out the dollar long-term.

The fact is that inflation is as inevitable as the sun rising tomorrow and there are now some $12.4 trillion reasons why. And so the problem isn't the mortgage market or even the manipulation of rates, but the eventual evisceration of the dollar.

Regardless of government statistics that suggest inflation is under control, the reality is that inflation is already well underway to the tune of 10% or more in this country. You know that as well as I do by what happens with your wallet every day. The costs of education, medicine, and groceries are all up, up, up. Apparently, the government bean counters are the only ones who aren't feeling the squeeze.

The other thing to consider is that by propping up Treasuries in an effort to keep inflation low, the Federal Reserve is undermining any semblance of a strong dollar policy. Bernanke and Treasury Secretary Timothy Geithner may talk a good game, but the reality is that money flows to where it is treated best. And that doesn't bode well for the dollar in the long-term.

Once the dust starts to settle, i nternational traders will move away from the greenback absent higher interest rates that compensate them for their investment. In fact, they've already begun doing just that. I know the dollar rose overnight following Tuesday's announcement but that's more in reaction to a short term flight to quality than a long term reflection or judgment of the dollar's staying power.

If it were, we would not have seen the dollar fall below 85 to the Japan Yen - a 15-year low - at the same time.

And don't forget about China. By propping up U.S. treasuries in an effort to keep interest rates from rising, the U.S. government may be trying to force the Chinese to revalue their Yuan more quickly than that government wants. This will go over like a lead balloon in Beijing, which holds nearly a $1 trillion of U.S. government paper in the form of short-term obligations.

So what we can do to profit from the situation?

Action to take: There are three ways to capitalize here:

Buy treasury indexed inflation securities or "TIPS" as they are commonly known. Because U.S. Treasuries remain one of the most liquid investments on the planet, it's very easy to participate in this trade. Inflation will get here - the only question is when. Now is the time to start hedging against it. My favorite choice is to begin averaging into a vehicle like the iShares Barclays TIPS Bond ETF (NYSE: TIP). The duration is a relatively short one-10 years, so most of the volatility that's going to plague long bondholders is avoided, but the potential return remains. I also like the 3.59% dividend yield, which compensates investors for the risks they take by holding this fund.
Short the Japanese Yen: This trade is a bit more subtle. If the United Stats is once again openly diluting the dollar, we can reasonably expect the Japanese to react - though not immediately, because things take time in Japan...lots of time. Think about it this way: Japan's economy is largely export based and there is almost no domestic consumption growth. A more expensive yen versus other currencies makes Japanese exports less attractive, so the Japanese government is under intense pressure to reverse this trend by weakening the yen. My expectation is that this will happen by the end of 2010, when the pain threshold reaches a crescendo and companies like Toyota Motor Corp. (NYSE ADR: TM) begin losing sales the way the German companies did years ago on the back of a super strong Deutsche marke. Spot FX or futures are your best bet here.

Buy Chinese Yuan: I've often referred to buying Chinese yuan as the closest thing to a no-brainer on the planet. The only question, given the Fed's shenanigans, is whether or not you have the patience to sit it out. Revaluing the Chinese yuan is in China's best interest, but doing so is hardly in Washington's, especially now. I believe this will make for a potent combination when the timing is finally right and one of the easiest ways to participate is through the WisdomTree Dreyfus Chinese Yuan ETF (NYSE: CYB).
Of course you could also take the easy way out and simply short the U.S. stock market as a whole...but then you risk fighting a government that rightly or wrongly doesn't know when it's been beaten and refuses to give up.

By Keith Fitz-Gerald, Chief Investment Strategist, Money Morning

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