FORTIGENT, LLC

Economic & Market Update: 

august 18, 2008

Chip Norton

Managing Director of Fixed Income & Economic Analysis

chip.norton@fortigent.com

“Dollar Remains a Winner”

Last Week’s Highlights:

Stocks:                                Late week rebound to Dow 11,659

Bonds:                                Treasury rally – 10-yr at 3.85%

Oil:                                     Selling continues to $113 per barrel

Gas:                                    Regular lower – $3.79 per gallon

Dollar:                                Dollar rallies to $1.47 per euro, 110 yen

CPI:                                    5.6%, highest in 17 yrs

Retail Sales:                        Lower, first drop in five months

Economics This Week:

Date      Item                                  Est.                     Comment

8/19       PPI                                     0.5%                     The wave higher continues

8/19       Housing Starts                   950m                    Stability at last?

8/21       Leading Indicators           -0.2%                    Downtrend in place

Selected Rates:

Fed Funds                                       2.0%

3-mo LIBOR                                  2.81%

10-yr Treasury                                 3.83%

2-yr Treasury                                   2.37%

10-yr AAA muni                              3.82% (TEY @35% =5.87%)

Taxable Money Market                   1.84%

Tax Free Money Market                 1.40% (TEY @35%= 2.15%)

30-yr Fixed Mortgage                     6.40%

6-mo CD                                          3.14%

5-yr CD                                            4.14%

Oil Backs Down Despite Crisis

This week will continue to be dominated by the news out of Georgia and Pakistan, but despite these two international concerns, oil prices continue to fall. This is incredible given the typical reaction to the dollar and oil to such events. Even with reports this morning of Azerbaijan suspending oil exports through ports in western Georgia after an explosion damaged a key rail bridge, prices are lower. Just a month ago, none of us would have been surprised at a $10 lift in crude on such news. But today prices are falling again even in the face of a hurricane lurking off Florida! There can be little doubt that the oil trade is dead for the moment (never count it out completely). The demand components are, of course, all down significantly in the US, with some statistics showing the largest monthly declines in energy demand in over 25 years. And, with weaker economic growth numbers coming out last week for Europe and Asia (China especially), many energy analysts say it’s very possible demand levels will continue to fall, allowing oil to move toward the $100 mark.  At that price it’s almost a steal!

Dollar Rally Marches On

With fresh reports from Europe showing a continued slow-down in economic activity, the US dollar continues to move higher. As we enter the week, the dollar stands at $1.47 per euro and 110 against the yen. Foreign exchange analysts are now calling for the dollar to rally to the $1.40/euro level by year’s end. The dollar rally can help US equity performance as a stronger dollar encourages asset flows move to the US, but the drawback will be higher prices overseas for US goods. This ultimately will slow down US export growth, which has been such a major force in the US GDP strength over the last six months. And, speaking of GDP, forecasters are now suggesting a 3% GDP for Q3 following the 1.9% (prelim) estimate for Q2.

The tough economic news this week will once again be inflation. After last week’s CPI data showing a 5.6% annual run rate, this week’s PPI data is expected to show a monthly increase of 0.5%, which would put it on track for an annual rate of close to (Gulp) 10%. Can you say “double digit inflation”?! It’s been a long while since we had to use that term, but the increase caused by the energy wave will linger for at least a few more months. The good news, of course, is that the sell-off in oil and gas prices will alleviate this surge in the coming months, but the retracement will still keep CPI and PPI at very high levels. This should leave the Fed in a slight tightening bias, but unlikely to actually pull the trigger on a rate hike until there is solid confirmation of economic growth.

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