The new year brings us a chance to make some predictions so I thought it was a good idea to throw out some ideas for the first half of 2008. Feel free to post yours as well.

1. Currency

The trend for the dollar will be weakness vs. the Euro and Yen, but strength vs. the Pound in H1 2008. The Euro will appreciate and continue to replace the dollar’s reserve currency status as the U.S. economy continues to cool during this period. Market turmoil will also accelerate the dollar’s losses vs. the Yen as carry trade positions are further unwound. Two factors will lead to the dollar’s gain on the Pound; unwinding of carry trades and UK economic weakness leading to further BoE rate cuts.

2. Equities

A cascade of problems exist for consumers and therefore business and equity markets. Consumer spending has the potential to take a huge hit due to factors such as rising food and energy costs, falling home values, weaker job creation and higher rates of unemployment, to say nothing of stagnant wages in real terms.

Businesses have been facing rising material costs for many months now while core CPI and PCE have remained contained. The bump up for these readings in their last reports indicate pass-thru effects may be starting to take place. Exports have continued to stay strong but rising commodity prices may squeeze profit margins, which will lead to lay-offs. Q4 Profits in the S&P 500 are projected by Reuter’s to fall 6.1%, as opposed to the October estimate for an 11.5% gain in the period. Profits in Q1 and Q2 2008 have also been revised down from October’s 11.4% projected gain to 5.1% and 5% respectively. Q3 2007 profits in the S&P 500 are already down nearly 4.0% from Q2.

3. Housing

Demand and therefore prices will continue to fall at least thru the first half of 2008. One of the main drivers of this are new mortgage regulations for conforming Fannie and Freddie loans. Increased fees and increased mortgage insurance requirements along with their demands for higher credit scores for prime borrowers (680 from 620) and higher down payments will shrink the pool of available buyers significantly. Also, as prices continue to fall, sellers and buyers will be more reluctant to get into the the market. There’s also the huge inventory overhang to deal with, which means supply is outstripping demand and placing downward pressure on price.

4. Economy/Fed

There’s no question the economy will slow; the only remaining questions are the depth and length. Another question that will be crucial for market survival is what the Fed will be able to do about it. The TAF auction system is helping to ease the liquidity squeeze, but the overall effect on the real economy is limited. A far more serious concern for the Fed and the economy in general is that the period of slackening demand may be accompanied with rising inflation i.e. stagflation. So while the Fed is expected to ease towards 3.5% in the overnight rate, the pace of reduction may be slowed and will likely be accompanied by more hawkish rhetoric in their statements and minutes-also a negative to carry trades and the equity markets in general.

5. China/Oil/Commodities

The trend for China to allow the Yuan to appreciate faster vs. the dollar will be a main feature for the global economy going forward. What’s essentially happening is that China is looking to control its inflation by lowering the prices it pays for commodities (which are paid for in dollars)-hence the faster appreciation of the Yuan. China also lowered its import tariffs on oil, further cheapening its price for Chinese businesses. Demand from China for global commodities will increase, which will have the ultimate effect of increasing their prices here. Oil could easily head towards $125.00/bbl in six months time which will drive the stagflationary environment in the U.S. that some economists are predicting.

For more details in-depth analysis on fundamental issues, please visit thenewstraderfx.blogspot.com.

Related Posts: