The Swiss Franc may see volatility late into the European session as the Swiss National Bank makes their quarterly monetary policy announcement, including an update on their policy of intervention into the currency market to prevent the appreciation of the currency. As with most major central banks, there is little doubt that the SNB will leave benchmark interest rates unchanged. Rather, traders will focus on any updates to policymakers’ commitment to keep a lid on the value of the Swiss Franc with direct intervention into the currency markets. Consumer prices printed a bit better in August, rebounding from the low set in July, and a similar moderation in Producer Prices earlier this week foreshadows slightly better results for the headline inflation gauge in the months ahead. Still, it is surely much too early to say that the specter of deflation has dissipated, so the SNB is unlikely to do a complete about-face on exchange rate policy. To that effect, the markets will look for a more nuanced hint at the bank’s bias going forward, such as an upward revision of inflation expectations. The 1.50 level in EURCHF seems to have been the threshold of the SNB’s comfort zone, and traders would be wise to watch the behavior of the cross vis-à-vis this juncture ahead of the policy announcement.

UK Retail Sales are expected to rise 2.7% in the year to August, snapping two months of consecutive gains in the annual growth rate. The metric has seen atypical volatility over recent months as rising unemployment grappled with rebounding asset prices and government stimulus for dominance over consumer sentiment. Looking ahead, we see the downside scenario as more plausible. Fiscal support is inherently limited with the UK budget deficit already set to average close to 13% of GDP though 2010, threatening the country’s sovereign credit rating. Meanwhile, global equities are looking increasingly overdone having finished August at the highest level relative to earnings since May 2003. The upward trend in unemployment looks far more permanent, however, with a survey of economists polled by Bloomberg expecting the jobless rate to top 9% by the end of next year. This will trim incomes and discourage spending, weighing on retail activity in the months ahead.

The Euro Zone Trade Balance surplus is set to expand to 6.4 billion euro in July, the most in over two years. Exports figures may prove disappointing, however: industrial production fell more than economists expected in the same period while the currency has been pushing higher in trade-weighted terms since late April, now up over 5.6%, making European-made goods comparatively more expensive and thereby less attractive to foreign buyers. A drop in imports seems like a much more plausible driver for an improvement in the headline figure, especially considering the sharp decline in Swiss industrial output reported earlier this week. As we have previously noted, manufactured goods top the list of Swiss export commodities, so the drop in production is indicative of lackluster demand in key overseas markets, where the top three Euro Zone economies alone account for close to 50% of demand.

Asia Session Highlights

Japan’s Tertiary Industry Index grew slightly more than economists expected, adding 0.6% in July to show that demand for services has rebounded to the highest level since February. The result likely owes to continued support from the government’s record-setting 25 trillion yen stimulus package. Indeed, government spending accounted for the bulk of economic growth in the second quarter. The question now facing Japan as well as most other developed countries is what happens when the flow of public funds invariably dries up. On balance, unemployment continues to push higher, trimming incomes and hinting at turn lower in spending (including that on services) in the months ahead.

New Zealand’s Business NZ Performance of Manufacturing Index fell to 48.7 in August from 49.6 in the previous month, showing the pace of contraction in the industrial sector quickened for the first time since May. The sub-index measuring New Orders led the metric lower, dropping by -5.1 points to register the largest decline in 9 months, while output shrank the most since February. The report follows news that manufacturing sales dropped the most on record in the second quarter, adding yet more weight to last week’s comments from Reserve Bank of New Zealand Governor Alan Bollard, who said the stronger New Zealand Dollar puts business profits “under pressure” and warned that “If the exchange rate were to continue its recent appreciation…the sustainability of the present recovery will be brought into question.”

The Bank of Japan unanimously agreed to keep interest rates unchanged at 0.10%, as expected, but policymakers raised their forecasts for economic growth as economic conditions begin to “show signs of recovery”, calling for growth to begin to rebound in the second half of the 2009 fiscal year (the 12 months ending April 2010). The bank still sees downside risks to the economy, however, saying fiancial conditions continue to be “severe” while consumption remains weak and capital spending is still falling. Policymakers made no changes to their asset-buying and lending programs. On balance, BOJ Governor Maasaki Shirakawa concluded that “risks to the economy are still on the downside [with the outlook] attended by a significant level of uncertainty.”

kay, the recovery will not be “V” shaped.  It may not be “W” shaped, so today’s media experts now refer to the recovery as “U” shaped, even if it is an extended “U.”

Well, one thing is for sure, the longer this recession-recovery goes on, the smarter the Oracle of Omaha looks.  Yes, Warren Buffet has a way of putting his finger on the pulse of the economy.  Frankly, the real mystery is why everyone else either does not see what he sees or why they are unable to express their vision as succinctly as the Oracle.

For the past three months, every time Buffett has appeared on CNBC he stresses one consistent symptom.  Hey guys and gals, listen up will you!  This guy gets it, plain and simple.

This recession was in large part caused by faulty and probably unscrupulous lending practices that inflated the value of the residential real estate market and loaded the banks with toxic assets.  The Oracle has said repeatedly that this recovery will not take hold until the excessive residential real estate inventory is brought under control, meaning sells out.  Everything else may be “less bad,” a popular news slogan these days, but that simply stands for baseless.

This recovery has no foundation until the existing residential real estate market is cleared up and moved out.  And, even the Oracle admits that the depth of the backlog may be bigger than expected.

As more and more residential mortgages fail and as more than 1 in every 355 homeowners is in the foreclosure process, the inventory ceiling has yet to be identified.  Buffett does not get too specific about this figure, but the facts are the facts.  There is at least one year’s worth of inventory backed up now.

Are Housing Starts Really Encouraging?

The Commerce Department released figures showing that new housing starts increased by 1.5% from July to August.  The seasonally adjusted rate is now at 598,000.  New building permits rose sharply by 2.7%.  Year-over-year permits applications were 37.3% ahead of last year.  On the surface, that looks like good news.

However, single family home construction actually declined by 3% to a seasonally adjusted rate of 479,000 units.  The figure had risen each of the previous five months.

Earlier in the week, this was precisely what Buffett had predicted.  In order to clear out the excess residential inventory, new single family housing starts needs to suffer further.  It is becoming increasingly evident that government initiatives are driving the recovery, not national or global economic growth.  Joseph Brusuelas of Moody’s Ecconomy.com explained; “We are at the stage where an economy exits recession.  The recovery is going to be moving along due to policy initiatives and inventory restocking.  It’s a U shaped recovery with some parts of the U a little bumpy.”

The rise in housing starts is partly fueled by the upcoming November 30^th expiration of the first-time homebuyer’s $8,000 tax credit.  On Thursday, Treasury Secretary Timothy Geithner reported that the administration has not decided to renew the first-time homebuyers tax credit or any version thereof.  This tax incentive is responsible for more than 375,000 single-family sales so far this year.  Real estate lobbyists have been pushing an expanded version of the tax credit that would put more money on the table and would not be limited to first time buyers.

The ball seems to be in the hands of the Federal Reserve, who meets next week.  As Chairman Bernanke has indicated, the recovery is underway.  The Federal Reserve is believed to be more interested in finalizing an exit strategy rather than pumping more money into the economy.

This is bad news for the 9.7% of Americans receiving unemployment benefits.  It is also bad news for the housing market.  The majority of existing home sales are in the low-end, first home buyer price range.  In addition to the first time buyer, 33% of home sales are distressed sales, meaning either facing foreclosure or already in the system.

Would someone please tell Secretary Geithner that a 2010 tax credit is absolutely necessary.  Let’s get this U moving upwards.  Rather than pull back from the tax credit policies of the past, let’s expand them and put some fuel on the fire.  This is important work.  Tim, talk to the Oracle of Omaha!

The economic recession, which hit the world last year, is still weighing on prices dragging it to the downside and raising concerns regarding deflation risks. Inflation rate in the euro zone witnessed the sharpest fall in at least 13 years in July, as a consequence of the decline in energy costs and the rising unemployment levels, which had reached its highest in 10 years

Today, the euro area will release its CPI for the month August, with expectations to remain at -0.2% on the year; and incline to 0.3% from -0.7% on the month. Also, core CPI will be released today with anticipations to decline to 1.2% from 1.3%.

In the second quarter, the euro zone’s GDP showed a slowdown in contraction to 0.1% from 2.5% in the first quarter, thanks to the unexpected 0.3% expansion recorded in Germany and France. This expansion is expected to push prices upward, to positive areas in the coming period, as recovery will boost demand on commodities, especially oil.

Oil prices, after reaching its highest level above $147 a barrel last year, it dropped to below $34 this year. However, since February crude oil started an upside trend that, lifting prices up to the highest in 10 months (near $75 a barrel) in August. With the ongoing improvement in the economic conditions that appeared since April, and became very obvious; starting from the third quarter, demand on energy prices is expected to increase; and therefore the general price level is anticipated to leave the negative territories in the coming period.

In Germany, the largest economy in the euro zone, CPI’s final reading for August remained unchanged at 0.0%, while the monthly reading stood at 0.2%. Prices in the gigantic economy, in the euro region, has left the negative areas, providing further evidence the worst is over and the economy is on the right path to recovery.

As a support to the economy to jolt it out of the recession, the ECB slashed the benchmark to a historical low of 1% and launched a 60 billion euros plan, to be spent on purchasing covered bonds to support markets with liquidity. In addition, the ECB provided liquidity to banks to spur lending and thereby spending. On September 29; the ECB will offer to lend banks more money for 12 months at the key rate.

The European Central Bank raised inflation forecasts for the 16-nation economy to 0.4% this year and 1.2% next year; above the 0.3% and 1%, respectively announced in June. However, The Bank has warned previously that the recovery may face hardships, such as the escalating jobless rate, which cripples spending and thereby put downside pressure on prices. Unemployment rate in the euro zone is now 9.5%, the highest since September 1999.

It seems that the rising jobless rate is not a serious problem only in the euro zone; the U.K. also is suffering from the rising unemployment figures. ILO Jobless rate surged to 7.8% in the three months ending June, the highest since 1996; where the number of job seekers rose to 2.44 million, the most since 14 years.

Later on today, the U.K. will release its ILO unemployment for the three month from May to July, where the rate is predicted to climb to 8.0%. It is obvious that the economic recession is still adversely impacting the economy, since many employers are cutting jobs to reduce costs. The rising unemployment and the easing prices are the main threats that may thwart recovery. The British Chamber of Commerce predicts the number of persons unemployed will climb to 3 million people in 2010.

Policy makers at the Bank of England (BoE) kept their benchmark interest rate at its record low of 0.5% and held the Asset Purchase Facility program at 175 billion pounds during their meeting in September. The BoE sees that the current monetary policy is suitable for this period and there is no need for further increase in the amount dedicated for buying gilts. However, there are talks about reducing the deposit rate for banks reserves to support banks with liquidity to enhance lending.

Switzerland’s Consumer Price Index is set to show continuing deflation as prices shrink -0.7% in the year to August, marking the fifth consecutive month in negative territory. As we noted earlier this week, the danger is that steadily lower CPI will translate into expectations of lower prices in the future, encouraging consumers and businesses to perpetually delay spending and investment as they wait for the best possible bargain and bringing economic growth to a virtual standstill. The Swiss National Bank has explicitly committed to “take firm action to prevent an appreciation of the Swiss franc”, keeping a lid on the currency’s purchasing power and thereby limiting the drop in prices in terms of the domestic monetary unit. It is much easier for policymakers to drive down the Franc than to support its value because they can simply print more money and let it loose into circulation, suggesting it should not be too difficult for the SNB to keep down the exchange rate. Naturally, currency markets are well aware of this, and traders may move to pre-empt central bank to sell the Franc as another negative CPI reading crosses the wires.

The European Commission is set to update their economic forecasts for 2009 and 2010, with the announcement is unlikely to carry much market-moving potential. Indeed, the Euro failed to build momentum yesterday as the analogous set of expectations was upgraded by European Central Bank after policymakers kept interest rates unchanged at a record-low 1% while ECB President Jean-Claude Trichet stuck a dovish tone in the press conference following the announcement. The bank chief said uncertainty about the economic outlook remains “very high” and cautioned that the nascent recovery noted in a number of leading indicators faces a “bumpy road” ahead. He further added that the ECB sees “low inflationary pressure over the medium term” and stressed that “today it isn’t time” to unwind unconventional monetary easing measures. The markets’ 1-year interest rate expectations dropped -12.8% following the release, the largest one-day drop in a month.

On balance, currency markets are likely to pay little heed to the European data docket to focus on the US Nonfarm Payrolls report set to cross the wires late into the session. Traders have viewed US economic data as a proxy for the state of the global economy at large on expectations that a rebound in the world’s largest consumer market will reverberate elsewhere.

Asia Session Highlights

Japan’s Capital Spending fell -21.7% in the year through the second quarter, rebounding from the record -25.3% annualized drop recorded in the first three months of the year. The non-manufacturing component of the metric was behind the improvement, where spending fell -14.2%, the least in a year, having declined -27.6% in the prior quarter. Capital spending for the manufacturing sector shrank -32.0%, accelerating from the -21.2% result noted in the previous period. On balance, this is somewhat encouraging: the non-manufacturing sector employs close to 66% of Japan’s labor force, so any signs that these firms are increasing capacity may translate into hiring, consumption, and ultimately boost economic growth. Still, it must be kept in mind that Japan’s savings rate stands at about twice that of the developed country average, so any improvement in the labor market will take considerable time to translate into spending growth.