US Retail sales gain by a surprising 1% , reducing expectations of an early Fed interest rate cut

By: Sarah_Jones

Two reports released on Wednesday showed retail sales surging in November by 1%, contrary to the expectations of a hard landing for the economy. The market had been expecting a rise of just 0.1%. Bonds immediately fell and the dollar strengthened on the news as the markets reevaluate the expectations of an early cut in US interest rates.

The expectation that the falling US housing market will feed through to consumers cutting back on expenditure is not being bourne out by the statistics, recent data is also showing that the housing market is starting to stabalise, as increasingly the housing effect during 2007 on the consumer will continue to dissipate, which implies stronger growth during the second half of 2007.

So what does this mean for US interest rates ?
This supports the Feds view of retaining a relatively hawkish tone despite the weak housing market. The Federal fund futures had been pricing in a rate cut in early 2007 at a probability of 76% on December 1st, now that stands at less than a 20% chance. This implies that given inflation is still above target, we may now even see another interest rate hike by mid 2007.

However the dollar is still expected to fall despite the current short-term rally into the new year, as the fundamentals of the twin deficits for the dollar have not changed, and the falling dollar will continue to pressure interest rates upwards due to the inflationary of a depreciating currency.

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