Macroeconomics

There is still very little happening in the general macroeconomic world. The headlines in the past two weeks have continued to be dominated by the war between Israel and Lebanon and in the last week by the thwarted terrorist attack on civil aircrafts coming into and out of London. The global community is in shock again and it is now clear that people almost anywhere can become victims of fanatical violence.

Stock markets and the whole financial community were affected by the situation and, in addition to the short term reaction, the community has started to analyse possible longer term effects. So far the global economy has not been too heavily impacted by similar incidents and implications have only had a short term effect in recent years.

Due to a pipeline problem in Alaska, speculators had another reason to push the oil price again, but it seems the market is more in need of another boost in the price of oil per barrel. At present there is not enough dynamic to push the price over $80 per barrel and more reputable voices are considering that oil prices may have already peaked and would not be surprised to see the market return to levels around the $50 mark.

 

US interest rates unchanged

A variety of mixed information and indicators were delivered from the USA. While home sales fell in June by 1.3%, consumer confidence still rose, which came as a surprise to many. The discussion about whether the economy is now finally slowing down continues, as well as whether a weaker economy will keep inflation under control.

Despite different opinions, the Fed decided to stop the process of a regular quarter point interest rate hike and left interest rates unchanged after almost two years of interest rate increases. Job growth in the US slowed, but inflation is still in sight with high energy costs and increasing labour costs.

In Europe, almost everybody is still on holiday. The European economy still seems to be quite robust and this leaves a further threat of rising interest rates which should narrow the gap with rates across the Atlantic.

After the summer break, all these fundamentals will return to discussions about the future of the currency market. For the time being, the $/€ exchange rate remains tightly locked between 1.25-1.29 and, after the Fed decided to leave interest rates unchanged, the $ failed to break out of this range and finished the period almost in the middle of the range at $1.27 again. With the currency still in range, it was possible to sell the $ below 1.26 and to buy the greenback above 1.28. We still believe that the new directions will be set at the start of September to increase the dynamic in the last quarter.

 

Market intelligence

The summer market remains listless and does not leave us with much to think about or report. Even our general ambition to view the situation from a wider perspective needs some input and this is missing at present in a way we haven’t seen for many years.

The fundamental situation—that sellers feel comfortable with their positions and buyers feel uncomfortable with prices and profitability—remains intact. This might not cover the entire global community in the leather pipeline, but it is fair to say that as a general statement it reflects the present situation pretty well.

 

Divided opinion over raw material market

Prices remained pretty much in the same very narrow range we have seen for a very long time and today players are getting excited about a move of 2%, which has not even been worth a mention in the past. This situation is also dividing the raw material market into two halves. While large producers of material in particular are feeling more and more comfortable with the situation, others are complaining bitterly as part of their ‘no risk, no fun’ game has been taken away. In terms of raw material trading operations, lack of market movement is leaving very little chance to generate sufficient margins – at least in standard material. This has again shifted a number of well known trading operations into the risky game of financing or offering unsafe payment terms to buyers who find it difficult to fund or finance their business out of their own facilities.

The market environment having been the same now for quite a long time the question remains as to whether it is finally heading for a major correction. Our regular readers know very well that there is not much chance of a major change in the short term. Indeed, we still see very little that could actually change this opinion, so it might be more of a gut feeling rather than the result of any rational analysis.

However, if one really wants to see some indications, we might be in a position to deliver at least some explanation as to why this market in the raw material section could turn into a weaker mood and prices may ease into the last quarter. Some time ago we gave a statement suggesting that average prices for raw materials could be lower in the second half of 2006 compared with the first half.   
     

It is worth noticing that most people are still considering this market to be in the same position as it has been for quite a long time and although some experts have even changed the more bearish position into a more stable one there might be some arguments as to why this market might now move slightly out of balance. It is definitely too early to make a final decision about market realities before the end of the summer break and before a clear evaluation of the situation in Asia after the Shanghai Leather Fair.

 

Surprising slowdown in trade activity 

However, one thing is weighing on people’s minds. The volume of trade in the past three to four weeks has definitely slowed down. We all know that sellers are not particularly concerned as they feel they are comfortably sold and there is no product sitting in their warehouses which could actually cause any headaches. As we said at the beginning of this issue, this is certainly true for the vast majority of standard products, but not for all. And as usual, it always has to start somewhere if things are going to change. So there is now a question over whether those items which are not selling particularly well will be absorbed quickly by the market, or whether this is just the beginning of a change in the supply and demand situation.

We have been speaking to members of the trade who would consider not following their own preferences who, when they discuss the situation with us, admit to situations which they perceive to be at least worthwhile monitoring carefully. First, all kinds of further price increases are scaring buyers away immediately, even those who admit that they are in possession of a pretty solid order book and are definitely not complaining about business as such.  However, they are not willing at present to buy any additional raw material for a clear loss and are certainly not willing to expand their inventories much into the last quarter of 2006 at higher prices. Second, they also admit that there are yet not many buyers that are willing to consider purchases for October onwards.

This may not mean anything, as it didn't in April. It is, however, pretty peculiar because we are entering what is not normally a busy season and leather production and tanners might feel that their inventory position is insufficient and, as prices could have a fair chance of advancing due to a lack of supply, they should be by far more prepared to secure more raw material into the busy season. Nevertheless this appears to be the case in very few places.

This might be completely normal just for the simple reason that, at least in the furniture upholstery section, a lot of new contracts need to be signed in the next eight to ten weeks. Tanners today do not actually know what the volumes are going to be or how people are going to react to necessary requests to increase leather prices. Traditionally, these decisions are made in September now and we still have to wait for the outcome of the big furniture fairs in the United States and Europe. So basically one could actually just lean back and not find anything strange about the present situation. But for quite a long time people in the industry at least have found it worthwhile to mention such a situation and to take a more sensible, rather than relaxed approach.

 

Relaxed approach to inventory situation

Another question raised by a number of people is that of inventories. Most people admit that a large number of warehouses are reasonably empty and sellers are still feeling pretty easy about the present situation. Some experts believe there is going to be a slowdown in shipments and according to some the heat has gone. The fact that nobody appears to be worried about the situation could also be a signal. Talking about the availability of raw material, there is already some accumulation in the US and we are also finding available hides in parts of Ireland and the UK due to export restrictions to Asia, particularly China.

As we have already said, we don't want to expand on this any further as we are still lacking more rational input. But at a time like this it might be wise to think a little further ahead, to at least debate the various options. In the last issue of the Market Intelligence report we focused more on the supply side and so it might be appropriate to examine the demand side this time.

            It is pretty unusual that we really cannot find a very clear position about the market development for the coming months. In the past we have sometimes been right and sometimes wrong, but we have always had quite a clear opinion about what we should expect. For the time being there is still a fair balance between the arguments for either side and we really fail to have a clear picture about the leather demand overall — quite a few question marks remain. One example is the future of the auto industry. While, at present only the big three in the USA are hit, a slow down could eventually also affect the rest of the market.

 

Garment leather could be in line for a boost

There is little to discuss in terms of the skin and the splits markets. Sheep and lamb skins are said to be receiving a little more interest but we don't think this is the start of a new era as yet. We also have to wait to see what tanners in Turkey and then later in Asia will receive from their customers. A bit more garment leather can be seen in magazines and on the catwalks, but it is still too early to tell whether this is an indication of what the consumer will be offered or what the consumer is going to buy.

For the next two weeks we think that market activity might slow down even further. Neither buyers nor sellers will be too ambitious to make fundamental decisions before the big meeting in Shanghai has taken place and a lot of members of the trade have spoken to each other and sorted out their impressions about the situation. This is again a situation where prices will hardly move either way. Lack of trading and the dominance of market tactics prevent any major movements. However, we would be very surprised if September does not provide us with the answers to the questions we are still pondering today.