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A Falling Tide Lowers All Boats
Market Directions Sunday June 22, 2008
A Falling Tide Lowers all Boats
Wherever you look the financial forecasters are pointing down. The
economically decoupled world, where United States grows and slows alone
has vanished, replaced by a vision of Atlantic unity. The current crop
of long term economic projections all predict sub 2.0% GDP growth in
the European Monetary Union and the United States through the end of
2008. If every boat is sinking does it really matter which one you are
In the twelve months since May 2007, statistics in the United States
and Eurozone have traced similar paths. In the European Monetary Union
(EMU) the Purchasing Mangers Index (PMI) of manufacturing has fallen
9.0%; the service side has dropped 11.7%. In the US the Institute for
Supply Management Index (ISM) has slid 9.8%, with the service sector
off 10.2%. In the EMU consumer sentiment registered -15 this May, a
year prior it was -1. The American Conference Board Survey of Consumer
Sentiment recorded 57.2 in May; twelve months earlier it had been
Headline consumer inflation, including food and energy prices, has,
surprisingly enough, risen faster in the Eurozone than in the United
States. In May of 2007 CPI was 1.9% in the EMU; in the US it was 2.7%.
A year later EMU inflation was 3.6%; a jump of 1.7%, in the US the
increase was only 1.5% to 4.2%. Given the relative sensitivity of the
respective banks, 3.6% inflation is probably far more threatening to
the ECB than 4.2% is to the Fed.
Likewise, the difference in economic growth between the EMU and the
States has been minimal. Despite the central place of the sub prime
mortgage crisis in the popular view of the US economy, European and US
GDP growth were almost identical in 2007. US GDP expanded 2.48%, the
Eurozone 2.65%, a difference of just 0.17%.
The greatest divergence between the world's two largest economic areas
now lies in the projections for economic growth in 2008 and 2009. Let's
look at the projections of the central banks themselves first. The
ECBâ€™s latest estimate posits a range of 1.5% - 2.1% GDP expansion in
2008 and a considerably weaker 2009, with GDP growing only 1.0% -2.0%.
The Fed is less sanguine for 2008, expecting only 0.3% -1.2% in growth
but more positive about 2009, supposing a GDP increase of 2.0% -2.8%.
The Organization for Economic Cooperation and Development (OECD) and
the International Monetary Fund (IMF) have published roughly similar
forecasts for the EMU. However, both organizations are far more
pessimistic for the United States' prospects.
The IMF suggests the Eurozone will grow 1.4% in 2008 and 1.2% in 2009.
This mirrors the ECBâ€™s own expectations for substantially lower growth
in 2009 than this year. The OECD anticipates 1.7% in 2008 and 1.4% in
Keeping in mind the Fedâ€™s GDP projections for the next two years (2008
0.3% - 1.2%, 2009 2.0% - 2.8%) only the OECD estimate for 2008, 1.2%,
coincides with the American central bank. For 2009 the OECD predicts
just 1.1% growth, barely half the Fed prediction. The IMF is even less
hopeful, expecting only 0.5% growth in 2008 and 0.6% in 2009.
Traders have punished the dollar for the past year for two main
reasons. First and foremost, because the Fed has cut rates by 3.25%
while the ECB has been on hold. But running a close second has been the
concern and fear engendered by what the mortgage and credit crisis
would do to the US economy.
The Fed has ceased cutting rates and without a further serious collapse
in the US economy it will probably sit tight until the economy begins
to recover. The economy itself has not, so far, fallen into the
catastrophe that began to be predicted almost immediately upon the
advent of the credit crisis last summer.
The ECB on the other hand has made it very clear that the Eurozone
economy may have to fall into recession before it will relax its grip
Two major factors, one known and one unknown could affect the
US outlook for the remainder of the year. The known factor is money
supply. With the Fed priming the money pump, traders can reasonably
expect an economic response in increased growth sometime in later 2008
or early 2009. The unknown is the American consumer. Despite all of the
economic concerns, the housing market collapse, slowly rising
unemployment and historic gasoline prices consumer spending has, so
far, been another long predicted catastrophe that has not happened.
The ECB has all but promised to raise rates in July. But they have also
given their word that this will be the only time. Ben Bernanke has
threatened renewed attention to inflation and underlined the role of
weak dollar in exploding commodity prices but almost no one believe the
Fed can raise rates on the weak US economy. Even if the ECB raises
rates in July, a one time hike will not cause the euro to prosper. It
is rate cycles that push long term trends in currency markets and
neither central bank in a position to begin the opposite cycle: the Fed
cannot raise and the ECB cannot cut.
After the prospective July ECB hike, the two
central banks will be in an extended period of vigilant watchfulness.
The Fed has simply stated that rates are more or less where they need
to be. ECB spokesmen have gone out of their way to assure the market no
hikes are planned after July. If the ECB is not going to hike in the
face of rising inflation they are certainly not going to cut. And
conversely if the Fed is not going to cut in the face of economic
weakness they are certainly not going to hike. Neither bank is in the
position to do much of anything for the rest of the year except talk.
Likewise the competing economic zones of the US and the EMU
will probably provide little to choose between them for the next
several months. The US is currently growing much slower but it has a
substantial economic stimulus already working and owns a continent of
spend happy consumers. The Eurozone is laboring under restrictive
monetary policy and harbors a continent of worriers. The result is
going to be a US economy supported by a worried Fed and optimistic
consumers, while the EMU is dragged down by a stingy central bank and
Currency traders watching for the next trend in the euro and
the dollar will have to be patient. Range trading will continue to
frustrate both dollar shorts and dollar longs for several months yet.
Chief Market Analyst
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