Confirmation was at hand this week for the ailing United States economy. Though the official notification for the beginning of a recession, if there is one, is still seven weeks away with the release of the advanced GDP report for the 1st quarter on April 30th, one of the last positive American statistics has crumbled to recessionary levels.
Non Farm Payrolls registered its worst result since mid 1993 as the economy shed 63,000 jobs in February far more than anticipated. In fact the details of the report were worse than the headline. Private payrolls, the jobs created in the private sector of the economy fell for the third month in a row, contracting by 101,000. Government jobs had added 38,000 to payrolls. The job rolls for January and December were also smaller than initially thought, losing 46,000 after revisions. Even the unemployment rate which fell by 0.1% to 4.8% was the result of a decrease in the labor market participation rate. That is, fewer people were looking for work, entering the â€˜discouraged workerâ€™ category of the survey. The euro set another record high against the dollar at 1.5465 immediately after the release then consolidated a figure lower in the afternoon.
It has been a storm of anti dollar news and developments for the past several weeks. Statistics in the US are either skirting recessionary levels or have tipped into contraction. The Institute for Supply Management Indices, manufacturing and service are below 50. Consumer sentiment surveys are at levels not seen since the beginning of the Iraq war in 2003. Retail sales are slipping and the housing market remains moribund. Job expansion had been the last reason for confidence that the US might avoid a serious slowdown. With GDP barely positive in the fourth quarter, kept afloat by exportsâ€”and the lower dollar, the remaining weeks of the 1st quarter are likely to bring further bad news.
When the news is unremittingly negative is just the time to begin looking for a market reversal. There should be a reasonable expectation that the US economy will respond to the 225 basis points worth of Fed rate reductions already in place. In normal markets this anticipation would already be tempering the dollarâ€™s fall. After all the real question for equity and currency traders is where will the economy be in the fall, six months from now? There is however, one complicating factor that may diminish and retard the full effect of the decrease in the Fed Funds target rate-- the credit crisis.
Eight months after its first explosion the combined banking, financial and credit crisis in the United States is still with us. With major financial institutions seemingly unable to clear their books or avoid continuing write downs and with the credit markets operating at much diminished levels for fear of what the future may hold, even excellent credit risk is not being funded by the banks. The Fed announcement that it will add $20 billion in available liquidity to future TAF auctions only underlined the unsolved nature of the banking and credit problems. Credit is the lifeblood of a modern economy. It will be difficult for equity and currency traders to assume the natural forward risk of betting on a turn in dollar when to do so they must also undertake the additional and unknown risk of a credit market meltdown.
The US housing market has been in slow motion decline for more than two years. Until very recently it has had little effect on consumer spending and only marginal impact on consumer sentiment. In fact I would argue it is the contraction in the financial markets and lending since last August that has had a far greater effect on business and job growth in the US than the collapse in housing. Nevertheless, with housing in extreme disarray and job losses now beginning, consumers are not likely to recover their animal spirits sufficiently to push the economy to recovery until the housing decline begins to reverse.
Worldwide commodity price inflation which has been fueled largely by demand forces shows no sign of abating. With the Fed taking a solely economic growth focus in the United States and a quasi-mercantilist position internationally, inflation in the States will get short shrift. It will also get worse. With headline CPI, which is after all what consumers must pay, having more than doubled since last July, consumers are worried about expenditures and not in the mood to increase spending.
Inflation is a known commodity in the financial and currency markets. Eventually, or sooner the central bank begins raising rates, when it becomes apparent that a tightening cycle is starting the currency rises. Recessions also have a known trajectory. Economies respond to lower interest rates and six months to a year after the reductions have begun GDP growth renews itself and the currency rises. The Fed has already supplied a substantial amount of stimulus to the US economy, and the US economy is six months into this rate reduction cycle. GDP growth and inflation will follow.
The US credit crisis has introduced a new and unknown factor into currency market calculations. Traders cannot be certain that the usual course of rate reduction by the central bank will prompt the usual delayed growth from the economy. At least they cannot be sure enough to stake speculative positions on the result. In this situation anticipation based on historical models, on the idea that the economy always recovers when the Fed applies stimulus, is not sufficient. Nor is the progression of rising inflation chased by higher central bank interest rates secure. The Fed is severely constrained by the health and liquidity of the banking system. Inflation is rising fast but Fed spokesman barely seem to have noticed. Rising inflation or a return to prospective economic growth should signal a recovery for the dollar. But until the credit problems in the United States subside any recovery for the dollar will be problematical at best.