What did not happen this week was more interesting than what did. Jobless Claims did not deteriorate, the Dow did, oil boomed, the United States housing market swooned and for all the negative news the dollar gave ground only grudgingly against the euro. The dollar did not collapse. It ended Friday three figures higher than where it began the week, but despite the provocation currency traders seem no more inclined to buy the euro beyond 1.6000 than they were three weeks ago. The US economy is in no worse shape than it was last month and the newest threat to an American recovery, the price of oil, is an equal opportunity danger.
Crude oil at $131.00 and rising will hurt the EMU economies as much or more than the US. American GDP for the first quarter will likely be revised higher to 1% or more this coming week. That is not a great deal lower than recent projections for the EMU. If the US is still growing at one percent and higher with the prolonged housing decline shaving percentage points from economic growth, and after the liquidity crisis and its attendant problems and the Europeans are at that growth level without having suffered any appreciable economic trauma what does that say about the next several months as the oil prices begins to bite hard into growth potential? Will EMU growth hold up under the flail of vastly higher energy prices and without any of the stimulus applied by the Federal Reserve? It is not likely. At least it is a bet currency traders seem reluctant to make.
The US economy, a far more flexible and integrated entity than the EMU fell from 4.9% GDP growth in the third quarter of 2007 to 0.6% growth in the fourth. Is the EMU, with a far less active consumer sector, not capable of such a dramatic fall?
The bad news absorbed by the usd over the past two months is considerable: job losses for four months running, generational lows in consumer sentiment, a sub 50 manufacturing ISM, weak retail sales, and stocks and housing as mentioned above. One might ask what else the market needs to see before it takes the euro higher. Or to ask the question another way, is there any statistic that will convince traders that, for one-- the Europeans will not shortly have a slowing economy of their own to contend with and two—the ECB will not soon begin lowering EMU rate?
Yes, spokesman for the ECB have been adamant and on message -- inflation is our concern, inflation is the target, price stability is paramount, we will fulfill our mandate. But to judge from the trading levels of the euro there is deep skepticism in the currency markets for that program.
The market expectation for an eventual ECB rate decrease is not just a wish. Traders and analysts are not simply talking their book knowing that lower rates are good for business or helpful to bank profits. The market 'expectation’ for a lower ECB refinancing rate is an expression of its collective judgment on European monetary policy and on how the ECB will respond to a future economic situation that is deemed to be distinctly possible.
If the market’s judgment differs from that of the ECB and its public policy pronouncements, that does not negate its validity. The ECB has several reasons, not all of them economic, for retaining its public anti-inflation mandate. Remember that the US markets had priced in rate cuts long before they occurred and remember too the Fed statements in the weeks between the onset of the financial and sub prime crisis in August and its first rate cut in mid September. Or recall Chairman Bernanke’s very deliberate rhetoric for much of the subsequent time. It is only recently that the Fed has publicly subordinated inflation to growth. Even so, the Fed has been accused of caving to market desires. The ECB has even more policy strictures because of its inflation mandate so it also has a grater need to preserve its independence and credibility.
Currency traders continue to place more emphasis on what is happening in the States than across the Atlantic. A great deal more has happened in the US and a great deal more is expected happen here. As we have noted before, expectations are fine and good, and can drive the markets a long way, but until the US economy delivers on the Fed promise, no trader will stake long term profit on the dollar. The limit of expectation has a very concrete aspect for traders; it is 1.5250.