A weaker outturn for U.S. first quarter gross domestic product of -6.1% compared to a contraction of -6.3% during the final quarter of 2008 didn't appear to detract from the script today. While it may have helped weaken the dollar across the board inside the report was perhaps a further sign that the heftiest elements of government, corporate and consumer spending shrift were now spent. As appears to be the growing trend, Eurozone business and consumer confidence also picked up from a low level and compounded equity market sentiment that a recovery is within sight.
One has to look back 51 years to find a worse six-month economic performance in the U.S. than that of the recent two quarters and while signs are that the current second quarter will create the longest recession in history, investors are reacting to the fact that businesses slashed inventories. Ultimately that ensures a shorter delivery time between final demand and manufacturing production as businesses will need to physically produce to fulfill new orders. That's a good place to be, but it took a long time coming.
We have been of the opinion that the dollar would remain strong based upon the enormous efforts made by the U.S. authorities to ring fence and rejuvenate the financial sector. That leaves the euro currency as a laggard and we noted that it might emerge only slowly from a more serious slump across the region and its key export markets. However, investors are beginning to ask whether the ECB might get away without easing quantitatively. By not cranking the printing presses, arguably there is less chance of inflation further down the road. Investors seem to favor the euro, which is higher today at $1.3257.
However, it's premature to write off the dollar at this stage. The recovery story is in its earliest form, which means that events are thawing rather than continuing to freeze solid. The so-called ‘green shoots' remain elusive and it's important not to consign the recession to the trash can just yet. If growth returns slowly, we think that the hard and fast reality of the appeal of the dollar will be more evident than the appeal of the euro. A large quantitative ease, which is what's on the Fed's schedule will produce an element of growth over a protracted period of time. Failure by the ECB to adopt a similar measure in the hope of a natural-born replacement will deliver continued contraction, which would be very difficult to address at a later phase.
Today the Japanese yen is fading in response to a calmer understanding of swine flu and its potential impact on the economy. To rely on swine flu to drive down the market is a weak argument by historic standards, but investors need to be acutely aware of casualty data. The yen slipped against the dollar to ¥96.94 while losing to the euro to ¥128.42. As risk appetite recovers we find more willing buyers of the recovery currencies. Crude oil is back above $50 per barrel today, which has helped the Canadian dollar rally to 83 U.S. cents while the Aussie dollar today buys 71.90 U.S. cents.
The FOMC statement at 2:15pm ET today will likely discuss the recent signs of economic stability. There will be no change to monetary policy since there is zero room left to do so, while on the quant-front, watch out for signs that the Fed might hold off buying mortgage and government paper. The recent improvements in credit markets are the result of those better signs accompanied by the Fed's bully-boy tactics to depress yields and create sufficient incentive to lend. It might be premature to hold off at this stage, but the yield on the 10-year government note benchmark has backed up lately to a near-six month high. It would probably benefit the Fed to stick to the tune and keep on buying paper at least between now and the next meeting.