Sunday, April 19, 2009

FX Briefing : US Economy: Velocity of Fall Diminishing


  • US manufacturing sector plunge seems to be slowing down
  • US residential construction is creeping sideways - at rock bottom
  • IMF warns of long recession and slow recovery

Over the last few weeks, the euro has weakened somewhat in relation to most major currencies. EUR-USD is currently around 1.31, a good 2 per cent lower than a fortnight ago. Similarly, EURJPY has fallen to about 130. USD-JPY has remained virtually unchanged at just under 100.

However, contrary to what one might have expected, given the experiences of the last few months, equity markets actually brightened up a bit. This was because earnings reports, particularly from the banking sector, turned out to be remarkably positive on the whole. Furthermore, numerous US politicians, from President Barack Obama and his advisor Lawrence Summers to Fed chairman Ben Bernanke tried to raise confidence. They all saw the first signs of stabilisation in the US.

We should not get our hopes up too high, however. About all that can be deduced from the data, is that the velocity of the fall could be diminishing. Industrial production fell to its lowest level in 10 years in March; the decline in the first quarter was 5.4% quarter-on-quarter - much steeper than in Q4. In the last quarter, the ISM index rose modestly, but its current level of 36.3 (the neutral level is 50) is still signalling an ongoing sharp contraction. The regional surveys of the Federal Reserve Banks of New York and Philadelphia, which were published this week, went up slightly more in April, but these indicators too are continuing to show contraction in the manufacturing sector.

After increasing the previous month, the number of housing starts and building permits dropped in March, almost reaching January's record low. With a bit of good will, this could be interpreted as “bottoming out”. But building activity is still at a catastrophically low level. At about 500,000, the number of housing starts was only a third of the average for the last 50 years; nominal (!) expenditure is currently at the same level as at the beginning of 1998. The situation is not likely to change much in the foreseeable future either. The massive supply overhang both for new and existing homes is making it less attractive to build new ones. And rising unemployment will probably also play a part in keeping the supply of houses up and demand down.

In the first quarter as a whole, private consumption seems to have remained relatively stable; it is possible that the increase in unemployment was initially balanced out by the purchasing power effect of lower energy prices. However, after having risen in the two previous months, retail sales fell again quite significantly by 1.1% in March. People are putting larger purchases of durable consumer goods on hold.

The International Monetary Fund published two chapters of the new World Economic Outlook in advance this week containing an interesting analysis on how long the global recession could last and what the upswing could look like. The IMF economists come to the conclusion that there is little possibility of a V-shaped recovery.

This is because, unlike in earlier recessions, no impetus can be expected from US domestic demand; in the recession at the beginning of the 1980s, for example, there was considerable pentup demand for property and durable consumer goods due to the high interest rate policy. When interest rates began to fall, people started spending, thus triggering a powerful spurt of growth. Things are quite different this time: consumers are deeply in debt (the monetary fund describes the situation as “overleveraged”), and their first priority will be to reduce their debts. They will therefore probably hold back on spending.

Another factor which is different from earlier recessions is the global dimension of the downswing. As a result, there is not much scope for countries to generate a recovery by means of exports. Therefore, the International Monetary Fund is expecting the recession to be long and the recovery to be sluggish.

We share the IMF's view. The job losses, credit defaults and insolvencies all pose significant economic risks in our opinion. The fact that the downswing has slowed down is currently being hailed as a positive sign, but it could drag on for several quarters and cause great damage. At present, capacity utilization is so low that “stabilising tendencies” are no longer enough to sustain companies and jobs.

In this environment, it is hard to make exchange rate predictions. In the short term, we are expecting the dollar to strengthen, primarily due to safe haven considerations and hopes of the more aggressive US economic policy succeeding (and vice versa, a critical assessment of the economic policy measures in the eurozone). In the longer term, however, we see a danger of the US discovering the dollar exchange rate as an additional policy instrument. A depreciation of the dollar could be justified from an economical point of view by the balance of payment situation, but it would exacerbate the problem, particularly in Europe.


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