Mauricio Carrillo - Leaving behind us the first quarter of 2012, market is facing now the next tranche of this year with kind of less confidence than pass weeks, Why? Despite the last months improvement in the fundamental figures across the US, many experts were alerting that the recovery pace wasn't enough to sustain the overall US economy. Why this lack of confidence taking that the US economy health is in a better condition than the last years?
Ilian Yotov, FX Strategist and Founder for AllThingsForex writes in exclusive for FXstreet.com the second issue of the "The US Observers" series. He title his piece as The U.S. Economic Recovery: Illusion or Reality? … And what does it mean for the U.S. Dollar? Hope you will enjoy as much as I did it.
The U.S. Economic Recovery: Illusion or Reality? …And what does it mean for the U.S. Dollar?
By Ilian Yotov, FX Strategist and Founder for AllThingsForex
(Allthingsforex.com) – With Q2 2012 on the horizon as the first quarter of the year winds down, currency traders continue to ponder the strength of the U.S. economic recovery, the trend of improvement in the U.S. labor market, the next move by the Fed and, ultimately, what all of this would mean for the future fate of the U.S. dollar.
At the start of the fourth quarter of 2011, in one of our weekly outlook articles, we wrote: “in the final three months of last year, the markets will begin a quest to find out if the U.S. economic picture is really as gloomy as the FOMC statement painted it to be.” The reason we felt that it would be important to take on such a quest was because the Fed’s outlook for Q4 2011 was not very optimistic, the EU debt crisis was far from over, and in the market’s eyes QE3 was only a matter of time.
Naturally, equities traders would have loved to see another round of quantitative easing to keep the stock market rally going, but currency traders knew that this would have been done at the expense of the greenback. And so, day after day, week after week, we diligently monitored the outcome of the main indicators on the state of the world’s largest economy with one objective in mind- to determine if the U.S. economic data would raise or reduce QE3 odds.
So far in Q4 2011 and Q1 2012, it turned out that the latter has been the case. Even the Fed Chairman Bernanke has recently acknowledged the signs of improvement, telling Congress that, "while keeping monetary stimulus is warranted… the drop in the unemployment rate has been more rapid than expected”. But don’t take his or our words for granted. The numbers speak for themselves…
GDP
The U.S. economy has managed to avoid a double dip and has registered stronger growth than each previous quarter for three consecutive quarters in 2011 (Q2, Q3 and Q4).
Jobless Claims
In Q4 2011, the U.S. weekly jobless claims finally broke below 375K, a number which economists estimated could serve as a leading indicator of future improvement in the U.S.job market and further decline in the unemployment rate. By March2012, the U.S. jobless claims have reached a 4-year low.
Employment Situation
The U.S. Employment Situation figures mirrored the trend of improvement in the weekly jobless claims with the U.S. economy adding over 200K jobs per month for three consecutive months (December, 2011, January and February, 2012) and with the unemployment rate declining from 9.0% in September, 2011 to8.3% in January and February, 2012.
Industrial Production
The U.S. manufacturing output has recovered after the drop in mid-2011and has been gaining pace for three consecutive months in December, 2011, January and February,2012.
ISM Manufacturing and Non-Manufacturing Indexes
Activity in the manufacturing and services sectors of the U.S. economy continue to show resilience,with both the ISM Manufacturing and Non-Manufacturing Indexes sustaining above 50 in expansion territory for over two years since December, 2009.
When examining the data listed above,it is hard to make the case for more doom and gloom. There are promising signs that the U.S. economy has gained traction and could continue to improve. But if there is anything that we have learned from the process of recovery from the Great Recession it would be to not get too overly optimistic, as things could take a turn for the worse at any time.
From a global perspective, there are a number of factors that could have a negative impact on worldwide growth and on the U.S. economy. China, the second largest economy in the world, is slowing and its “soft landing” could turn out to be less cushy than anticipated. The EU leaders are still yet to convince investors that the worst of the debt crisis is behind and that they are capable of building a strong firewall to prevent contagion into the larger economies of the monetary union. The recent disappointing manufacturing and services PMI reports from Germany and the Euro-zone have put into question the expectations of a Euro-zone rebound in the first quarter of 2012.
Domestically, there are also weak spots in the U.S. economy with inflationary pressures picking up, the trade deficit widening and the housing market still lagging behind the improvement in other sectors.
Looking ahead at Q2 and the rest of2012, the future fate of the greenback will continue to be dependent on the Fed’s next move and, in particular, on QE3 expectations. The strengthening U.S. economy has and will continue to reduce the odds of the Fed “doing more” (which are the new code words for additional quantitative easing).
In the last couple of quarters, we’ve seen the inverse relationship between the U.S. dollar and risk beginning to fade away as evidence of a stable U.S. recovery mounts.Since the collapse of Lehman Brothers in 2008, stock market weakness and risk aversion have lead to U.S. dollar strengthening approximately 80% of the time. On the other hand, risk appetite and the rally in equities in most instances have resulted in U.S. dollar weakness. The percentage of this inverse relationship between risk and the greenback has fallen to about 40% in the first quarter of2012.
This, of course, does not mean that the only way would be up for the U.S. dollar going forward. At least not until QE3 is completely out of the picture. The Fed has been and will continue to stand ready to deploy it if economic conditions begin to deteriorate in the months and quarters to come. There may be a reason why the U.S. central bank has not yet ruled out completely the option of doing more quantitative easing. As witnessed throughout the last 4years, things could get ugly fast. Q1 2012 GDP forecasts already point to a slower growth of 2.3% in the first quarter compared with3.0% q/a in the fourth quarter of 2011. The current quarter U.S. GDP model by Moody’s predicts an even smaller number with the U.S.economy forecast to grow by 1.8% q/a in the first quarter of 2012.Rising oil prices and tax cuts set to expire by the end of the year could also become a significant drag on the U.S. economy.
Despite of the dangers ahead,economists estimate that the current pace of growth would be sufficient enough to continue to lower the unemployment rate. Should such expectations become more than just wishful thinking in the upcoming quarters, the Fed could consider steering away from QE3 and could begin to change the course of its monetary policy, directing it towards tightening before the promised deadline of “late 2014”. If this is what the market believes and begins to price in, the U.S.dollar’s future might just get brighter.
