Dollar rally picks up speed, supported by US economic performance
20/May/2013 • Currency Updates•
The US dollar continued to rally last week, spurred on by the increased divergence in the macroeconomic backdrops of the US and those of most of the rest of the world, particularly Europe. Worries about another US spring slowdown have eased, even as Chinese growth decelerates to the weakest in a decade and Europe fails to emerge from its double-dip perma-cession. Dollar strength has now become decoupled from the wider risk themes; last week, in fact, saw equities rise to new cycle highs, precious metals dived by 5%, and Government yields generally backed up, particularly in the US. Fed officials continue to hint that the pace of quantitative easing may be reduced in the coming months, adding further support to our view that the Fed will lead other Central Banks in scaling back emergency monetary easing.
The Bank of England Inflation Report for May was published on Wednesday. In line with most expectations, growth expectations were revised slightly upwards, on the back of the first-quarter better-than-expected outcome. However, the inflation profile was revised significantly downwards from February. This is the last Report to be published under the leadership of Mervyn King. Carney takes over as Governor, and our call for further expansion of the Gilt target in the August meeting is predicated on our expectations of a more aggressive leadership style from the incoming Governor, as well as the negative impact of Europe’s continued recession on UK output. Sterling continued to track along our forecast path, squeaking higher against the euro but dropping notably against the US dollar.
The string of negative economic surprises out of the eurozone shows no sign of abating. Last week it was first-quarter GDP growth. Consensus had pencilled in a contraction of 0.5% quarter-on-quarter, seasonally adjusted and annualized; the actual headline was a 0.9% contraction. The country-level detail also made for depressing reading. The German economy grew just 0.3%; a very disappointing bounce back from the previous quarter drop of -2.7%.. France has now re-entered recession, having posted two consecutive quarters of contraction. Italy contracted by -2.7%, and its economy is now smaller than it was at the bottom of the 2009 crisis. These numbers illustrate exactly what we refer to as Europe’s “perma-cession”. The eurozone has now reported an astounding 6 consecutive quarters of economic contraction; the longest in its history.
In addition to GDP, a combination of Easter calendar effects and the fall in commodity prices led to a sharp downward surprise in eurozone headline inflation. The continual downward surprises in both economic growth and inflation should put additional pressure on the ECB, and we now expect some major announcements in regard to easing credit access for SME and/or negative rates at the June meeting. Investors increasingly agree with our views, and the common currency extended its drop against most world major currencies except the yen.
A strong nominal retail sales number for April, combined with a lower-than-expected inflation reading, makes us more comfortable with our call of 2.5-3.5% overall growth for 2013 in the US, and 2.5% for second-quarter growth. US demand is clearly holding up well, and has so far shrugged off the effect both of the January tax hikes and the sequester budget cuts. For some months now, we have been pointing to the mild virtuous cycle between employment, consumption and private investment; economic numbers out of the US so far fully support our prediction. The sharp contrast to the mess across the Atlantic, as well as the slowdown in Chinese growth and commodity prices, make us more comfortable with our call for a sustained medium-term dollar rally.