We continue to believe that the dollar is seriously undervalued and, now that the global economy is less divergent than in 1H08, it will be more difficult for it to weaken further, even if the US economy slows further in the coming quarters. In fact, in the quarters ahead, there will be as many opportunities for many other economies to underwhelm as there will be for the US to disappoint, in our view. We continue to expect to see a tentative and asynchronous recovery in the dollar, more by default than on merit. (This is exactly the reverse of what happened to the EUR in 2004-06, that it rallied hard, despite the fact that Euroland economy was rather lacklustre.) Our US economics team is looking for the US to enter a technical recession in 4Q08 and 1Q09, but expects the FFR to stay at 2.00%. We don’t dispute this outlook. Detailed 2Q GDP data released earlier today suggest that much of the upside surprise to US growth in 2Q was due to trade. When the rest of the world slows later this year, the US is likely to lose this source of support. In a way, in 1H, the US has been coupled to the RoW, not the other way around.
Stephen Roach, Head Economist, Morgan Stanley
Weekly Bank Research Center 08-04-08
The Dollar to Rally by Default, Not by Merit
Stephen Roach, Head Economist, Morgan Stanley
We continue to believe that the dollar is seriously undervalued and, now that the global economy is less divergent than in 1H08, it will be more difficult for it to weaken further, even if the US economy slows further in the coming quarters. In fact, in the quarters ahead, there will be as many opportunities for many other economies to underwhelm as there will be for the US to disappoint, in our view. We continue to expect to see a tentative and asynchronous recovery in the dollar, more by default than on merit. (This is exactly the reverse of what happened to the EUR in 2004-06, that it rallied hard, despite the fact that Euroland economy was rather lacklustre.) Our US economics team is looking for the US to enter a technical recession in 4Q08 and 1Q09, but expects the FFR to stay at 2.00%. We don’t dispute this outlook. Detailed 2Q GDP data released earlier today suggest that much of the upside surprise to US growth in 2Q was due to trade. When the rest of the world slows later this year, the US is likely to lose this source of support. In a way, in 1H, the US has been coupled to the RoW, not the other way around.
ECB Will Wait and See
Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank
Data released since the previous publication of Weekly Focus generally indicate that Europe is heading for a slowdown - a slowdown that could become a recession if business confidence continues to slide. Annualised inflation, meanwhile, does not appear set to ease anytime soon, as the recent fall in the price of oil will take some time to feed through. June saw consumer prices rise by 4% y/y, and the first estimates of the July number indicate an increase to 4.1 % y/y. We expect that inflation will hit a peak of 4.2% y/y in the course of Q3. The main event of the coming week will undoubtedly be Thursday.s rate decision from the ECB. Like the market, we expect that the ECB will keep interest rates unchanged at 4.25%, after hiking by 25bp at its July meeting on fears of second-round effects on inflation. The ECB now expects that inflation will not moderate towards the central bank's target rate of 2% until 2009.
More Tough Talk From The Fed
E. Silvia, Ph.D. Chief Economist, Wachovia
The Fed is expected to make no change to the federal funds target rate at Tuesday’s FOMC meeting. Several Federal Reserve Bank presidents continue to make noise about the need to head off rising inflation expectations. We continue to believe this talk will not result in any action, beyond a few descent votes at the regular meetings. The actual inflation data is not bad enough to warrant any additional action and we continue to believe we are closer to another rate cut rather than a rate increase. The financial markets apparently take another view. Fed funds futures continue to price in a quarter point hike in the federal funds rate over the next three meetings. In order for such a move to happen we would need to see much stronger economic growth than we currently anticipate or much worse news on core inflation.
Three Out of Four Ain't Good
Steve Chan, Economist, TD Bank Financial Group
As if we needed any further evidence that the slowdown in the United States is continuing to weigh on economic growth in Canada, May’s GDP by industry reading went ahead and provided it anyway. Economic activity contracted by 0.1% (-1.3% annualized) in the month, led by a fall in oil and gas extraction. While manufacturing production eked out a small gain in the month it remains the biggest laggard on a trend basis - down 5.5% from a year ago. The services side of the equation has so far been keeping growth in positive territory but it too was flat in the month and is showing clear signs of decelerating. All told, the Canadian economy is well into excess supply territory and looks to be walking a fine line between expansion and contraction. We continue to expect a modest positive number on GDP growth for the second quarter, which will avoid the recession title. But recession or not, annual growth is expected to come in around 1% for 2008, the slowest pace since 1992 - and hardly something to crow about.
Fed, ECB and BoE to Hold Interest Rates on Growth Fears
Trevor Williams, Chief Economist at Lloyds TSB Financial Markets
The US Fed, the ECB and the Bank of England are widely expected to keep interest rates on hold at 2%, 4.25% and 5%, respectively, this week. This is due to continuing signs of slow GDP growth, but rising inflation, in turn, is inhibiting cuts. Chart a below shows that real interest rates are already negative/low, therefore, likely to lead to stronger economic performance, as reflected in the pick up, albeit modest, in US GDP growth in Q1 and Q2 from contraction in Q4 2007. Key data this week are likely to show the US Fed's preferred measure of inflation, the core PCE deflator, rose at a monthly rate of 0.2% in June, up from 0.1% in May, reinforcing the view that the Fed holds a tightening bias and that their next interest rate move is likely to be upwards. However, US ISM and UK & EU-15 PMI services sector surveys may add to the gloom settling from last week's manufacturing survey releases. These service activity reports are again likely to be indicative of contraction, see chart b for past trends; suggesting that economic growth in the major economies is weak. The RBA is likely to hold interest rates at 7.25% this week.
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