Financial Forecasters All Pointing Down

Wherever you look, the financial forecasters are pointing down. The economically decoupled world, where United States grows and slows alone, has vanished, replaced by a vision of Atlantic unity. The current crop of long term economic projections all predict sub 2.0% GDP growth in the European Monetary Union and the United States through the end of 2008. If every boat is sinking, does it really matter which one you are riding?

In the twelve months since May 2007, statistics in the United States and Eurozone have traced similar paths. In the European Monetary Union [EMU] the Purchasing Mangers Index (PMI) of manufacturing has fallen 9.0%; the service side has dropped 11.7%. In the US, the Institute for Supply Management Index [ISM] has slid 9.8%, with the service sector off 10.2%. In the EMU consumer sentiment registered -15 this May; a year prior it was -1. The American Conference Board Survey of Consumer Sentiment recorded 57.2 in May; twelve months earlier it had been 108.5.

Headline consumer inflation, including food and energy prices, has, surprisingly enough, risen faster in the Eurozone than in the United States. In May of 2007, CPI was 1.9% in the EMU; in the US, it was 2.7%. A year later, EMU inflation was 3.6%; a jump of 1.7%, in the US, the increase was only 1.5% to 4.2%. Given the relative sensitivity of the respective banks, 3.6% inflation is probably far more threatening to the ECB than 4.2% is to the Fed.

Likewise, the difference in economic growth between the EMU and the States has been minimal. Despite the central place of the sub prime mortgage crisis in the popular view of the US economy, European and US GDP growth were almost identical in 2007. US GDP expanded 2.48%, the Eurozone 2.65%, a difference of just 0.17%.

The greatest divergence between the world's two largest economic areas now lies in the projections for economic growth in 2008 and 2009. Let's look at the projections of the central banks themselves first. The ECB’s latest estimate posits a range of 1.5% - 2.1% GDP expansion in  2008 and a considerably weaker 2009, with GDP growing only 1.0% -2.0%. The Fed is less sanguine for 2008, expecting only 0.3% -1.2% in growth but more positive about 2009, supposing a GDP increase of 2.0% -2.8%.

The Organization for Economic Cooperation and Development [OECD] and the International Monetary Fund [IMF] have published roughly similar forecasts for the EMU. However, both organizations are far more pessimistic for the United States' prospects.

The IMF suggests the Eurozone will grow 1.4% in 2008 and 1.2% in 2009. This mirrors the ECB’s own expectations for substantially lower growth in 2009 than this year. The OECD anticipates 1.7% in 2008 and 1.4% in 2009.

Keeping in mind the Fed’s GDP projections for the next two years (2008 0.3% - 1.2%, 2009 2.0% - 2.8%) only the OECD estimate for 2008, 1.2%, coincides with the American central bank. For 2009 the OECD predicts just 1.1% growth, barely half the Fed prediction. The IMF is even less hopeful, expecting only 0.5% growth in 2008 and 0.6% in 2009.

Traders have punished the dollar for the past year for two main reasons. First and foremost, because the Fed has cut rates by 3.25% while the ECB has been on hold. But running a close second has been the concern and fear engendered by what the mortgage and credit crisis would do to the US economy.

The Fed has ceased cutting rates and without a further serious collapse in the US economy it will probably sit tight until the economy begins to recover. The economy itself has not, so far, fallen into the catastrophe that began to be predicted almost immediately upon the advent of the credit crisis last summer.

The ECB on the other hand has made it very clear that the Eurozone economy may have to fall into recession before it will relax its grip on inflation.

Two major factors, one known and one unknown could affect the US outlook for the remainder of the year. The known factor is money supply. With the Fed priming the money pump, traders can reasonably expect an economic response in increased growth sometime in later 2008 or early 2009. The unknown is the American consumer. Despite all of the economic concerns, the housing market collapse, slowly rising unemployment and historic gasoline prices consumer spending has, so far, been another long predicted catastrophe that has not happened.

The ECB has all but promised to raise rates in July. But they have also given their word that this will be the only time. Ben Bernanke has threatened renewed attention to inflation and underlined the role of weak dollar in exploding commodity prices but almost no one believe the Fed can raise rates on the weak US economy. Even if the ECB raises rates in July, a one time hike will not cause the euro to prosper. It is rate cycles that push long term trends in currency markets and neither central bank in a position to begin the opposite cycle: the Fed cannot raise and the ECB cannot cut.

After the prospective July ECB hike, the two central banks will be in an extended period of vigilant watchfulness. The Fed has simply stated that rates are more or less where they need to be. ECB spokesmen have gone out of their way to assure the market no hikes are planned after July. If the ECB is not going to hike in the face of rising inflation they are certainly not going to cut. And conversely if the Fed is not going to cut in the face of economic weakness they are certainly not going to hike. Neither bank is in the position to do much of anything for the rest of the year except talk.

Likewise the competing economic zones of the US and the EMU will probably provide little to choose between them for the next several months. The US is currently growing much slower but it has a substantial economic stimulus already working and owns a continent of spend happy consumers. The Eurozone is laboring under restrictive monetary policy and harbors a continent of worriers. The result is going to be a US economy supported by a worried Fed and optimistic consumers, while the EMU is dragged down by a stingy central bank and pessimistic consumers.

Currency traders watching for the next trend in the euro and the dollar will have to be patient. Range trading will continue to frustrate both dollar shorts and dollar longs for several months yet.

Comments

[ezrasfund]

Everyone seems to forget to mention that gasoline and other energy products are a part of consumer spending. We're spending plenty, but it's not going to help most sectors of the economy.

[iThinkBig]

"Despite all of the economic concerns, the housing market collapse, slowly rising unemployment and historic gasoline prices consumer spending has, so far, been another long predicted catastrophe that has not happened."

GDP: 49% Small Business and Service Jobs (shrank in 2007). 21% Government (growth in 2007) 31% Megacorporations (growth in 2007).

Analaysis: Moving paper around amoungst Megacorporations or Megacorporations and big money guys offshoring does not help the 49%. The disconnect is in goverment and big business whom have not tasted the full pain as the 49% have in the last several months.

Small businesses are on there own and have been for several months. No banking help, no investment and no government help. No ATM's for there home, tightening credit. Instead, predators exist in utilities and government abound. If your part of 51%, you have personell to deal with legislative and utility problems, tax accountants, lawyers. The little guy has none of this and it drains additional productivity needed for small business to come up with creative solutions, adding to the direct financial pain and further crushing the 49%.

Now we begin to see the effects of all areas of the GDP begin to be dragged down because of inflation and credit crisis but the 49% is what is really going to drag it down.

The worst is just beginning but American's are innovators. What needs to change is our politics back to common sense. It will change because of pain.

Human nature in all nations on earth are cyclical. The U.S. has a 20 year cyclical pattern of greed by banking (Republicans) brought on by utopian-foolish legislation enactment or safeguards (Democrats) that mount up to hurt the little guy. The little guy steps up into leadership roles and has become seasoned to create or retract foolish legislation and how to run economies business or government.

Some cycles are more severe. Then there's a 100 year supercycle of this. Last one was 1908 deep recession and the net result was WWI. Next cycle was 1928, deep depression and WWII. 2008, market crash deep depression and WWIII?

Let's hope not but a lot of this is based on whether Washington supports existing and new asset classes that focuses on large scale job creation such as alternative energy or subsidies into higher ed to retrain the population for skilled jobs, does not raise taxes etc. I am negative right now because the current political climate has momentum and this takes a few years to stamp out. We're at the beginning of the 20 year new period and historically see big pain years 1-5, some common sense and 'floors' years 6-13 (probably best time to invest) and then booms years 7-20. The Mayans were as advanced mathmaticians were the first culture to document such trends as there culture was old enough to apply the trends in 20 years and then they had 500 year supercycles. That is why Mayan 'prophecies' (statistical probability) was so accurate. In fact, biblical prophecy works the exact same way, with the prophet Daniel (w/inside information from above) knew the reformation in Israel would occur and recognized by the nations in 1948. Daniel was six months off in his calculations, almost 4,000 years in advance.

[iThinkBig]

'We're at the beginning of the 20 year new period and historically see big pain years 1-5, some common sense and 'floors' years 6-13 (probably best time to invest) and then booms years 7-20.'

Typo, meant booms years 14-20.

[semar]

well, it all comes down to business cycle and inflation expectations in currency valuation. Don't how how much the ECB can move, but from my point of view the Fed has pretty tied hands with 0.2% in GDP