EUR/USD breaks to a new record high of $1.3681 after U.S. first quarter gross domestic product (GDP) growth slowed to 1.3%, the lowest rate in four years, undershooting consensus forecasts of 1.8%. Although personal consumption expenditure slowed to 3.8% from fourth quarter’s 4.2%, it was well above the 2.8% low in third quarter 2006. The 2.0% pickup in business investment following a 3.1% decline in fourth quarter may help relieve worries on the slowing capital expenditure story, but the pace is well below the 10% registered in third quarter.
Although today’s GDP reading lacks the March trade figures, the extent of the growth slowdown highlights the contrasts between United States and Euro zone growth and monetary policy.
Our calls for a June Fed funds rate cut remain cemented by protracted slowdown in housing as well as the continued decline in sectoral employment payrolls as seen in the three-month moving averages in services, manufacturing, construction and retail. With U.S. manufacturing expected to remain in a recession and services based on a shaky consumer foundation, the slowdown story will start to drag on inflation. As history has proven over the past 15 years, economic shocks are the source of inflation declines, which will make the current stagflation tendencies a temporary phenomenon.
With the yield curve further normalizing after nearly two years, the Fed funds rate exceeding 10-year yields for over a year and the real funds rate (fed funds minus core CPI) at six-year highs, monetary policy tightness is more of reality than is commonly thought, despite the surge in private equity deals and M&As.
The Japanese yen continues to serve as an important floor to the dollar’s deteriorating foundation in trade weighted terms (basked against EUR, JPY, GBP, CAD, CHF and SEK), preventing the greenback from dipping below the 80 figure, a break of which would be the lowest since the 1991 recession.
The only short-term obstacle we see for the euro is an unexpected defeat by French presidential candidate Sarkozy, the right of center candidate and preferred choice of the markets. Euro zone officials may start to express words of concerns in the event that euro appreciation picks up the pace (1.3750 before end of next week) but the markets’ increased acceptance of the odds of a Fed easing by fourth quarter as well as central banks’ continued euro buying on the periodic dips will further cement the currency’s climb.
The final April reading of the University of Michigan sentiment survey is expected to be revised to 85 from the preliminary reading of 85.3, following 88.4 and 91.3 in March and February.
Fukui supports yen after weak CPI
The yen recovered in Friday Asian trade after Bank of Japan governor Fukui suggested interest rates could rise more than expected following earlier losses resulted by a 0.3% y/y decrease in core March inflation, weaker than expectations for a 0.2% decline. The 0.7% decrease in retail sales also helped USD/JPY push up to 119.73, but the pair dropped back to 119.35 after Fukui opened the door for more and rate hikes than was previously expected. With interest rates at 0.5%, we expect a 0.25% rate hike in August, followed by another tightening in fourth quarter.
We expect preliminary support to pullback to 119.10, followed by 118.90—38% retracement of the 117.6-119.74 rise. Key foundation stands at 118.67. The periodical dollar buying after the European close could lift the pair back to 119.30 and 119.70.
Sterling struggles relative to EUR
Our positive outlook for EUR/GBP reflects GBP/USD’s inability to follow the rise in EUR/USD, which is 30 pips from its all time highs, while cable remains below $2.00. U.S. GDP has the potential to drag the pair to 1.9950 and 1.9920.
Ashraf Laidi
Chief FX Analyst
CMC Markets US
140 Broadway, 30th Floor
New York, NY 10005
(212) 644-4220
a.laidi@cmcmarkets.com
