It has taken a year for the U.S. economy to stop falling. In June and July the Institute for Supply Management (ISM) Manufacturing Index registered its first two months at or above 50 since January. This was the first reversal of the declining trend which had held since June of last year. The ISM Services Index, which never dropped as far as manufacturing, fell below 50 for the first time this year in June and will likely recover in July. The Chicago Purchasing Managers Index which has been below 50 since February, and falling for over a year, poked back above 50 in July. Non Farm Payrolls, the focus of so much consternation, has been steady at -50,000 for three months now. And the two statistics which have fallen the farthest, the University of Michigan Consumer Sentiment Index and the Conference Board Consumer Confidence Survey both moved higher in July, albeit by very small amounts. Lastly, GDP has recovered to a stimulus enhanced +1.9% in the second quarter after a negative fourth quarter last year and anemic first quarter this year.
One should be careful not to ascribe the attributes of a recovery to the merest indication of stabilization, to paraphrase a British statesman. But this mere indication has been enough to improve the dollar almost three percent against the euro.
There is in fact no recovery in sight for the U.S. economy. There is only a great deal of speculation about the pending effect of the Fed rate cuts on the consumer economy and the effect of liquidity measures to fortify the banking system. The housing market has not stopped falling. The declines in existing home sales have diminished, settling near -2% per month since January. The number of months supply of unsold new homes on the market also decreased for the first time since April of last year.
The U.S. economy is mired in an unusual economic cycle. Americans are restrained by the housing losses and debilitating oil prices are crimping consumer spending, the single biggest contributor to GDP growth. But exports are booming due to a weak dollar and benefit from still strong (comparatively) growth in other parts of the world. But the export sector is vulnerable to any overseas economic slowdown.
Have the Fed rate cuts simply prevented the bottom from falling out of the U.S. economy or has the positive effect of Fed boosterism been delayed because of the housing and financial problems and the economic drag from the price of oil?
European statistics have turned drastically down in the past few months. European Monetary Union (EMU) Economic Sentiment figures for business and consumers are at multi-year lows. The Purchasing Managers Index for Manufacturing and for Services have both been below 50 for two months now. Retail Sales, Industrial Production and New Orders are weak. The ECB continues to hold the rate sword aloft threatening further hikes.
For the dollar and the euro what happens next in the EMU is, for the moment, more pertinent than events in the U.S, provided, that is, that the U.S. remains stable. Except for inflation, consumer sentiment and GDP, major U.S. statistics have not changed appreciably for six months. If the U.S. remains quiescent then the decision on the immediate fate of the dollar will depend on how far EMU growth falters. If second quarter EMU GDP is negative, the dollar will strengthen.
If the U.S. is only delayed in recovery due to the housing crisis and energy prices then it is ahead of the EMU in the business cycle and will recover first. The housing fall will not last forever. There is however the danger of another oil price spike. There is no assurance that crude oil has seen its high. A further nuclear development in Iran or an Israeli threat could send the price of oil skyrocketing again. The decline in prices that began with President Bush's call for U.S. oil drilling was largely predicated on the idea that Congress would be forced to lift its own ban on U.S. energy production. If that does not come to pass, or is much delayed, the benefit in lower oil prices from the promise of greater supply will wear off and prices will begin to rise again.
Rising oil prices are the greatest threat to the American economy. Consumers are stretched, jobs are fragile and if oil returns to $140 and higher it is hard to see how the U.S. can retain positive economic growth.
Will the EMU slow enough for currency traders to force a break through the bottom of the range, at 1.5350, that has held firm since March? Will the U.S. Congress permit American energy development and a U.S. economic recovery or will they drive the economy into recession? The answer to the first question is only partially amenable to human intervention; the second is at the mercy of human foolishness.
