NEWS / Foreign Exchange

Slowing US Growth Fait Accompli for Euro Record Highs

EURUSD breaks to a new record high of $1.3681 after US Q1 GDP growth slowed to 1.3%, the lowest rate in 4 years, undershooting consensus forecasts of 1.8%.

Although personal consumption expenditure slowed to 3.8% from Q4??™s 4.2%, it was well above the 2.8% low in Q3 2006. The 2.0% pickup in business investment following a 3.1% decline in Q4 may help relieve worries on the slowing capex story, but the pace is well below the 10% registered in Q3. Although today??™s GDP reading lacks the March trade figures, the extent of the growth slowdown highlights the contrasts between US and Eurozone growth and monetary policy.

Our calls for a June Fed cut remain cemented by protracted slowdown in housing as well as the continued decline in sectoral employment payrolls as seen in the 3-month moving averages in services, manufacturing, construction and retail. With US 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 2 years, the Fed funds rate exceeding 10-year yields for over a year and the real funds rate (fed funds minus core CPI) at 6-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. Eurozone 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 Q4 as well as central banks??™ continued euro buying on the periodic dips will further cement the currency??™s climb.

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