There’s a long list of negatives for the US dollar. Interest rate differentials are moving firmly against the US which is facing a credit crunch and a likely recession. Then there’s the debt ceiling issue looming.
By the time this article is live, the European Central Bank and Federal Reserve may already have had their meetings. I expect a further rise in US official rates, of 25 bps, but believe US interest rates are nearing their peak. Indeed, the market is pricing in cuts later this year.
By contrast, the European Central Bank is likely to push their rates up by 50 bps and deliver further hikes over the balance of the year. The result would be a positive spread in favour of the euro versus the dollar for the first time in some time.
US headline inflation is well below last year’s peak and although the core rate has been sticky, there is a reasonable hope that it will start heading down soon. Rents – the biggest component – are clearly slowing and indeed rents for new tenancies are already in negative territory. A sustained fall in core inflation requires a recession and that looks increasingly likely.
The credit squeeze looks like it might turn into a credit crunch. The demise of First Republic Bank will have sent shivers down the spines of many other US banks that are already nervous following the collapse of SVB. The Survey of Senior Loan Officers is due on 8 May and is likely to show a further severe tightening, especially to small firms. Senior Loan Officers had already tightened significantly according to January’s survey, which was well before the banking crisis erupted. Optimists point out that the US corporate bond market is functioning well and that the mega banks, untouched by the crisis, do much of the lending. That may be true, but they are unlikely to take up all the slack and will instead seek to widen spreads. The next shoe to drop is a rise in unemployment. This would feed directly into stress tests that all banks must now undertake.
The US labour market is incredibly tight but is easing, with both continuing and initial claims for unemployment on a clear rising trend. We will get a much lower and possibly negative payroll number out of the US in the next few months, possibly as soon as this week. US corporates are suffering a squeeze on margins and the current reporting season is seeing companies beating analysts’ estimates – but only because forecasts had been slashed. Earnings growth is negative on a year ago and companies are already cutting back on capital expenditure and hiring. Firing is set to increase beyond the highly publicised plans already announced by some major companies.
US consumers drove the US economy last year despite a squeeze on real incomes, drawing down on savings accumulated during Covid – the so called “Covid piggy bank”. They are now running out of steam. Their European cousins, by contrast, were so frightened by sky-high energy prices that they saved more. Wage inflation is also rising in Europe and strong demand will keep the labour market tight.
I won’t say much about the debt ceiling except that it is hardly a positive. The “Divided States of America’ still has the dominant currency, the strongest economy and is home to many world-beating companies. None of that will change this year. But the mighty dollar looks likely to become a good deal less mighty in the months ahead.