Highlights
- Favourable US data support dollar
- Chinese won’t be pushed
US economy not yet out of the woods
In the last few weeks, the US dollar has been basically firm, mainly due to better economic indicators. Whereas EUR-USD had hovered between 1.35 and 1.36 during the first half of the month, the exchange rate fell towards the end of the month and is currently around 1.3440. Most European currencies, plus AUD and NZD, followed a similar pattern. The pound Sterling and the Canadian dollar were the exceptions: in both cases, the likelihood of the central banks raising interest rates again has been increasing.
The dollar’s development versus the Asian currencies has been varied: the renminbi rose slightly faster than usual, partly because the People’s Bank of China tightened its monetary policy again, and partly because Washington’s strategic dialogue with China is fuelling hopes that there will be larger shifts in China’s exchange rate policy. Against this backdrop, and combined with renewed rate hike speculation in Japan, the yen was able to hold its ground against the US dollar at around 121.50.
Chinese weeks in Washington
Only a few days before the meeting of delegates from China and the USA in Washington within the framework of the strategic dialogue between the two countries, the PBoC has tightened its monetary policy. The Chinese central bank lifted the minimum reserve ratio from 11.0 to 11.5% and simultaneously raised the one-year lending rate from 6.39 to 6.57%. Moreover, the maximum permissible USD-CNY deviation from the daily reference rate was raised from ±0.3 to ±0.5 %, which would theoretically make a more rapid appreciation of the renminbi possible. At the same time, there was evidence of a more rapid appreciation of CNY on the forex market: so far this month, the renminbi has gone up by 0.8%, which is as much as the total of the three months from February to April.
All in all it does not look as if the meeting in Washington had many tangible results. In individual sectors, such as air travel and financial services, market access is going to be improved. The US side, headed by US Treasury Secretary Henry Paulson, has been urging for substantial progress in making China’s currency regime more flexible. Mr Paulson explicitly said he was “impatient” for faster change. The latest Chinese measures can be seen as gestures of goodwill but the government in Beijing has made it clear that the level of the exchange rate will only be adjusted in very small doses. PBOC governor Zhou Xiaochuan said the exchange rate was already moving fast enough.
Spring fever in the USA
After a weak first quarter – the growth rate could be revised downwards to 0.8% (annualised!) – hopes are now rising that the worst is over and economic growth could pick up again somewhat in the second quarter. Several factors have contributed to the more upbeat mood, which is also reflected in the significant increase in the 10-year Treasury yield by about 20 points to 4.84%.
Firstly, the situation in the manufacturing sector seems to be easing slightly. Production has picked up in March and April. The output in April is already 0.9% above the first quarter’s average. After collapsing at the beginning of the year, durable goods orders have made a significant recovery. Even without taking the strong demand in the transport sector (mainly aircraft) into account, there was still a resounding 2% increase in April, quarter-on-quarter. The ISM index improved in April, and the Empire State Manufacturing index and the Philadelphia Fed index both followed suit in May, confirming the more favourable trend. Furthermore, the development in orders and deliveries of capital goods (ex defence and aircraft) indicates that investment in machinery and equipment could pick up again somewhat in Q2.
Some other indicators improved in the last few weeks too. For instance, initial jobless claims dropped to below 300,000 in the first two weeks of May; the University of Michigan’s consumer sentiment index rose significantly from 87.1 to 88.7. The development of new home sales in April was particularly spectacular with an increase of over 16%.
Whereas the data for the manufacturing sector have been relatively consistent, the other figures should be treated with more caution. Initial jobless claims have probably been distorted by seasonal adjustment factors: the weakness in the construction industry over the last few months suggests that the increase in jobs is being overestimated and that the development will remain relatively flat in the second quarter. The fact that the UMI consumer sentiment has improved slightly after declining significantly for three months running, is actually not all that surprising. It can hardly be taken as a change in trend, particularly as the weekly ABC index is pointing further downwards, and record high gasoline prices at the beginning of the driving season are digging a hole in consumers’ pockets. As regards new home sales, individual monthly data is hard to interpret, all the more so if other indicators such as building permits and the NAHB housing market index are pointing in the opposite direction. Moreover, the strong increase in new home sales was obviously connected with a marked decline in the median sale price. Buyers are reacting to price reductions, which is a positive sign, but by no means enough to get rid of the supply overhang.
All in all, our forecast for US economic growth remains cautious. Compared with the previous quarters, consumer spending is slowing down considerably; high gasoline prices and weaker employment growth are dampening the development. The housing market and construction are not yet out of the woods. And it will take a few months until we know whether the rebound in machinery and equipment is here to stay.
