USD Bulls Must Be Patient

Economic indicators out of the U.S over the past few months have surprised to the downside on a number of occasions bringing into question Q1 growth prospects.

As highlighted below we can see there have been 4 months of below expectation expansion on the ISM Manufacturing PMI release. Although we’re yet to see a reading below 50.0 that indicates contraction, we are trending lower and in that direction. This is a genuine reason for concern.

In the midst of falling commodity prices, and specifically oil, it is no real surprise to see inflationary data in the U.S in negative territory. However, this does give the Federal Reserve more flexibility when it comes to the much talked about interest-rate hike. If prices were above the target level deemed acceptable in the Fed’s mandate there would be less of a debate about when the central bank would be tightening monetary policy.

A real concern is that the falling oil prices that were likened to a ‘tax cut’ by U.S officials has not been represented in the U.S Consumer. Retail Sales in 2015 have consistently come out negatively. The worry is that U.S consumers are supposed to have more disposable income as they are saving money at the pump, yet spending by consumers is in decline.

This brings into play the University of Michigan Consumer Sentiment survey. There has been a significant drop-off in this sentiment survey since the lofty high of 98.2 in January. The latest report showed a reading of 91.2 in March after 93.6 in Feb. Yes these are positive, again we’re seeing softness.

The real question is how this will impact on U.S growth prospects. A recent report suggests U.S GDP is projecting growth of 1.2% in Q1.

So what does this mean for our market outlook? We have to take into consideration the harsh winter being experienced across the pond, plus the disruption on the West Ports was mentioned no less than 5 times in the “What Respondents are saying” section of the latest ISM Manufacturing report.

If we take into account both the harsh weather conditions and the West Port disruptions are temporary in nature, then we can expect a rebound in U.S economic data as we head into spring and then Q2. The U.S economy still has the benefit of low funding costs and a healthy appetite for lending by U.S banks. This is a good sign for longer-term growth prospects.

Let’s also remember this time last year when another cold winter severely disrupted U.S growth. This resulted in a sell-off in USD throughout Feb and April. EUR/USD rallied from 1.3480 to 1.4000 in this period. However, after the blip in the U.S economy had passed, the market began flooding into USD again.

Currently the circumstances are very similar in terms of longer term fundamental outlook. The divergence in growth and monetary policy remains in place as the ECB embarks on QE whilst the FED considers a rate hike. That said, the noticeable difference this year is the positioning of the market. The softness in data this year come after a monumental USD rally across the board. With the long USD trade overcrowded we would not be surprised to see a more pronounced USD pullback before our longer term bullish dollar bias resumes.

We still favour USD strength across the board, and especially favour the greenback to outperform the AUD as detailed in my previous report.