Is the US economy dysfunctional? Euro and the ECB?

(Clifford Bennett – ACY Securities)

Is the US economy dysfunctional?

US debt to GDP

US equities continue their steep decline.

We have been warning of as much as a 20% decline from current levels. We do this not because we want it to happen, but it is important for investors to be aware of just how high the stakes are here.

The US is clearly stumbling, and the high Jobs Openings numbers are not reflective of a healthy economy.

They scream dysfunction. In fact, this is perhaps the best way to describe the US economy at the moment. Not that this would be popular among Americans, but there is something really going on here.

The whole notion of a return to a new normal that would more closely represent a Nirvana economic outcome had become pervasive through the Great Covid Rally. Driven as it was by quantitative easing and near zero interest rates. This period brought on great wealth creation. Everything went up. Even crypto. Now though, we are in a more ‘reality bites’ economic period and asset price correction.

People seemed to forget that the US economy was not looking that great before Covid. Getting carried away with the idea that free money from the Federal Reserve would power endless wealth for everyone for years to come.

It was all an artificially generated wealth creation period paid for by taxpayers themselves borrowing from their children. This was never going to end well.

On the day, US stocks again struggled to make any real headway to the upside at all, and ended lower. We have already seen a significant fall and the dominant risk must be viewed as being very much to the downside.

The ‘new risk is 20% choir’ is growing, as more fund managers and traders begin to see through the veil of hype to an economy with high job openings, super inflation, slowing manufacturing and services, flat retail sales, and a Federal Reserve Chairman who is happy if the economy is hurt by his rate hikes. Continuing massive fiscal and trade deficits.

If that is not dysfunctional, I do not know what is.

The USA just partied hard on debt. Did no one expect a hangover?

Euro and the ECB?

“The European Emperor has no clothes” has never been more true at any point in history than it is today.

The EU is hard at work to revolutionise the energy power regulations so as to afford some relief to consumers and businesses alike.

At the very same time, the ECB is considering 75 point rate hikes.

What one hand gives the other takes away. To be fair, rates in Europe do need to rise. Inflation is very real and growing. German inflation hit 7.9% yesterday, and a quick look at a 25 year chart really brings home the magnitude of the issues here.

The ECB will be raising interest rates significantly, but is this a reason to buy the EUR/USD cross?

The situations of Europe and the USA are very different now. Based merely on the fact of war in Europe. There is no quick fix outcome for a conflict that is clearly entrenched. The economic consequences for Europe are complex, but tend heavily to the negative.

There have been the supply disruptions in food and energy, both due to the conflict and to the sanctions applied. All of this has discouraged shipping companies to some degree as well.

Much is being done to alleviate the immediate and clear energy challenges facing Europe. The USA has said it will work to fill the energy gap. The truth is that even at best efforts the USA will only be able to make up about 20% of the energy supply loss from Russia. The EU continues to work urgently to diversify its energy supply further.

All of this takes significant time, and probably a lot longer than will even be planned for.

In the meantime, fast entrenched inflation, across all services and goods, will only add to the misery of potential energy shortages through the winter period. Across the channel, the UK is again looking to develop fossil fuel resources in the North Sea. The challenges for the EU are even greater. Germany has already directed for limitations of energy use in businesses. It will get much worse.

EU consumer and business sentiment indicators remain clearly recessionary. Given the circumstances this is highly appropriate, as Recession, possibly a “Dark Recession” is very much on the cards. Likely through winter and possibly beyond.

We have seen a general financial markets interest rate outlook fixation develop of late, particularly in US equity markets. Where traders and investors attempt to dumb down the world into a single make or break criteria. That being the Fed’s actions  Every economy is of course far more complex than this.

However, this style of sentiment was very much prevalent on the day in Euro trading, as expectations of more aggressive ECB rate hikes to come were encouraged. Subsequently, the EURUSD has certainly stabilised for the moment at least.

The price action characteristics are of a market attempting to reject the sub-parity movement. It is normal for markets to become trapped for a time around nice round numbers in their pricing, but their importance is highly illusionary. The reality is the Euro has been far lower than this before.

Expectations of a more aggressive ECB, may well be founded and generate significant buying in the short term. Over the medium to long term however, with a wintery dark recession risk fast approaching and a still safe-haven strengthening of the US dollar, the most likely scenario is for the major downtrend in the Euro to resume.

Having recently adjusted my long held Euro target of .97 for this year, down to .9200, I continue to see further risk. After some initial ECB hike buying, people will remember the remaining huge and still growing differential to the US dollar. The Fed is likely to continue to outpace the ECB in this regard. There is in fact no reason why the Euro cannot fall as low as .8800.

For the moment, the market seems trapped in a 0.9900 1.0110 range and wants to test the upside toward 1.0200. However even a break below immediate support at .9970, would be a significant warning.

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