Are the Early Signs of Recovery Strongest With the US and Dollar?

Optimism surrounding an eventual economic recovery is growing; but all those making positive forecasts do so with a disclaimer for timing and barring any unforeseen events. These stipulations are perhaps as important as the general concept of a recovery itself; and therein lays the source of the market’s next dominant fundamental theme. Will the US economy recovery before its G10 counterparts?


The Economy and The Credit Market

         Optimism surrounding an eventual economic recovery is growing; but all those making positive forecasts do so with a disclaimer for timing and barring any unforeseen events. These stipulations are perhaps as important as the general concept of a recovery itself; and therein lays the source of the market’s next dominant fundamental theme. Will the US economy recovery before its G10 counterparts? Is there a next shoe to drop? And, if that is the case, will the dollar take the role of safe haven or growth candidate? These are the questions that all fundamental market participants will be asking themselves; but that the greenback traders in particular will be attempting to discount. Over the past week, the outlook for the US (compared to the rest of the globe) improved modestly on a smaller than expected drop in May payrolls and the in ‘tolerable’ shortfalls of those 10 American banks that failed the [Federal Reserve’s stress test](http://www.dailyfx.com/story/currency/eur_fundamentals/US_Dollar__Japanese_Yen_Face_1241731901042.html). However, it is important to realize that the recovery in risk appetite is fully derived from speculation of future growth, earnings and returns. Things could fall apart quickly… 

A Closer Look at Financial and Consumer Conditions

         The underlying development in the financial markets is the only tangible improvement for the US and globe to this point. While the prospect for growth and capital gains is still a long ways off, stability in credit and lending can offer some permanence in the form of much-needed stability. Reflecting this improvement, we have seen expansion of liquidity at the central bank level (through a record low benchmark lending rate) filter down to the corporate- (credit default swap costs are at their lowest since September), consumer- (the average rate on the 30-year fixed mortgage is at a record low), and investor-level (junk bond premiums have tumbled to their lowest level in six months).

                                   

         

         

         

         While the US economy doesn’t look like it will show positive growth anytime soon, policy officials and market participants are nonetheless optimistic. This past week, the docket was topped by the ever-market moving [non-farm payrolls (NFP) release](http://www.dailyfx.com/story/topheadline/US_Unemployment_Hits_A_25_1241790177148.html) for April. Tempered to bleak numbers and a frightening outlook, the 539,000 net jobs lost through the month was considered a boon – as it was significantly less than the 600,000 expected and the 699,000 from the previous month. However, a slower decent should not negate the need for an objective appreciation of current conditions. The jobless rate is at its highest since 1983 and more than a half-million Americans lost their jobs.  


The Financial and Capital Markets

         Expectations for economic and market conditions to slowly improve through the year (to the point where both turn positive heading into 2010) has fueled the aggressive rebound in capital markets. However, at some point, traders will have to ask themselves how long speculation can drive the market higher before a lack of earnings and investment starts to cloud the future once again. Such a realization may have been grown more opaque this past week with the release of so many major economic events. Acting as a barometer for the health of the world’s largest economy, the US non-farm payrolls report reminded traders that they are taking on risk when the recession is still in full swing. Perhaps the more critical weight for sentiment though was the Fed’s Stress Test results. Meeting expectations that 10 of the 19 would fall short of a reasonable cushion to an extended recession, the $74.6 billion in capital needed seemed tolerable. However, the belief that these figures were contrived is growing. Did the government lowball risk and what about the threat of ongoing defaults?

A Closer Look at Market Conditions

         The steady bullish run from capital markets was knocked back a step this past week. Despite the positive light the Stress Test and NFPs were cast in this past week; the potential for demand, production, earnings and return are still suffering. Perhaps the more stable advance comes from commodities. The [CRB Index](http://www.dailyfx.com/story/dailyfx_reports/cross_markets_data_reaction/Canadian_Dollar_Correlation_to_Crude_1242071711926.html) tested its highest levels for the year as the sharp drop in commodity production may have finally met the slow and tentative rebound in production that will eventually turn into positive growth. Equities are far more uncertain. Earnings will struggle to stay positive and investors are nervous that the government could change the rules at any time.

                                   

         

         

         Risk indicators have leveled off somewhat over the past week. The [DailyFX currency market volatility index](http://www.dailyfx.com/story/strategy_pieces/weekly_range/Forex_Strategy_Outlook__Dollar_Breakdown_1242050535212.html) has rallied over the past few days back above 14 percent. For equities, the rise in the VIX has been far more controlled; but the shift has been notable. This shift has come despite the passing of major scheduled event risk including central bank decisions, major event risk and most prominently the Fed’s Stress Test results. Why would risk and the sense of uncertainty rise [I]after [/I]such an influential round of market fodder? Investors are now left to wonder how a recovery will actually progress and whether the government can allow the market to take over the responsibility in a timely fashion.  

Written by: John Kicklighter, Currency Strategist for DailyFX.com
Questions? Comments? Send them to John at <[email protected]>