My view on the continued divergence between the U.S and European economies.
Anyone who follows me, especially if you receive our daily newsletter, know I have been a big fan of the dollar for the last three to four years. Recently when the DXY dropped below a hundred I was commenting it was ridiculously undervalued and now its back to around 105.
The U.S continues by far to be the strongest economy, along with possibly one or two oil producing nations. The amount of stimulus added over Covid was in the trillions of dollars and this has helped their economy go from strength to strength, unfortunately, it did also add to inflation pressures.
You only have to look at household wealth to see why the U.S economy will manage a soft landing. With house prices steadying and stock markets at high levels, household wealth grew by over $5 trillion dollars in the second quarter of this year, which is around $37 trillion dollars above pre-Covid levels. Even if you deduct total household debt it still leaves a net worth of a huge $154 trillion dollars. Sadly, this wealth is not evenly spread out with those on a lower income struggling to fight high food and energy prices, and even those in the mid-income bracket have spent their Covid savings which has helped reduce household cash and savings deposits by some $200 bn.
On the downside, students loan repayments commence again now, and there has been increase in defaults on credit cards and car loans, plus as expected the unemployment rate is increasing. Although with interest rates now peaking, unless energy causes another spike in inflation, it will leave the Fed leaving rates where they are until mid-2024 at the earliest.
Europe, including the UK are still battling inflation and may need to increase rates once more before pausing. The economic conditions are much worse than the U.S which is why I still see more room for the USD to make further gains. Indeed, it could rely on another mild winter to prevent Europe from entering a recession and that is likely to be decided by El Niño! Food and energy prices have been slower to drop in Europe with oil prices rallying in September due to OPEC+ keeping supply limited and now we have Australian gas worker strikes that could spike gas prices again. Fortunately, Europe should have high level of storage now ready for this winter.
Although rates will soon peak, do not expect them to quickly drop any time soon. Inflation may be slowly moving towards the central banks 2% target, however, the closer it get the harder it becomes. As rate hikes take time to feed into an economy it may take the rest of this year for those more recent hikes to be felt by the economy. This will be key to whether any final hikes were needed and could be enough to push Europe into recession. The fact Germany seems to be almost the weakest link in Europe, flirting with recession, highlights the risk there is for the whole of Europe!
Please note we do not offer trading or investing advice. This is simply my view!