Germany is pulling again and Europe will soon leave recession behind, while the US economy should continue to grow moderately. The EUR/USD exchange rate is reaching the important resistance line of 1.3820; the next target is 1.44.
Europe emerging from recession
In January the German jobless rate declined to 6.8%, the lowest level in 20 years. Unemployment fell for the second straight month with the job market seeing the biggest fall in a year. The positive trend should persist throughout013 as the debt crisis fades away and will help peripheral nations pull out of recession. Wages are expected to rise as well and will boost confidence and increase consumption. The EUR/USD exchange rate is targeting 1.3820, which corresponds to the higher channel line of the past eight months. It should hold at first; nonetheless, the uptrend should persist, and the next target should be 1.44.
In reality, some uncertainty remains over the Italian election results at the end of February. Former Premier Berlusconi, the leader of the far right coalition, has just declared that Germany should stop its hegemonic policy toward Europe or Italy will have to leave the Eurozone. However, the financial markets expect the center-left coalition to win the elections. In Spain, on the other hand, the revision of the deficit targets by February could inspire Moody to cut the credit rating again. This will raise the cost of the Spanish debt and press the government to ask for help from the European Central Bank. Finally, Greece will probably not meet its commitments to the world financial community and might ask for help again this year. None of these events would be surprising enough to change market trends.
Political friction may cause US rating to be slashed again
After having increased 3.1% on average in the third quarter of 2012, the US Gross Domestic Product fell 0.1% in the last quarter of the year. However, the decline should only be temporary. Defense spending fell the most since 1972, and super storm Sandy took a chunk out of the supply chain. In fact, the pace of growth in private domestic demand rose 3.1% and was in line with 2012's positive numbers. Also, business spending remained strong. The ISM manufacturing index rose to 53.1 in January from 50.2 in December. The biggest push came from inventories, new orders, and employment. Decline of the unemployment rate is set to continue this year as well, despite January's uptick to 7.9%. Hourly earnings are still positive at 2.1% year on year. Finally, growth in the housing sector should expand and eventually accelerate.
Another deal for the reduction of the deficit will probably be made at the last minute. The increase of revenue limits and the spending cuts agreed to so far by Mr. Obama could cause GDP growth to contract by around 1.0%. Cuts in the deficit should contain inflation and increase the budget's balance. However, fiscal consolidation is not enough to reduce the debt-to-GDP ratio. Despite rumors about unleashing the third round of quantitative easing (QE3), the Federal Reserve should keep its monetary policy unchanged until the end of the year. A high and consistent number of newly employed is expected before rates rise again. This will limit downside challenges, but it will not boost growth.