Growing risks of the US economic recession limit the USD growth potential

While the Fed’s presidents deny the link between the yield curve and recession, this top is still exciting the financial markets. The gap between the short-term and long-term US securities has been the narrowest since 2007, and the inversion quite accurately indicated US economic recession earlier. In late 2005, Alan Greenspan stated the yield curve to be not the same as it had been before, but, two years later, it proved its relevance. According to Ben Bernanke, numerous QE limit the growth potential for long-term yield; and Janet Yellen once said that the close correlation is not yet a causal link.

Jerome Powell, with regard to the hot topic, prefers to speak about the strength of the US economy and the US labour market, and about steady inflation rate. The Fed is not confused by the increase in the US consumer price index to 2.9% in June. The central bank is based on inflation expectations, including the changes in 5-year TIPS rates. Treasury inflation-protected securities suggest a soon slowdown in CPI and PCE, which is largely due to the correction of oil and energy prices.

Dynamics of the US Treasury Inflation-Protected Securities

Source: Bloomberg

The US economy really looks strong and able to stand with higher than currently rates for loans. Atlanta Fed’s leading indicator suggests the higher US GDP up to 4.5% in the second quarter. As for the yield curve, the rates on the short-term bonds are increasing because of the Fed’s willingness to normalize its monetary policy. It can be stopped only by slower inflation and trade wars. According to Jerome Powell, the economy, based on protectionism is less competitive, and so, less productive.

In the meanwhile, the US president’s economic adviser Larry Kudlow charged China’s authorities with the unwillingness to reach a compromise. According to him, if China canceled all the present tariffs and extended the foreigners’ access to its markets, they wouldn’t speak about any US trade wars with China. Regular escalation and deescalation of trade conflicts make investors worry. They were surprised by the US dollar sharp price rise in April-June. And earlier this year, the consensus forecast for the USD index was bearish. As a result, the market buys the USD index, based on higher US debt rates. In addition, a higher global risk appetite lures traders back to carry trade strategies.

Dynamics of popular strategies' efficiency
  

Source: Bloomberg

So, the greenback looks strong due to a high demand for the US Treasuries. Foreigners bought Treasuries worth $27 billion in May. The White House is interested in supporting the demand for the US Government securities. The US administration predicts that the expected US budget deficit will be extending $100 billion faster in the next three years than it was suggested earlier.

In my opinion, Jerome Powell managed to comfort the markets. Supported by not so scary information about trade conflicts, EUR/USD develops the middle-term consolidation in the range of 1.15-1.2.    

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Price chart of EURUSD in real time mode

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The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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