Slowing economic growth may support US dollar short-term

Morgan Stanley has cuts its global growth forecast as a result of rising oil prices. Excerpt of chief economist Stephen Roach’s commentary:

Danger Zone
As the odds of a full-blown oil shock rise, we have little choice other than to cut our global growth forecast... We are reducing our 3.9% estimate of world GDP growth for 2005 by 0.3 percentage point to 3.6%... This relatively modest cut to our annual growth numbers masks a worrisome shortfall we now anticipate in early 2005 -- a shortfall that pushes the global growth rate down to its “stall speed.” History tells us that is a very precarious place to be -- it doesn’t take much to tip a stalling global economy into outright recession. As I see it, that remains the major risk as we peer into 2005.

By region, our forecast cuts are pretty much across the board. For the major developed economies of the world -- the US, Europe, and Japan -- we are paring our previous GDP growth estimates for 2005 by -0.3 percentage point. That leaves us with a consensus forecast for the US (3.5%), slightly below consensus for Europe (1.8%), and well below consensus in Japan (1.0%). Our downwardly revised estimates are also below consensus in Asia ex Japan, where we have cut our pan-regional 2005 growth forecast by 0.3 percentage point to 5.5%. A reduction to our China forecast bears special mention, where we are cutting our 2005 growth prognosis from 7.5% to 7.0%; inasmuch as this follows an upwardly revised 9.5% estimate for 2004, our projected deceleration in Chinese economic growth is all the more dramatic...

Roach has been a pessimist on the sustainability of global economic growth for some time. But with NYMEX crude oil surging past US$54 a barrel today, his warnings are sounding increasingly ominous.

In my post yesterday and my article "Disappointing job growth may hurt US dollar", I had suggested that present trends imply that the US dollar should weaken.

The US trade deficit to be reported on 14 October will probably add pressure on the US dollar, with economists seeing no respite there. Earlier, Bloomberg quoted Richard Yetsenga, currency strategist in Sydney at Deutsche Bank, as saying: "It's hard to see the trade numbers be dollar supportive." It may fall beyond $1.2450 per euro, he said.

Indeed, yesterday on CNBC, well known investment manager Jim Rogers said he expected the US dollar to fall "for years to come".

And yet, if it is true that the US economy is slowing, the US dollar may actually benefit. This was pointed out by Marc Faber on CNBC today when he commented on last Friday's jobs report.

And I had in fact alluded to the same in "US dollar dragged down by trade deficit": "The US economy's strength, fuelled by consumption spending, is causing it to suck in too many imports and feeding its current account deficit, which is the basic cause of its weak currency." By the same argument, a weak economy may strengthen the US dollar.

It would not change the long term trend of the currency -- which must still be down -- but it does give currency traders a chance to make money from a countertrend bet.