Yesterday US weekly initial unemployment claims registered their lowest number since May 2008. The improved tone of this data series was supported by better than expected results from the Empire manufacturing and Philly Fed surveys. As a consequence of recent better than expected US economic data the urgency for another round of QE from the Fed has receded. 

The threat of more QE still remains on the table, not least because with around half of jobless Americans being unemployed for over 40 weeks the US labour market continues to be a major concern. That said the smaller risk of more US monetary stimulus combined with the ECB’s recent rate cuts and the step up in liquidity provision from the ECB is bearish for EUR/USD. 

The relatively better position of US growth going into 2012 is again feeding the confidence of USD bulls. We would agree that EUR/USD remains a very vulnerable currency pair in the coming months, not least because a solution to the Sovereign Debt crisis is still proving to be evasive.  However, the longer-term outlook for the USD appears less robust. 

US growth has been maintained with the support of a large degree of fiscal stimulus in addition to a very accommodative monetary policy.  In the next few weeks, once US lawmakers managed to reach an agreement, additional short-term fiscal stimulus should be confirmed by way of extensions to payroll tax cuts and unemployment benefits. 

Independent analysts have estimated that if this benefits were to be allowed to expire 2012 growth could drop by up to 1.5% to 2%; potentially enough to take the US into recession.  While for social, perhaps moral, reasons this additional stimulus is set to go ahead, it doesn’t sit well with the fact that the US government is running a budget deficit in the region of 9% of GDP and the country will have to tackle its fiscal demons sooner or later. 

Obama has outlined a 10 yr plan to tackle the US’s ugly deficit.  But, against the backdrop of slow growth, this doesn’t adequately deal with spending commitments which are dominated by huge outlay on Medicare, Medicaid and defence.  This US’s poor fiscal backdrop has already been sufficient for S&P to remove the AAA Sovereign credit rating from the US. 

The treasury market took this news in its stride – perhaps because of the debt crisis underway on the other side of the Atlantic.  But the US treasury market is unlikely to be able to hide behind the greater fiscal recklessness of some Eurozone governments for ever.   

If the US does move towards fiscal repair – perhaps after 2012 election, monetary policy will have to play an even greater role in supporting US growth and this is consistent with a weak US dollar. 

We expect EUR/USD to remain vulnerable going into Q1 2012, but on the assumption that Eurozone political can lurch towards a solution for the Eurozone debt crisis we look for EUR/USD to move higher on a 6 to 12 mth view.

source: Rabobank