The positive Retail Sales report this morning has helped improve sentiment that was earlier showing a mixed picture due to the soft GDP read out of Europe. This morning’s economic readings spotlight the growth divergence between the U.S. and the rest of the developed world, which has been the primary driver of the dollar’s strength recently.
The Euro-zone economy barely stayed in positive territory in Q3, with GDP growth of +0.1% in Germany and +0.3% in France, the top two economies in the region; GDP growth in the third largest economy, Italy, came in the negative (the growth rates are from the preceding quarter, not year over year). Overall growth for the currency block as a whole came in modestly better than expected at +0.2%; GDP growth was +0.1% in Q2 when Germany had slipped into the negative territory.
On a comparable measurement basis, the U.S. economy expanded +0.9% pace in Q3 and +1.1% in Q2. Greece and Spain — two of the countries hardest hit by the Euro-zone’s financial crisis of the last few years — displayed a lot more economic vigor, with GDP growth of 0.7% and 0.5%. But they aren’t big enough to move the needle for the currency bloc’s roughly $12 trillion economy. Please note that the region’s economy still hasn’t reached the pre-crisis size of 2008; it is about 2% below that level.
These growth numbers make it extremely difficult that the region will be able to get out of its disinflationary bind any time soon on its own momentum. The region came out of the financial crisis on the assurances of the European Central Bank (ECB) that it remained ready to do whatever needed to be done.
In fairness to the central bank, it has done a number of easing measures, ranging from interest rate cuts to purchases of asset-backed bonds. But it hasn’t gone all the way and taken the route of the U.S. Fed and Bank of Japan by buying government bonds. The Germans aren’t letting the ECB go that way, but data along today’s lines and the weight of market expectations will make it difficult for them to hold out much longer.
It is this growth and monetary policy divergence that has been the primary diver of U.S. dollar strength lately. This morning’s better-than-expected October Retail Sales numbers show that U.S. growth is accelerating, which is the reason why the Fed ended its QE program and is getting ready to start raising interest rates.
The divergence isn’t solely between the U.S. and the Euro-zone; it is actually even more pronounced with Japan which has taken the dollar to a 7-year high relative the Yen. The dollar strength showed up as a drag on the bottom-line results of many S&P 500 members like Coke (KO), Procter & Gamble (PG) and others in the Q3 earnings season. The trend will most likely be even more prominent in the current period.