Economic slowdown?

The economy looks headed toward a big slowdown, with the housing sector a significant drag, but growth is still expected to be positive, not negative. A lot depends on whether the yield curve steepens but the long-end (10 years) remains a tad over the European counterparts, or the whole yield curve shifts down. If buyers of 10-year paper think inflation is not really whipped, they will demand the extra premium over short-term paper. This would be a lifeline for the dollar, which is highly correlated with the bond/Bund spread. That assumes, however, that ECB rhetoric about the upside risk of inflation is just that — rhetoric. It’s difficult to imagine the ECB continuing to hike rates if the U.S. falls into seriously slower growth. True recession (two quarters of negative growth) is a dim prospect, since the Fed can be counted on to cut rates until the idea is shoved out of people’s minds. After all, Fed chief Ben Bernanke is an expert on the Depression.

We can dismiss oil and stock markets as affecting everyone equally, and not the dollar to a greater extent than any other currency. The portfolio outflow can be explained away as an aberration. The G7 is not indifferent to the dollar; it simply doesn’t attack a member’s currency directly. If the U.S. gets recessionary, chances are it will spill over into other countries, too. As for sovereign wealth funds, they are created by countries with no obligation to report holdings, although the G7 wants the International Monetary Fund (IMF) to look into it and get “non-discrimination, transparency, and predictability.” Well, at least the sovereign funds are on notice.