Postcards from Old Europe – Al Quo Vadis?

The recent FOMC statement reiterated the Fed’s view that economic weakness is mostly attributable to higher energy prices and the high measure of geopolitical risk. As soon as these brakes on economic growth are gone everything will be just fine and the economy will continue to zoom ahead at warp speed.

This scenario has been the Fed’s playbook for so long that they are effectively staking their reputation on things working out this way. An essential part of this Fed worldview is that the massive fiscal and monetary incentives which were thrown at the economy have done their thing and started the real economy’s engine.

Pimco’s Paul McCulley called this “the hand-off from Wall Street to Main Street” a couple of months ago. To me it looks as if this hand-off may turn out to be as bungled as the US women’s team’s baton hand-off during the 4×100 women’s relay final.

Main Street took the baton but seems to be losing its collective grip. Profits and cash flow are slowing. Investment is down and looks to surprise further on the downside. The story behind the corporate sector’s impressive recovery can be summed up by two words: “cost reduction”. Companies have destocked and offshored themselves back to financial health. Alas this won’t continue for ever. Profit growth is already losing momentum and will probably continue to do so in the foreseeable future.

Slowing profits also means sputtering employment – at least at home. This paints a sorry picture for domestic households who have seen their real incomes stagnate and have thus wagered on the future by using debt to fund today’s purchases. Now if the future turns out to be less rose-tinted than expected, we might just see a sharp deterioration of household spending.

Investors in the US and holders of USD denominated assets are watching what happens with bated breath. They stand to lose a lot of money while Alan Greenspan is staking his reputation on the soft patch being just a patch and not a meadow.

I wish you all a great weekend and invite you to visit CurryBlog, my other home on the web.