Growth Surprise up a Notch on the Probability Scale

Key News

  • China’s property sales surged 60 percent by value in the first seven months (Bloomberg)
  • Latvia’s statistics agency says the Baltic state’s economy shrank by nearly 20 percent in the second quarter compared with the same period last year.

Quotable

“Fourth Law of Thermodynamics: If the probability of success is not almost one, then it is damn near zero.”

                             David Ellis

FX Trading – Growth Surprise up a Notch on the Probability Scale

Though one non-farm payroll report doesn’t make a trend, especially given the number of job seekers leaving the scene entirely, many are declaring the recession is officially over thanks to Friday’s report. On the currency front, there was significant change in price action that followed the “growth surprise.”

For the first time in recent memory, the dollar actually moved in the same direction as stocks. And adding to the interest, the yen was hit hard along with the Europeans, while the commodity currencies held their ground…

The question: Is Friday’s price action a harbinger of anything, or just another volatile jobs report day?

From our perspective, the “growth surprise” scenario has been on the radar for a while, but it hasn’t been our most confident alternative of the many available from The Dollar Smile:

The Growth Surprise scenario says the dollar rises (most relative to the European block currencies) because the US comes out of the recession before and faster than Europe. Thus, the expectation builds for the Fed to hike first and therefore improve the US dollar yield differential relative to European currencies; thus the dollar gains yield and growth advantage.

This view also assumes the emerging and developing economies continue to lead the way (thus still supporting commodity currencies), driving US exports in the process—a growth driver for GDP.

However, still high on the list of scenarios is the Risk Bid as we watch China struggle with their bubble. The Risk Bid is the left side of the dollar smile, implying a move higher. Another scenario is of course the Muddle Through, or Implicit Weak Dollar Policy scenario—one the second stimulus crowd seems to prefer (and one the consensus still sees as number one on the hit parade).

Forecasting the future based on one day of price action seems a bit silly; in fact, attempts to forecast the future based on any amount of evidence is a mug’s game. The game should be about trying to determine market expectations and watching how reality plays out against those expectations in the form of market tone. This is where I think building alternative scenarios can help—it keeps you open to information that can invalidate your most confident view (by virtue of developing a most confident view you have denuded your objectivity) and hopefully more quickly allows you to focus on a shift in market expectations.

The Growth Surprise has just hiked up a notch or two on the probability scale I think. Stay tuned.

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