U.S/Euroland: Beyond Convergence

June 4, 2008

My 15:19 update from June 2nd addressed a convergence in U.S. and Euroland PMI-manufacturing scores, wherein their first difference (U.S. minus Ezone) was halved from -4.0 in January to -2.1 in April and halved again to -1.0 in May. Service-sector PMI readings in the two economies reported earlier today showed a decisive swing in the advantage back to the United States. In that second set of comparisons, the first difference of +3.0 points in May after -1.1 in April puts the U.S. economy in its best light relative to Europe in at least a year. A comparison of sub-readings for new orders produced a spread of +3.2, 4.8 points better than in April. Not surprisingly, both regions experienced faster increases in prices, with the U.S. shift toward greater price pressure being more pronounced than Euroland’s.

Chairman Bernanke’s supportive comments about the dollar could not have been better timed from the standpoint of background economic news. Service-producing industries represent around 70% of all economic activity. Even without taking that asymmetry into effect, the sum of the two spreads — -1.1 and -2.1 in April followed by +3.0 and -1.0 in May — improved 5.2 points from negative 3.2 to positive 2.0. In fact, conditions shifted even more sharply in May than the unweighted raw figures imply. Of course, this is just a single observation point in data that tend to bounce around from month to month. But if May results do not prove a fluke, an inference to draw is that the Fed truly doesn’t need to cut rates any further and should soon be planning how it will normalize monetary policy before price stability is squandered irrevocably. The ECB’s dilemma, on the other hand, might be tougher than the Fed’s in that the second derivative, i.e, rate of change in growth, is more adverse in Europe than America, yet inflation is still cresting and therefore posing a rising risk of upwardly creeping expected inflation.



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