Experts Talk Euro's 'No-Win Situation,' Data, Defaults

Businessweek.com compiles comments from Wall Street economists and strategists on the key economic and market topics of May 14.

Audrey Childe-Freeman, Brown Brothers Harriman

The risk [aversion] trade is back on and the U.S. dollar and yen are bid while the euro is in a no-win situation at this point. There are renewed concerns over the situation in Dubai (ahead of Dubai Holdings' next repayments) and China, while the euro zone economic and social outlook is being questioned in the wake of the latest austerity measures. Commodities currencies have lost momentum as oil prices eased. The euro has fallen to its lowest level since late 2008, with downward momentum in place in the U.S. session.

White House economic adviser and ex-Fed Chairman Paul Volcker's doubts over the euro are not helping sentiment, nor are press reports (later denied) suggesting French President Sarkozy threatened to leave the euro at last week's European Union Greek bailout negotiations. [The U.K. pound] is weak, approaching the $1.45 support. Possible disagreement with France and Germany over hedge funds regulation (which would be detrimental to London) is in the limelight and weighing on the pound ahead of next week's EU financial ministers meeting.

Michael Englund, Action Economics

Today's U.S. reports revealed a stronger-than-expected round of retail sales figures mostly via [upward revisions to prior months], alongside figures for business inventories, industrial production, and the University of Michigan consumer sentiment index that met expectations. The retail sales data boosted the first-quarter consumption trajectory, though with a trimmed outlook for the second quarter that offsets some of the first-quarter strength.

For our gross domestic product outlook, we now expect a 3.5 percent first-quarter GDP gain, vs. the 3.2 percent advance estimate, with real [inflation-adjusted] consumption growth of 3.8 percent vs. the 3.6 percent advance figure. Consumption growth should slow to 2.8 percent in the second quarter given today's data, however, as the April sales gain was concentrated in the building materials component that doesn't enter the consumption calculation, and we will keep our second-quarter GDP estimate at 3.2 percent.

Jan Hatzius, Goldman Sachs (GS)

There is no inconsistency between the current, still-high level of initial jobless claims and the pickup in employment growth. The reason is that the proportion of "job losers" who enter unemployment and thus presumably file for benefits is unusually high at present, while the proportion who exit the labor force and thus presumably don't show up in the jobless benefit rolls is correspondingly low. The most likely explanation for this behavioral shift lies in the high levels of unemployment and underemployment, as well as the slowdown in wage growth. In such an environment, individuals who lose their jobs are relatively likely to have financial problems already, and thus to be under greater pressure to look for a job and collect jobless benefits.

The implication is that there is no contradiction between initial jobless claims of around 450,000 per week and continued employment gains. If our expectation of softer GDP growth proves correct, employment growth is likely to slow anew in the second half of 2010 and, in any case, the level of unemployment is likely to remain high for years. But for now it seems that employment really is rising at a reasonably healthy pace.

Diane Vazza, Standard & Poor's Ratings Services

No global corporate issuers defaulted this week, leaving the 2010 year-to-date tally of global corporate defaults at 32. By region, the current year-to-date default tallies are 22 in the U.S., two in Europe, three in the emerging markets, and five in the other developed region (Australia, Canada, Japan, and New Zealand).

Our baseline projection for the U.S. corporate speculative-grade default rate in the 12 months ending in March 2011 is 3.5 percent, with alternative scenarios of 4.9 percent at the pessimistic end and 3.0 percent at the optimistic. Our baseline forecast for yearend 2010 was 5.0 percent, with alternatives of 6.9 percent (pessimistic) and 4.3 percent (optimistic), compared with a long-term (1981-2009) average of 4.5 percent.

Nevertheless, we believe residual default risk beyond the one-year forecast horizon could increase because of the significant overhang of surviving leveraged corporate issuers. The substantial decline in risk premiums for lower-rated borrowers and the return of what we view as questionable practices and structures in some recent deals—such as raising bond funds to pay out shareholder dividends or sponsors—further raise flags that the optimism might be overdone.