There are two separate by related developments that are lifting the euro to its best level in three-months against the US dollar.   

First, the US economy is off to a disappointing start to Q2 after the economy appears to have contracted by around 1% annualized pace in Q1. The strong bounce back after the contraction in Q1 14 has thus far not materialized.   

The unemployment rate may be falling faster than the Federal Reserve had anticipated.  This has been the case since almost the start of the recovery.  However, the FOMC will likely find itself in the difficult position of having to downgrade its growth forecasts for the year at its June update. The central tendency of Fed’s forecast was for growth to be 2.5% this year.   

For the sake of the argument, let’s assume that the contraction in Q1 is offset in full by the recovery in Q2. That means that the economy would need to grow by 5% in the second half to achieve the Fed’s forecast. The US grew by an average (annualized) quarterly pace of 4.8% in Q2 and Q3 last year.  That was the fastest since H2 03.    The risk is that the Fed’s forecast for this year is revised below 2%.  This may leave it in a better position to raise its forecast at the September meeting, for which we still have not been persuaded that April data rules out lift-off in four months.  

One of the questions this raises is about the underlying growth rate of the US economy.   Fed Chair Yellen noted that with lower growth forecasts announced in March that the Fed was still expecting the economy to grow above trend.  Among other things, this means that the slack in the labor market would continue to be absorbed.   

Trend growth is determined by two variables.  The growth of the workforce and its productivity. Both are notoriously difficult to measure. Demographic shifts typically are the driver of the growth of the workforce.  Many economists assume around 1% annual growth in the workforce. Productivity is considerably more difficult to measure, especially in the service sector.