Todayâ�,��"�s GDP report expected to print at an anemic 2.0% (the lowest reading  since Katrina ravaged 1.8% result for Q4 of 2005)  should confirm the fact that US economy is decelerating rapidly. After a gangbuster Q1 reading of 5.6% the falloff in the pace of  US economic activity has been dramatic this year compressing 300 basis points to 2.6% in Q2 and even further to the anticipated 2% rate in Q3.  The most recent economic data from the disappointing Philly and Richmond Fed numbers to the lackluster rebound in September Durables Goods which rose only 0.1% ex- transportation to the  16 month low set by ISM Manufacturing report all points to further weakness ahead.

What are the key macro drivers behind this dynamic? The twin pillars of oil and housing continue to impact US economic growth and the future performance of those two sectors may well determine if the US economy and in turn the US dollar will experience a soft landing or a hard crash as we head towards 2007.

Oil â�,�“ No More Downside?
Undoubtedly, the remarkable decline in oil prices from their peak of nearly $78/bbl in early August to their most recent low of $57/bbl in late October has been a tremendous boost for the US consumer. The even greater decline in gasoline prices from over $3.30/gallon to just $2/gallon put billions of discretionary dollars back into the pockets of US commuters. Yet despite the tremendous stimulus â�,�“ akin to a massive tax cut for most Americans â�,�“ US consumer spending has merely tread water. The latest results from the total Retail Sales figures for September showed a decrease of  -0.4% on a seasonably adjusted basis. While US consumers buoyed by lower energy costs, gladly spent money in department stores on clothing and general merchandise, they curbed their purchases of larger items such as flat panel TVs, furniture and household appliances. Faced with record debt services ratio of 13.55% of their income consumers simply did not  generate enough in wages to propel additional growth in spending.  Furthermore,  as OPEC makes concerted efforts to halt the slide of crude at the $60/bbl level by cutting back production and unseasonably cool weather settles over the Northeast most of the benefits from the sharp drop in crude may have already been delivered. At best it appears that prices will stabilize at current levels having a neutral impact on future economic growth. However, should geo-political or nature-driven events send prices higher, the depressive effect of higher energy costs could slow consumer spending even more in the upcoming months

Housing â�,�“ the 2 Trillion Dollar Question?
While the decline in oil has been a tremendous positive for US growth in Q3 of 2006, the decline in housing values has had the exact opposite effect. Although still buoyant in the Southeast, housing in all other geographic regions of US is in the midst of a major contraction. Latest Existing Home Sales figures once again missed analysts estimates and registered their lowest reading in well over 3 years. While New Home Sales increased from the month prior as present day buyers clearly preferred the steep discounts and repair-free attraction of new housing stock even those numbers were off by nearly 20% from the year prior. 

Housing presents two gargantuan risks to the US economy. First and foremost is the repricing of nearly $2 Trillion of Adjustable Rate Mortgages - many  of which contain teaser rates, interest only options and negative amortization schedules. The possible increases in debt service could trigger a wave of foreclosures bringing more supply to the market which would push prices even lower.. For the time being however, this dour scenario has been kept at bay by nimble real estate financing companies which have created a slew of new loan products to ameliorate the impact of larger monthly debt service burdens. Indeed, if rates remain relatively stable, the â�,��"ARMâ�,� ticking bomb may well be defused for a while longer.

However, of far greater concern to the long term growth prospects of the US is the simple fact that house values have stopped appreciating. Throughout the past 3 years of economic expansion mortgage equity withdrawal (MEW)  has served as a major source of cashflow for American households. Faced with stagnant real wages as a result of both global wage arbitrage  from India and China and skyrocketing benefit costs to US employers,  US consumers resorted to Housing-as-ATM strategy in order to consume beyond the level their salaries would allow. With the salad days of MEW financing behind us, little wonder then that consumption of durables and major ticket items has cooled materially. This in fact represents the greatest danger to the soft landing scenario for the US economy. If housing values continue to decline US consumers will curtail their spending even further as their ability to borrow against equity will be greatly reduced.

Currency Implications
What does such course of action portend for the greenback? If the slowdown scenario plays out US rates are likely to remain stationary even if energy based inflationary pressures return. Indeed, as we wrote in yesterdayâ�,��"�s piece, â�,��"the FX market is coalescing around the idea that the Fed has actually stopped rather than merely paused the interest rate tightening cycle.â�,� If US rates do not rise further, the euro could see some long term benefits as its own rates climb higher on far more hawkish policy posture by the ECB and the interest rate spread between the two currencies continues to narrow. Additionally, the yen may be a beneficiary as well.  Although latest Japanese CPI data puts in doubt any immediate BOJ rate hikes, the mere fact that US rates will not rise further should trigger some carry trade liquidation in USD/JPY as speculators may now consider this position to be â�,��"dead moneyâ�,� and will look elsewhere for more fertile profit opportunities.

The US slowdown scenario is by no means a foregone conclusion.  Mild winter,  and lower demand could push oil prices to $50/bbl and possibly even lower, creating a second wave of stimulus for the US consumer. Housing, too, may stabilize if the Fed maintains its pause and interest rate environment remains benign. Still, currency traders and investors   would be well advised to monitor the latest US economic releases. The patient that is the US economy is not yet terminal, but he is certainly far from being in perfect health.

Boris Schlossberg is a Senior Currency Strategist at FXCM.