A key piece of economic news last week came from a government report showing that U.S. industrial production was flat in April despite expectations of a 0.4% gain. Manufacturing has been a highlight of the post-crisis recovery, so it was disappointing to see the sector falter.

Most of the decline was in durable goods. This marks the first decline since June 2010 and the biggest kick in the keister since the middle of 2009. The bulk of the miss came from a shortage of auto parts from Japanese manufacturers. This was the first month that the impact of the earthquake and tsunami was felt in this sector and we can see how much Toyota Motor (NYSE:TM), Honda Motor (NYSE:HMC) and Nissan have slashed output.

It wasn’t just Japanese automakers that cut back on production, however. Both Ford (NYSE:F) and Chrysler have stopped making vehicles that used a certain sparkly paint color only available in Japan.

This was a temporary setback and the decline should be undone in the coming months. Toyota has said that it would return to 70% production by June on all cars with eight major models at 100%.

All told, motor vehicle output dropped by 8.9% month-over-month in April, with the number of vehicles produced falling to 7.9 million from 9 million annualized. The problem will persist for a few more months and it will probably worsen in May.

Yet eventually either Japanese production will come back on line or manufacturers will secure parts from other suppliers, possibly even domestic suppliers, which will help erase these negative figures and get factories humming again.

In other negative economic news, though, we learned last week that U.S. housing starts plunged in April. Starts plunged 10.6% in April to 523,000 units annualized, which is terrible. Sure there was a lot of flooding and tornadoes in the South, but the Midwest and West actually had an increase in housing starts last month, and the Northeast, which had fine weather, experienced a 4.8% drop.

Single family homes and multi-family dwellings were the leading contributors in the monthly decline, the third of the past year. Construction of single family homes fell 5.1% and apartment complex building fell 24.1%. Single family home starts are now at their lowest point since 2009.

Analysts note that building permits give a hint of how much construction will be in the works, and it doesn’t look to be too much. Permits fell 4% in April, which was worse than expected.

Combining both of these data points, we can see that the current economic recovery is very weak, despite all the efforts by the Federal Reserve Bank and the federal government. This view will guide us going forward during the summer. And it shows why the ECRI Weekly Leading Index has hit turbulence.

The bottom line is we need to brace for a hard landing. But there is a catch. And it is …

RISK ON, GARTH

A few days ago, I heard from some friends on the prop desk of a top brokerage and also from a colleague in the research department of a big hedge fund that there are stirring signs that the “risk-on” trade might be ready to come back, just when it’s least expected.

Exhibit No. 1 in this notion is an indication that the euro, which has plunged since the start of May, has reached an oversold level that has been associated with its major reversals in the past year.

The chart of CurrencyShares Euro Trust (NYSE:FXE), an exchange-traded fund that tracks the euro, shows this pretty dramatically. You can see that every time the euro reversed higher from being highly oversold on the 9-day RSI (bottom clip in the chart), a broad, swift and sharp recovery got underway very shortly.

I don’t want to bore you now with all the details, but you need to know that when periods when the euro is rising vs. the dollar are associated with a condition that has come to be known as “risk on.” I  usually show it in the opposite way: When the dollar is falling vs. the euro, that’s the same “risk on” climate that allows commodities and equities to rise in value.

It’s a little hard for us equity people to understand, since we think stocks are at the center of the universe, but the reality is that currencies and bonds drive world markets. When the dollar falls and the euro rises, that leads to a rebound in the prices of equities, commodities and emerging markets. And sure enough, emerging and Asian developed markets were all strong overnight, led by South Korea and Indonesia, two of my favorites.

Bottom line: If the euro does keep moving higher out of the recent low, we should not think of it as a minor matter. It should be a big deal that could create a positive backdrop for stocks, energy, precious metals and industrial metals to get going again out of their recent lows, and also provide a boost for the sales of U.S. industrial goods overseas.