Quad-Regional Economic Uncertainty
May 15, 2014
The second quarter of 2014 is half completed, and the unofficial summer trading season in foreign exchange begins in two weeks. Summer trading currency traders are coming and going from summer holidaysl has unique properties, notably a drop in volume and participant continuity. Although several important forex trend reversals were conceived in summer, a bigger generalization to make is that price movement tends to be less representative of underlying market reality and therefore a less reliable guide to what’s likely to happen a quarter or so down the road.
In some respects, the first three-eighths of 2014 has mapped out like a summer season from the standpoint of the choppiness of currency movement. Breaking the year so far into three equal segments, each a month and a half in length, one sees that none of the dollar’s relationships against the euro, yen, sterling, kiwi or Canadian dollar posted the same directional change in all three of the periods. Nor did the key EUR/JPY pair. Only Aussie dollar versus the U.S. dollar managed that simple trick, falling from USD 0.8923 at end-2013 to USD 0.9036 on February 14, USD 0.9267 at end-1Q and trading currently at USD 0.9348. None of the net year-to-date movements had eye-popping magnitudes.
Economic prospects in Euroland, Japan, the United States, and China are fraught with uncertainty. After months of denying that Euroland is flirting with deflation, ECB officials at last are taking the risk seriously. The euro fell to an eleven-week low of $1.3650 today as markets took account of the mounting likelihood that the European Central Bank will ease monetary policy at its June meeting. There’s a wide range of measures and combinations of actions that could be taken by ECB officials. Also to be decided are how forcefully to act and whether what the market sees will be what in fact is done. ECB President Draghi has proven very adept in the art of bluffing. I suspect only a thin layer of policy uncertainty will be peeled away at his June 5th press conference. The most successful illusion, associated with the unveiling of the still-unused OMT facility, continues to shrink intra-euro area 10-year spreads almost two years later. Premiums over German bunds have narrowed since end-2013 by a further 72 basis points in Spain’s case, 195 bps in Portugal’s, 149 bps in Greece’s, and 48 basis points in Italy’s instance.
Euroland’s economy remains very polarized between German and the other seventeen members of the bloc. Germany constitutes 28.5% of the Ezone economy, roughly the same share as California, Texas and New York comprise in the United States. German GDP expanded some 3.3% annualized last quarter, while the rest of the union edged down 0.1%. Between 1Q13 and 1Q14, GDP rose 2.3%, and the rest ticked up 0.3%. German consumer prices rose by a non-deflationary 1.3% over the past year, but the gang of seventeen saw their collective CPI go up at a dangerously low 0.5%. The tension for the euro springs from the fact that Germany exerts more than a 28.5% proportionate influence over regional policymaking.
The over-riding uncertainty in the Japanese economy will be the distortion caused by the consumption tax hike to 8% from 5% last month and continuing to not know for sure if a further rise to 10% will be enacted in October 2015. Japanese GDP shot up 5.9% at an annualized rate last quarter, exceeding forecasts by a factor of 1.5. Non-residential capital spending, residential investment, and consumer spending respectively jumped by 21.0%, 12.2% and 8.5% annualized. One could conclude the data attest to greater underlying economic resilience than realized or, alternatively, that the spike bodes even more poorly for the second quarter and maybe the third as well than markets had imagined. Japanese CPI inflation of 1.6% is not too far from target, however, and Bank of Japan policymakers have been very clear that now is a time to monitor data and not modify policy while the economy continues in its present limbo state.
In the United States, talk abounds that a new generation of asset bubbles is progressing well along. The Great Recession accomplished surprising little structural change to make the U.S. economy better balanced and less accident-prone. America’s ability to infect other economies has not been reduced, either. Expert opinions differ on the slack in the U.S. labor market and how much inflation is percolating under the surface. Foreign policy, which plays a strong role in America’s overall image, has looked over-matched and ineffective. U.S. real GDP expanded 0.027% last quarter (0.1% annualized) and 2.3% per year between 1Q11 and 1Q14 despite an extraordinarily loose monetary policy. A cloud over the U.S. economy involves not knowing whether it will ever be able to handle rising Federal Reserve interest rates and what long-term financial market damage may result from the status quo. Another is the repercussions of stagnant income growth for most of the population, and a third is the erosion of a national sense of shared identity, culture and history. Who is the United States and for what will it stand? Without definable answers, can the dollar remain a trustworthy linchpin of the international monetary system?
The meteoric rise of China’s economy since 1978 has entered a transitional stage that is still evolving in uncertain ways. Past success rested on dynamics that will not continue to be stable at the economy’s current level of development, but a full leap to a new workable growth model has not been engineered. There is no historic facsimile to suggest where China might be headed. One fear is that the road could follow a path similar to what Japan traveled in the past two decades. But China is neither a democracy nor an insignificant player in global geopolitics. Decades of extremely low growth cannot be tolerated by either Beijing’s government and the rest of the world in the way that such was for Japan. One way or another, something very different is going to happen in China from what transpired in Japan, but exactly how events will unfold is highly uncertain. And whatever happens will profoundly influence other world economies, the flow of international capital, and the movement and major currency relationships.
Like a deer caught in the headlights, currency markets are frozen by the glare of unfathomable uncertainty in every direction that investors peer.
Copyright 2014, Larry Greenberg. All rights reserved. No secondary distribution without express permission.
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