Economic Convergence and Forecasting Forex

August 28, 2017

Members of the Group of Seven, a collection of industrial economies ┬áhave experienced similar rates of economic growth during the past year. Between 2Q16 and 2Q17, real GDP advanced 2.1% in the United States, 2.0% in Japan, 2.1% in Germany, 1.8% in France, 1.7% in Great Britain, 1.5% in Italy, and 2.3% in Canada. Euroland’s GDP grew 2.3%. Growth in this and recent business upswings has been more tepid than norms in the early year of floating foreign exchange rate, and the downward pressure on everyone’s growth has also squeezed growth differentials between economies. In 1979, for example, real GDP climbed around 6.0% in Japan, 5.0% in Italy, 4.4% in Germany, 3.4% in France, 2.9% in Canada, 2.3% in the United States, and 1.7% in the U.K..

A convergence has also occurred in rates of inflation. Latest G7 rates of CPI inflation range from 2.6% in the U.K. to 1.7% in both the United States and Germany, 1.3% in Euroland, 1.2% in Canada, 1.1% in Italy, 0.7% in France, and 0.3% in Japan. When U.S. CPI inflation peaked at 14.6% in March 1980, by contrast, the scatter diagram of CPI inflation in other G7 economies was extremely wide at 21.3% in Italy, 19.8% in Britain, 13.7% in France, 9.3% in Canada, 8.0% in Japan, and 5.8% in Germany.

The wide variation of results within Europe in pre-euro days were associated with individual currencies. The governments of Europe tried to limit daily movement in their currencies against one another, but stochastic big adjustments would occur from time to time when cumulative market pressure based on dissimilar economic fundamentals would build up.

Nowadays, current account balances that measure net flows in trade of goods, services, investment income and transfer payments reflect wider disparities and do the growth and inflation rates of G7 economies. Japan and Euroland are running surpluses that exceed 3.0% of GDP. Britain has a deficit of about 3.5% of GDP, and both the U.S. and Canadian deficits are hovering near 2.5% of GDP. Within the euro area, there are Dutch and German surpluses of 10% and 8% of GDP but French and Greek deficits of more than 1% of GDP. However, the configuration of current accounts hasn’t been changing much lately from year to year, limiting the influence of this factor on currency movement.

Likewise, long-term interest rates are low and thus compressed. Compared to a year ago, ten-year sovereign debt yields have risen sort of in tandem, with rises of 60 basis points in U.S. treasuries,46 bps in German bunds, 49 bps in British gilts, but just 7 bps in Japanese bps.

When I entered the job market in the mid-1970s, I found my calling as an international economist in the nascent cottage industry of foreign exchange forecasting. The task, even then, was daunting, because currencies are influenced by virtually everything, but the comparison of economic fundamentals at least provided at least provided guidance.  That framework can no longer be considered reliable. For policymakers and private-sector investors and businesses with foreign exchange exposures, foretelling future moves in key currencies is but a shot in the dark without infrared corrective lenses.

Copyright 2017, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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