A big data week ahead of us with the FOMC announcement on Wednesday. There will also be interest rate decisions from Japan and Norway, albeit of less global significance, and in addition we will get a chance to look at the minutes of the central banks of Australia and England, as well as numerous speeches by some key central bankers. Needless to say, by the end of this week, we will have a far better picture of the state of global monetary policy.
In Europe, some comments by the Dutch and German representatives on the ECB governing council make it clear that the divide is not Germany against the rest, but Northern Europe against the rest. Recent comments by both these central bankers have raised concerns about the moral hazard of the ECB’s quantitative easing policy. After all.. what reason do the French and Italians have to reform when the QE panacea has been given to them, it’s hard to argue with this, but then I’ve never been supportive of a policy, central to which is the belief, that the best way to fixed an over-indebtedness problem is to make it as easy as possible to borrow. Silly me!
But the most significant issue this week has to be the FOMC. We already know from Ms Yellen’s congressional testimony that the Federal Reserve is keen to get rid of its “patient” pledge before raising interest rates. This will open the way for the central bank to assess the interest rate level on a month by month basis. As I’ve said before in recent blogs, the pace of strengthening of the US dollar has in my view reduced the probability of hikes, although there’s a strong argument that even two 25bps hikes – which would take the policy rate to 0.5% – isn’t exactly a huge burden! But my point is that a strengthening dollar IS a tightening of monetary policy and is in fact an implicit increase in the interest rate already.
It’s the US dollar that captures my attention at the moment. While the rise has been hugely impressive it is important to remember that a large number of countries have tried to maintain the value of their own currencies in relation to the US dollar, this has been a popular strategy in the Far East for example, and while these currencies have weakened against the US dollar, it is possible they may not have weakened as much as fundamentals might require. Foremost amongst these currencies would be the Chinese yuan. Consider this… in 2015 the euro has fallen 13% versus the greenback, while the yuan is down only about 1%. This means that the yuan has appreciated by 12% versus the euro, or I could say that the cost of Chinese exports to Europe have gone up by 12% since the start of the year. Clearly there is a significant risk of an export slowdown from China, and there’s very little chance that increased exports to a booming United States economy is going to be enough to compensate. If you weren’t aware of it already, it’s worth pointing out that China probably exports more to Europe than the United States. This is important. Particularly when you consider that Chinese companies have been heavy borrowers of US dollars over the last half decade, they really need to maintain their sales to pay off their debts. I’m not making a forecast so much as identifying a possible risk on the horizon. One that is not dissimilar to the problems in 1997 in the Asian crisis. As always vigilance is key.
Meanwhile in Europe stocks are flying. The DAX index is already up 23% in 2015 and is in record territory. QE continues to deliver for those who have shares, which is mainly the wealthy and the pension funds. Much the same as it was in the United States and the UK. We can only hope that the more rigid economic structure in the Eurozone will also be able to recover as quickly as the Anglo-Saxon economies… but don’t hold your breathe!
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