Forecasts for the Federal Reserve’s first rate hike have been pushed back by a majority of economists, the expectation is for a move in late summer. Interestingly, the IMF published a report this week suggesting concerns that there is still a dislocation between market expectations of a Fed hike and what policy makers are saying, but it’s worth noting that a senior Fed policy maker quickly played down this concern, observing that the market is correctly reflecting the levels of uncertainty surrounding a possible first US rate hike in 8 years.
I would just reiterate a point I made about this some months ago when this was a hot topic… developing countries which have accumulated high exposures to dollar debt are going to find life more difficult going forward as funding issues come into play. It is one thing to borrow at cheap rates but when those rates start to rise, investor concerns about the sustainability of payment schedules will mean that the yields these economies experience will go up somewhat more dramatically than any hikes that actually occur. The same – and more so – goes for corporates in these economies that borrowed extensively when the US dollar was weak. Now they will find themselves in a situation where their local currency earnings do not go as far in covering their interest payments as they did when the dollar was cheaper. Even if they are still able to comfortably cover interest payments, the proportion of their cashflow which is required to cover interest payments will be rise, earnings will be adversely impacted and leverage will increase. Obviously this will be less relevant for the companies with the foresight to hedge their dollar loans, but how many of them have done that? According to the data, corporates in China, Brazil and India have been particularly keen to take on these dollar loans, and the burden of indebtedness will be lower at the country level this cycle and more focussed at the corporate. As the situation evolves later on this year we should see signs of pressure in some markets, and you can be sure of contagion as the innocent are penalised as well as the guilty.
Looking at the charts of the major currencies (specifically EUR, JPY and GBP) versus the greenback, we are approaching rather interesting territory. Resistance is just above for EUR/USD and GBP/USD and we are already breaching the support zone for USD/JPY. In short, we might be in for a bout of dollar weakness. My level of confidence in this view will increase if we see a more sustained attack on these resistance and support levels, as always I will endeavour to keep you informed on this matter. For now, it is certainly not enough that USD/JPY is showing signs of weakness, I would rather see cross-confirmation from the other major currency pairs. For what it’s worth I am monitoring the 1.0850 – 1.1075 zone in EUR/USD and the 1.50 – 1.51 zone in GBP/USD. If we trade for a period of 48 hours above the upper bounds of the aforementioned zones it could be an indication of a more prolonged period of US dollar weakness.
The rather uninspiring data coming out of the United States in recent days might be the proximal cause of dollar weakness, but to be honest the data isn’t indicating a slowdown so much as it points to a levelling out of growth in the U.S economy. And if employment growth remains solid as the signs suggest then we will see a tightening of the labour market in the United States. A US consumer buoyed by wage growth could easily sustain a healthy U.S economy for quarters to come.
This morning we get aggregate inflation data for the Eurozone, and economists are forecasting an unchanged year on year number at 0.6%. Low, but hardly deflationary. Let’s see what happens in a few months when the levelling off of energy prices starts to be get reflected in the numbers. What excuse will Mr Draghi come up with for continued extraordinary monetary policy then? Germany is forecast to grow 2% this year, hardly panic stations. Across the pond we should also see inflation data published as well, and just as important we should get some Michigan sentiment data. It will be interesting to see if the softening up of data is impacting future growth expectations. And from a traders perspective I will be keen to see how this affects the price action in the greenback.
For now currency markets remain trendless in terms of the bigger picture, while the bullish paradigm in major market equities and bonds continues…
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