The end of last week saw prospects for interest-rates come to the fore. In the background we had the hints and promises of Mario Draghi about the Euro area going further into the negative interest-rate zone. Then Thursday saw the “unreliable boyfriend” Mark Carney give us somewhere around Forward Guidance 8.0 as a Bank Rate rise in the UK receded around yet another corner. Following this on Friday came the strong non-farm payroll report in the United States which shifted upwards the market view of US interest-rates. However none of the above have actually happened yet and there was one area which has already shifted that is the world of currencies and exchange-rates.
You may choose to consider this in the light of the famous “currency wars” statement from September 2010 or not but the truth is that a long list of countries are trying to manipulate the value of their currencies right now. For all the talk of interest-rate changes and extraordinary monetary measures if we look at economies the main player these days is the exchange-rate which the media often overlooks.
The strong dollar
This is a fact of life and let me illustrate it with some detail from DailyFX on Friday and the emphasis is mine.
Eight months of congestion have been brought to a dramatic end this past week as the US Dollar mounted an impressive rally in the aftermath of the October labor report……Now that we have seen rate speculation soar and the Dollar break to 12-year highs, many will simply presume the currency to continue rising under its own.
Unfortunately the St.Louis Federal Reserve is rather tardy in updating the official measure so let as take a look at that hardy perennial the US Dollar Index. It has been in a bull market since late April 2011 when it dipped below 73 although the main move to the current level of 99 has been since the summer of 2014. Just for clarity it is not at its equivalent highs to the official measure for the simple reason that it covers the major currencies and misses out the moves against the South American currencies for example. The extreme move there has been against the Brazilian Real which has fallen by 41% in 2015 so far.
Some care is needed with the hype as I note that Goldman Sachs is projecting the US Dollar a fair bit higher as one could just as reasonably point out in terms of interest-rates buy the rumour and sell the fact. After all who wants to be a “muppet”.
The economic impact
If we were analysing the UK then the rally in the US Dollar since the summer of 2014 would be equivalent to a 4.75% rise in Bank Rate. Again care is needed because the US Dollar’s role as a reserve currency and the fact that in relative terms it is less of a trading nation means one would expect a lower impact on two counts.
The US Federal Reserve itself is noticeably reticent on the issue I was all over their speeches earlier in the year when the US Dollar but they veered away from being specific. However Vice-Chairman Fischer tell us this.
Thus, it is plausible to think that the rise in the dollar over the past year would restrain growth of real GDP through 2016 and perhaps into 2017 as well.
If we use the chart he produced and add the current numbers to it then we might reasonable expect there to be a total reduction in the path of US GDP by around 1.5% peaking late next year. The effect on core inflation is faster and would be of the order of 1% and if it is not in play now it soon will be. Here is the chart that he used.
I counsel a dash of salt with such analysis as it is a generalised expectation and in reality there are always other influences.
What about trade?
The main player in the impact on economic growth is trade and the New York Fed offered us a view back in July on the expected impact. It concentrates on the impact of exports because the impact on US imports is lower via its role as the reserve currency. For the UK or Europe a change in the currency changes the price of oil,copper,steel. many foods and so on but the US does not see that due to the vast majority being priced in the US Dollar.
The numbers here are as follows.
The New York Fed trade model suggests that a 10 percent appreciation of the U.S. dollar is associated with a 2.6 percent drop in real export values over the year. Consequently, the net export contribution to GDP growth over the year is 0.5 percentage point lower than it would have been without the appreciation and a cumulative 0.7 percentage point lower after two years
So in approximate terms we have a present impact in play of around double that.
The estimates above all rely on that latin phrase which means “all other things being equal”. Of course they never are! And the history of the credit crunch is that a lot is in play at whatever point you choose. Let me illustrate by picking just one influence the price of Dr.Copper.
This has been falling since early 2013 in this phase although the peak was back in 2011. Over the past year it has dropped by just over a quarter to US $2.24. Now if we look at its impact on the US economy we see that step one provides a boost via a cheaper price for a basic commodity. Monetary policy muddies the waters a little as the US Federal Reserve of course does not like something which it has contributed to which is lower inflation. But a simple step one is easy. Happy Days.
However it does not stop there as there are losers such as commodity producers as well as other winners such as other commodity consumers. Then we have something perhaps not so cheery if we consider why it is falling in price? As if that is less demand than we thought we had then Taylor Swift needs to get ready for a burst of “trouble,trouble,trouble”. On that road we can look at yet another disappointing set of trade figures from China over the weekend as it is a major commodity player/consumer.
If we look at other countries you might think that they would be unreservedly happy as they have a lower exchange rate versus the US Dollar in general. The Bank of Japan and the European Central Bank will be pleased it is helping with something they wanted anyway. But others such as many South American countries and others will be frowning as their falls have created problems with inflation. You might think that such a thing is very odd in our current disinflationary environment but I guess over time there have been examples of fires in the Arctic.
Also it would be remiss of me to remind you of the generalisation that commodity prices often move in the opposite direction to the US Dollar which creates its own cross-currents. This time around a stronger US Dollar has also seen falls in the gold price.
There is much to consider here and let me return to the subject of interest-rates. Back in September a major factor in the US Federal Reserve’s inaction was in my opinion concerns over low commodity prices and a strong dollar. Those who automatically assume it will raise next month might lie to note that they are back. The dollar rise reigns back the chances of a rate rise but of course did it depend on expectations of it? I will stop there on that point as you can just keep going and merely point out that for the US and indeed Euro area and UK in 2015 the main monetary player has been the exchange rate as yes I do count the beginnings of ECB QE in that especially after the latest disappointing business lending figures. But of course the relationship between QE and currency value is another area where one can end up “spinning around” like Kylie albeit much less gracefully.
One important factor we do not know is how long this will last as we will not know the full impact until as George Bension put it “hindsight is 20/20 vision”.
As for musical influences well the financial markets have been singing along to Aloe Blacc for a while now.
I need a dollar dollar, a dollar is what I need
Well I need a dollar dollar, a dollar is what I need
And I said I need dollar dollar, a dollar is what I need
And if I share with you my story would you share your dollar with me