Archives par catégories : Countries/Regions

The Fed’s big bet

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With thirteen of its sixteen members believing that monetary tightening would be appropriate starting in 2015 and ten of those believing that the level of the Fed Funds will be greater or equal to 1% at the end of next year, the message delivered by the Fed following its meeting on March 18th and 19th breaks with its past communication. Standing in stark contrast with the bond market’s current anticipations, this shift is liable to trigger sharp reactions, which is troubling for a variety of reasons:

– for the capital markets, first, the distinct possibility that interest rates and the equity markets in the US and elsewhere in the world will overreact to this shift in tone;

– for the US economy, second, whose robustness is unclear and ability to deal with more expensive credit even more uncertain;

– and for emerging markets and the countries of southern Europe, lastly, who are exposed to the increasing risk of capital flight. 

The appreciating euro or the competitive deflation trap

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You heard it here first: the euro would not drop versus the dollar and could even increase. And here we are. During trading yesterday, the euro flirted with USD 1.40, its highest level since October 2011 after gaining in excess of 7% since the start of the year. This is a worrying development, which could erase nearly all of the support that improving global conditions have provided to exports.

Two reasons explain why our forecasts, unlike the market consensus, never strayed from the EUR 1.40/euro exchange rate in the past two years:

• the first is rooted in our skepticism with regard to 1) the consensus that the US economy is presumably in good health and 2) anticipations that the Fed would normalize its monetary policy in response to the expected improvement.

• the second is grounded in the side effects of the competitive deflation policies carried out by the EMU countries. The shrinking inflation gap between the euro area and the rest of the world, resulting from these policies, protects the currency’s purchasing power. Consequently, these policies offer de facto support to the euro, particularly versus the greenback whose value is automatically diluted by the massive scale of pump priming in recent years.

Therefore, it is hardly surprising that the recent disappointments on American growth have pushed the euro higher, especially since the ECB dashed all hopes of additional monetary easing last week.

Mr. Draghi Seems Quite Sure of Himself…

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The President of the ECB is confident in his ability to stare down deflation risk and bring the inflation rate up to its official target of 2%…on a 2016 horizon. Well that was reassuring; the euro celebrated the news by increasing to USD 1.386 this morning, a record since October 2011! Could we have expected anything different? Apparently not. The ECB wasn’t about to shoot itself in the foot by announcing that its forecast pointed to a deflationary scenario, tacitly recognizing that it would fail in its deflation battle.

Global Inflation – Disinflation Is Gaining Ground Across the Globe

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At the global level, disinflation is gaining ground. After a temporary rebound during spring, global inflation continued its downtrend in the second half of 2013 and ended the year at 3.2%. Inflation remains very weak in the developed world, at 1.3% in December, and has also sagged in many emerging markets in recent months, to finish 2013 at 6.1%.

In fact, as of December 2013, nearly half the countries (39) in our sample of 80 countries had inflation rates of less than 2%, which is markedly higher than a year ago (24). These figures have seen the addition of a growing number of Asian economies (6), the United States and Canada as well as all 27 members of the EU – without exception. Moreover, the number of countries with moderate inflation (3-4%) decreased sharply while the proportion of high-inflation economies (>6%) has not changed considerably and includes African countries and conflict-plagued countries for the most part.

  • Disinflation Is Gaining Ground Across the Globe
  • Commodity Prices Easing
  • Price Picture Still Mixed in EMs
  • Deflation Risk Remains High in the West  
  • United States, Not Quite in the Clear Yet
  • Euro Area, Deflation Risk Spreading to Core
  • Imports, an Additional Source of Disinflation
  • Increase in Real Interest Rates, the Bigger Threat

Shift Afoot in China?

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Just noise or a real signal? The hypothesis that the sudden drop in the Chinese currency in recent days is unlikely to have major repercussions and has been orchestrated by the authorities in the sole aim of curbing speculative currency flows on the currency, is not completely unfounded given the wide-scale efforts to eradicate the growing sources of shadow banking. Assuming the hypothesis is true, the move would be a sea change, and a worrisome development for a number of domestic sectors that are heavily-dependent on foreign financing, although one with no major direct consequences on other countries.

However, the reasons liable to underpin a strategic shift with a view to provoking the yuan’s depreciation are more than sufficient to support the theory that a forex policy shift is afoot in Beijing – with much more potential damage occurring abroad. After two years of near-continuous increases, the appreciation of the Chinese currency is a major handicap for the country and cannot, by all accounts, continue indefinitely. Consequently, the time of the much-feared policy shift, which we have been fearing for several quarters now, may have finally come (for more on this subject “2013-2014 Scenario: The Financial Crisis, Act III… and Epilogue?”).

Has Spain Found a Winning Strategy?

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Moody’s decision to upgrade Spain’s sovereign debt rating last week is yet another sign that investor confidence is returning to the Iberian Peninsula—a region often held up as a model for crisis-stricken Southern Europe. The Rajoy administration hopes that lowering Spain’s labor costs will boost the country’s competitiveness, enabling it to export its way out of the crisis. With a battered economy and an arduous deleveraging process that will likely leave a lasting dent in domestic demand, many see this as the only strategy for Spain to get back on track to balanced growth—even if it comes at an immediate high social cost.

So is Rajoy’s bet paying off? Has the Spanish economy picked up enough over the past few months to mark a lasting turnaround in the country’s fortunes?

Let’s Not Kid Ourselves, Mr. Draghi

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The euro area is unquestionably doing better. In fact, it’s now the world region with some of the most upbeat indicators, from business climate survey results to industrial production and the outlook for exports. So the first quarter will see growth across the currency bloc—far from dazzling, no doubt, but still well above prior expectations. But let’s not kid ourselves: eurozone countries are going to be in trouble unless they get additional monetary policy support.