Fed Meeting Leaves Analysts Scratching their Heads but EM Currencies Rally
2016 has been dominated by commodity price weakness and a rampant US dollar. However the tide is turning as the Fed and key market players realise the risks of maintaining a strong USD for the big picture. Anxiety has returned to the markets and high volatility is commonplace. Investors are uncertain about the future direction of the global economy, with many opting for a negative outlook based on the complete loss of confidence in central banks around the world. Financial stocks on the S&P 500 index have plunged across the board, with only 8 out of the 90 stocks reporting profits in 2016 to date. Add to that the real concerns about deflation taking root in Japan, across Europe and elsewhere, and the picture becomes grim.
A growing contingent of analysts is now of the opinion that the US will enter recessionary times in 2016 and this is being fueled by China weakness, the commodity price rout, a strong USD and a firestorm of investor dissatisfaction with the financial sector. There have been several notable developments outside of the US that are now weighing on US sentiment, notably the actions taken by the Bank of Japan to reduce the deposit rate to -0.1%. This move threw the global economy into a tailspin, since nobody was expecting the governor of the Bank of Japan to announce such a startling decision. Nonetheless, it gave policymakers at the Federal Reserve Bank pause with respect to the March interest-rate decision.
At the recent meeting held in Washington DC, Janet Yellen spoke of a robust US economy that is capable of sustaining further rate hikes. She also underscored the volatility in global markets, including equities markets at home as a result of the general perception among investors that the global economic picture is grim. There is decreased confidence in the ability of central banks to halt the financial rot, but Yellen and other policymakers remain convinced that the right way forward is a series of gradual interest-rate hikes throughout 2016.
Financial analysts and forecasters who were polled in January were overwhelmingly convinced that the first rate hike of the year with take place in March 2016. Barely a month later and the majority of those respondents have now pushed back expectations of array type to June, some even December 2016. The fact of the matter is that China weakness, the commodity price rout and slack global demand will not react positively to a rate hike in the US. USD will appreciate against a basket of currencies, causing dollar-denominated commodities demand to decrease substantially. This will cause a further weakening of emerging market currencies and result in accelerated capital flight from those countries, disinvestment on a large scale a chasm between the success of EM countries and developed countries.
Positive Economic Data from the US
According to the Bureau of Labour Statistics (BLS), the official US unemployment rate is down to 4.9%. This is a level it is not seen since the global financial crisis 8 years ago. In other positive news, there was an increase in hourly wages of $0.12. However there are concerns about the slowing pace of new hires as January figures were substantially lower than December figures. For the year to date, the USD has performed well against a basket of currencies, notably the Russian ruble - the USD has appreciated by 7.37% against the Russian ruble in 2016. It has also appreciated by 2.69% against the Korean won, 2.62% against the South African Rand and 1.21% against the Chinese renminbi. The greenback has depreciated against multiple currencies too for the year-to-date, including the Japanese yen (-5.8%), the Swiss franc (-2.45%) and the Singapore dollar (-1.38%) among others.
Asian currencies have been hit hard recently. On Friday, 12 February 2016, Japanese stocks were hammered. The reasons for the sharp selloffs in Japan are not dissimilar to the reasons for the sharp selloffs all over the world – a loss of confidence in central banks. The Japanese currency has heretofore been regarded as a safe-haven asset during times of regional instability, notably with China. The yen actually managed to turn around against 31 currencies on the back of China weakness in 2016. However it plunged by 0.7% against the greenback to close the day out at 113.22. Other currencies that have been hitting the skids include the South Korean won, the Malaysian ringgit, and the Thai baht. The 2-day meeting with Janet Yellen offered some hope to emerging market currencies, in that the likelihood of a rate hike appears to have been pushed back from March 2016 to June 2016. This has tempered volatility in the markets, and resulted in more bullish sentiment for emerging market currencies. This was evidenced by the strong gains made by the South African Rand, the ruble and the ringgit. However, the general consensus among currency traders is that 2016 will be a difficult one for emerging markets. Any short-term rallies in the currency cross-exchange rates are unlikely to hold for any period of time owing to the structural weakness in China, the oversupply of crude oil and a total loss of confidence in financial markets.