We have been continually bullish on the USD throughout 2014 and the dollar has started to repay our faith through the second half of the year. It will continue to do so should we see data smash expectations like Friday’s payrolls announcement did.
The US economy added 321,000 jobs in November, more than the 230,000 the market was looking for and driving to the highest level since January 2012. As ringing endorsements go, there are few better than a release that strong. We also saw a positive revision to October’s number – 243k from 214k – and most importantly, a 0.4% increase in earnings, keeping the year on year figure at 2.1%. It is this last number that is all important to us as it will in turn govern the outlook for inflation in the United States.
The argument around the movements in monetary policy in the US and Eurozone are very similar, although in very obviously different directions. In the Eurozone, inflation expectations are low and falling continually and all everyone can talk about is the need for lower rates. With the higher wages in the United States, it is only a matter of time until inflation expectations in the US start to run higher.
As we have pointed out before, within developed economies, inflation expectations have been very well anchored throughout the course of the Global Financial Crisis. That is to say that the average American, Brit, German, Japanese, and Swiss etc. have been relatively unworried about prices rising too quickly in nominal terms. Whether this is a function of relatively low levels of inflation within developed economies in the past 25 years and the implicit belief that developed economy central banks are therefore adept at fighting inflation is up for discussion but guards the Federal Reserve’s decision making process.
In the short term, it has had an obvious effect on the USD. As we open up in Europe we are looking at fresh two year lows in EUR/USD while USD/JPY has hammered to fresh seven year highs. GBP/USD is eyeing up the 1.55 level and the commodity currencies – AUD, NZD, CAD – are all getting hit hard as investors pile into the USD. Of course, it is not just US economic strength that is driving these moves but the weakness seen elsewhere.
The euro is lower this morning as the market continues to bet on the belief that the European Central Bank’s stimulus efforts will have to take a dramatic surge higher in 2015 to rescue the beleaguered Eurozone economy. This Thursday, the ECB will tell us how much money European banks have borrowed as part of the latest TLTRO lending program that was supposed to increase lending to the continent’s real economy.
Unfortunately, expectations have fallen dramatically and expectations are that the number will fall short of EUR150bn. That seems like a lot of money but is nothing compared to the EUR270bn that Eurozone banks are due to repay to the ECB between now and February. These repayments stem from loans made in 2011. With Draghi’s desire to take the European Central Bank’s balance sheet close to EUR3trn – EUR1trn higher than current levels – something else must be done.
JPY is getting hit hard as the second reading of Japanese GDP for Q3 showed an economy deeper in recession than had been originally thought. Output contracted by 1.9% in Q3 on an annualised basis, more than the 1.6% seen at the first estimate and rounds off a pretty poor picture for Shinzo Abe as his campaign for re-election as Japanese PM picks up. It’s a case of how high can you count for some people when looking at the yen versus USD moving forward and we believe that Abenomics will continue to weaken the JPY into 2015.
Despite an article in the Financial Times this morning that says home owners are in a position to handle a rate rise in the UK, GBP has not been able to take advantage this morning. The report from the Bank of England states that up to 200bps of rate increases could be taken up by mortgage borrowers with only 4% of those borrowers being pushed into a situation where they would have to cut back on spending habits and/or increase their hours worked. Sensitivity around rate increases has been a worry for MPC members in the past 12 months but this report may help to soothe those fears moving forward.
AUD and NZD are lower this morning on a poor Chinese import number overnight. Imports fell by 6.7% in November it was shown, missing a 3.7% expected increases.
