domingo, 10 de enero de 2016

domingo, enero 10, 2016

Dangerous Escalation In Currency Wars - Next Move U.S. Treasury

by: Tim Clayton


Summary

- Global currency wars are liable to escalate over the next few months as China devalues.

- Without international co-operation, there will be growing domestic demands for US trade retaliation and a weaker dollar.

- The US currency is liable to weaken sharply from any move to near parity against the Euro.

 
Global central banks outside the US will be under sustained domestic pressure to boost growth through aggressive monetary policies, but this policy will increase the risk of globally crippling trade wars as the US Treasury and Congress will be under intense pressure to respond with sanctions if the dollar continues to appreciate. The Federal Reserve will be boxed in and find it increasingly difficult to curb domestic excesses with higher interest rates. In this environment, there will be growing pressure for dollar strength to be curbed either through multilateral co-operation or unilateral US Treasury intervention. Risk/reward for holding long dollar positions against European currencies will be increasingly unattractive.
 
The latest US manufacturing PMI release registered the second successive reading below 50.0 and the lowest since Mid 2009. Surprisingly, the export component actually registered a figure above 50 which suggests an expansion in overseas trade, but the overall export performance has been lackluster at best with November goods exports the lowest level for over three years and there will be growing concerns surrounding the US manufacturing sector. Although competitiveness has certainly been improved over the past few years by falling energy costs, this is being undermined by a stronger dollar and the US economy is not immune to the strong-currency impact.
 
There has also been further evidence of an escalation in currency wars over the past few weeks.
 
Late in 2015, the Chinese central bank effectively switched to targeting a stable yuan against a trade-weighted basket of currencies rather than against the US dollar, a clear signal that the PBOC was looking to weaken the yuan against the dollar and the Chinese currency has moved to five-month lows against the US currency.

The ECB has pursued an aggressive monetary policy, in part to push the Euro weaker in an attempt to ease imported deflationary pressures. This week, the Swedish Riksbank indicated that it was now willing to intervene in the market at any time to weaken the krona against the euro. The Bank of England was effectively forced to rule out a first-quarter increase in interest rates due to lower inflation forecasts and Sterling strength against the euro.
 
Although the Bank of Japan has been expressing greater confidence surrounding the inflation outlook and looking to declare victory in the battle against deflation, the stronger yen and lower energy prices will trigger a fresh decline in consumer prices over the next few months with the bank back to square one. Japan is also losing competitiveness in regional markets once again as the yuan weakens. There will be growing pressure on the Bank of Japan to sanction another boost to the quantitative easing program.
 
With the Federal Reserve raising interest rates in December and expecting to tighten further during 2016, the dollar has pushed higher once again with a fresh advance against European currencies. The yen has also strengthened against all major currencies at the start of 2016. The Federal Reserve and Treasury are likely to be increasingly uneasy over the implications of a stronger dollar, especially given the pace of gains seen during the past 12 months.
 
It can be argued that the stronger dollar will have a beneficial impact as it will tend to limit the scope for Federal Reserve interest-rate increases. There is, however, a major problem in that US economic growth is being supported by internal demand and there is a strong case that interest rates are too low for the domestic economy. There is a growing risk of destabilizing domestic bubbles and accelerating inflationary pressures within sectors not exposed to international competition.
 
The Federal Reserve will either have to set interest rates too low for the domestic economy in order to curb further dollar strength or it will have to push rates higher and risk a serious contraction in the manufacturing sector.

Politically, this issue will also become increasingly sensitive in a presidential election year.

There will certainly be strong congressional pressure for more aggressive trade action including, for example, retaliatory action and anti-dumping tariffs on China. Trade policy would also be a key element in the presidential campaign and protectionist rhetoric would intensify. Any move to parity against the Euro could be a breaking point for US officials, at a minimum US rhetoric would become more aggressive with verbal intervention. The last thing the global economy needs in the current cycle is an escalation in trade wars and international co-operation is needed to avert these risks.
 
A further strengthening of the dollar will also increase debt-servicing costs in dollar-denominated loans which will cause further stresses within emerging economies. This will tend to negate the potential beneficial impact in the form of lower debt interest costs, especially as bond yields would eventually rise in the face of increased domestic inflationary risks.

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