Currencies | Feb 06 2012
– US economy slowly recovering from recession
– A stronger economy no longer automatically means a stronger currency
– ANZ notes current account balances also impact on currency markets
– This suggests the greenback is unlikely to gain much ground
By Chris Shaw
While stronger data in recent weeks gives the suggestion the US economy is slowly recovering from recession, ANZ Banking Group cautions this is unlikely to do much to help the US dollar strengthen against other major currencies.
This can be explained by assessing the US current account, which ANZ expects will have finished 2011 at a deficit of around 3.5% of GDP. Under a floating exchange rate any current account deficit must equal the capital account surplus, with the currency adjusting to ensure net current account and net capital account flows exactly offset.
In terms of the question of whether a stronger US economy should lead to a secular turn in the US dollar, ANZ suggests this depends on both whether the US is leading world growth and the structural evolution of the growth being generated in the US economy.
A current account deficit of more than 3.0% of GDP is not overly large when viewed in isolation, but as ANZ points out, the key is can the US attract enough flows to firstly fund such a deficit and then drive the dollar higher.
As a basis of analysis, ANZ estimates the US current account deficit for 2012 is likely to be around US$500 billion. Good news in this regard is Foreign Direct Investment (FDI) has been running at a net outflow of 1.0-15% of GDP, which implies a turn higher in FDI would suggest some support for the greenback.
The bad news is despite a 10-year downtrend in the US dollar, net FDI has been negative for most of the decade. This means the depreciation in the currency is being more than offset by structural drivers such as shifts in global demand and productive capacity to emerging markets.
To ANZ this implies some modest improvement in the US economy is unlikely to be enough to generate on its own a sustained improvement in FDI levels. What is likely to be needed is a sense the US economy has returned to prosperous, non-stimulus fuelled growth, something that has not yet occurred.
A stronger US economy should attract a greater volume of portfolio inflows but ANZ notes this has not really been the case in past months. Rather, ANZ suggests the dollar would have been weaker if central banks had not been buying US Treasury securities in unprecedented amounts.
Resident repatriation is also a factor in terms of the capital account, but this appears wishful thinking in terms of generating a stronger US dollar in the view of ANZ. This is because the actual amount of outflows in recent years has in fact been modest.
This leaves one clear conclusion for ANZ, namely that a cyclical bounce in the US economy is unlikely to be enough on its own to drive a turn higher in the US dollar. This reflects the fact the US has a current account deficit higher and interest rates lower than many debtors, a combination seen as unlikely to generate anything other than a weak currency.
For ANZ, the benefits of a stronger US economy are more likely to be seen in currencies other than the US dollar. These include emerging market currencies such as those of India, Korea and Taiwan, the Japanese yen and to a lesser extent the Australian and New Zealand dollars.
ANZ cautions the latter two currencies are likely to see some underperformance on other currency crosses even while strengthening against the US dollar. For the US dollar against the yen, ANZ continues to expect the US dollar will break to the downside, this given ongoing low US bond yields and the likelihood Japanese fiscal fears have been overblown in the market.
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