Australia | Jun 20 2013
– Fed dust must now settle
– Japan may need more stimulus
– German election key in Europe
– Beijing hampered by property bubble
– More AUD weakness expected
By Greg Peel
Last night US Federal Reserve chairman Ben Bernanke used a scheduled press conference to put an end to the rampant speculation over monetary policy that has driven global market volatility these past several weeks. The Fed’s policy did not change, rather Bernanke provided clarity with regard to the FOMC’s thinking on timelines for an eventual QE exit.
If the US economic recovery continues on its current trend, and the Fed’s forecast employment and inflation targets are on path to be met, the central bank will first reduce the quantum of its monthly asset purchases later this year, then cease asset purchases around mid-2014, then look to raise its cash rate incrementally from 2015. It is important to note the Fed is not signalling an “exit” from QE, but a gradual end to ongoing QE. The Fed will not reduce its balance sheet, but rather stop increasing it.
The timeline is not set in stone and requires the US economy to play to script. If not, the Fed will either extend its timelines, or even increase its monthly purchases as per a policy agenda that has remained consistent over 2013. But for now global markets can set to expect the first QE tapering to begin maybe as early as September, or perhaps not until as late as December. Interim data, particularly non-farm payrolls, will provide greater certainty.
FOREX.com was not expecting an announcement on tapering to come as soon as the June FOMC meeting, believing September ratification to be more likely. The currency specialists published a September quarter 2013 Markets Outlook ahead of last night’s meeting and suggested more volatility to come for US stock, bond and currency markets as the tapering debate dragged on. We can now assume that once Wall Street finds its equilibrium level in the wake of Bernanke’s revelations, a good deal of potential volatility is removed. But that is not to say global markets can now rest easy and coast through to year’s end. There remain many sources of global volatility to consider, FOREX.com warns, emanating from other major financial regions across the globe.
The Bank of Japan began implementing its new, aggressive monetary policy strategy in April under the new governor and with the encouragement of the new prime minister. The pace and amount of BoJ asset purchases has increased significantly in this time, affecting a major devaluation of the yen. The goal is to achieve 2% inflation in Japan within two years, following two decades of entrenched deflation.
For now the BoJ appears satisfied with its efforts to date, expecting Japan’s CPI to turn positive in the September quarter. FOREX.com expects the central bank to largely remain on the sidelines for the time being, but believes more stimulus will eventually be needed if the 2% inflation target is to be reached in the timeframe.
While Japan’s new strategy has met with criticism and scepticism in some quarters, major world economies and organisations have voiced their support, including the International Monetary Fund. Thus the BoJ has been given a global green light to keep up the good work. The yen’s devaluation has not been achieved without a sharp correction from the initial sell-off, and FOREX.com expects further yen weakness ahead with increased volatility and even sharper corrections.
The major yen correction came about as a result of the strong rise in yields on Japanese government bonds. As the Fed introduced successive QE programs from 2009 to 2012, US government bond yields fell to historically low levels. The BoJ is now doing likewise yet JGB yields have shot up. The governor has optimistically put the yield increase down to expectations of GDP growth and inflation ahead. However FOREX.com points out the inherent danger in higher JGB yields is that they negate the value of QE and force the need for more.
The government also plans to do its bit with fiscal stimulus measures to support the radical monetary policy stance, including a stepped increase in the consumption tax. Both monetary and fiscal initiatives will take time to filter through the Japanese economy, FOREX.com notes, and the data will dictate whether more stimulus is needed and a yet weaker yen can be expected.
There will also be a new man in the governor’s chair of the Bank of England next quarter. UK markets are anticipating a swift increase to the BoE’s existing QE program that has remained unchanged for some time, but FOREX.com believes it could yet be months before any changes are made. Since the GFC the UK has suffered a near stagflationary environment of high inflation and low growth. Previous attempts by the former BoE governor to increase QE fell on deaf ears with the Monetary Policy Committee indicating the governor’s power is not absolute. If former Bank of Canada governor Mark Carney is to attempt to raise the level of British QE he still has a lot of convincing to do, FOREX.com warns.
On that basis the pound is likely to continue to appreciate, and only fall swiftly in the unlikely event the new governor is able to speed up the printing presses in a hurry.
There will be two federal elections of note in the month of September. Australia’s result is as good as known and will have little global or no currency impact. The result in Germany is nevertheless not so clear, and volatility awaits. Angela Merkel’s national approval ratings are currently on the right side of healthy, but her party has suffered high-profile losses at recent local elections.
The German election presents a significant sovereign risk in Europe. The eurozone sovereign crisis has abated in recent months, peripheral bond yields are back to normal levels and the European Central Bank appears to have matters under control. The eurozone economy is far from recovering, but appears to have stabilised for now. If Merkel wins her election she should solidify her position as the de-facto leader of Europe, FOREX.com suggests, and at present the polls are in her favour.
A Merkel win would be well-received by markets, which prefer the stable status quo. A brief relief rally might be in order, but little ultimate market impact is expected from the German election unless Merkel does not win. Recently Merkel has eased off on her strict austerity stance and provided some deficit leeway for struggling eurozone economies. Europe is nevertheless unlikely to emerge from recession until 2014, FOREX.com believes, and unemployment levels remain drastically high.
While the ECB has managed to calm the situation it has done little to encourage growth, and bank lending continues to contract, although FOREX.com does not believe the central bank will be spurred into any action in the September quarter following the rate cut in May. Unless another sovereign flare-up eventuates, the ECB should remain ready and willing, but quiet over the next three months.
The euro has been rising uncomfortably of late and any further rise may prompt the ECB into threatening a cut to deposit rates, but the Fed tapering announcement should reverse the euro on dollar appreciation from here.
The IMF suggests the world economy is currently split into three regional speeds. Top speed represents emerging countries with persistently strong growth, mid-speed represents economies that are on the mend post-GFC and includes the US, Australia, Canada, New Zealand, Sweden and Switzerland, while low speed represents those economies with some way to go such as Japan and the eurozone. Such unevenness provides for ongoing fragility but tail risks have now abated, the IMF believes. FOREX.com expects world growth ahead to remain subdued and uneven, with tight fiscal policy in Europe and the US inhibiting stronger growth in Asia. Japan is gradually picking up and China has slowed to a more sustainable growth level.
FOREX.com expects US growth to have slowed in the June quarter from the March quarter, but notes leading indicators suggest a pick-up in the September quarter. While US manufacturing has slowed this year, consumer confidence has rebounded strongly in the world’s largest consumer economy. Growth will likely be below potential next quarter, but still an improvement on this quarter, FOREX.com suggests.
US corporate profit growth began to slow in the March quarter but analyst consensus still has a healthy annual growth rate of 8.5% pencilled in for 2013. FOREX.com fears forecasts may need to be downgraded as a tapering of QE forces investors to pay closer attention to corporate balance sheets. They may not like what they see. If that’s the case, it may be difficult for Wall Street to rally out of any post-tapering announcement correction.
Both the Aussie and Kiwi dollars have experienced a “perfect cocktail” for devaluation this quarter, FOREX.com notes, given anticipated rate cuts from the Reserve Bank of Australia, a drought in New Zealand, weakness in China weighing on commodity prices, and a global swing back towards the US dollar. More pressure on the Aussie is expected as the resource sector spending boom peaks and the non-mining economy drags its feet in filling the gap, prompting likely further rate cuts from the RBA. China is a concern on both sides of the Tasman.
The Aussie dollar was already overvalued, FOREX.com claims, and the foreign unwinding of Australian bond positions is likely to continue.
Global markets would prefer Beijing to be loosening policy right now, but the government is hamstrung by the significant property bubble, which threatens the capacity to manage the gradual slow-down. The Chinese central bank is limited in what it can do to ensure a smooth transition to a domestic-driven rather than export-driven economy. FOREX.com nevertheless thinks Beijing has both the will and the capacity to prevent a hard landing.
Clarification from the Fed will take some of the immediate madness out of global markets, but the world is far from sitting in a comfort zone. Markets will need to work through their initial responses to the Fed’s planned withdrawal of stimulus in the near term, and then the longer term outlook beckons.
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