Investor’s get to kick start the New Year for real this week. Hopefully all will go according to plan despite the frigid weather conditions that currently dominate +140m peoples lives throughout the US and Canada. All asset classes have been playing make believe over the recent holidays, as market liquidity remained the unknown variable.
2014 is expected to be a very different year for various Central Banks with the previously united stimulus front about to get a general makeover. “Following the leader” is not going to be a prerequisite anymore. The Fed is to get a new head at the helm and Janet Yellen will be remembered as the lady who began pulling back on the US’s quantitative easing amid stronger domestic growth (very much preserving helicopters Ben Bernanke’s legacy). Across the Atlantic Ocean, Bank of England’s Governor Carney will be doing his level best to try and cool the UK’s housing market, while his counterparts at the ECB and Bank of Japan will be fighting their fear of “deflation.” As early as this week, Draghi and company at the ECB may get to put into motion various monetary actions or policies to stimulate ‘price.’
To all forex watchers, it has become obvious that the “mostly synchronized stimulus that supported the world economy for the past six-years, ” has many investors believing that the sign posted trade for 2014 is a much stronger dollar, aided by higher long term US treasury yields. Should the market now be expecting the end of easy money? Nope, not possible, the ECB and especially the BoJ will be most concerned about deflation providing its own death grip on the Japanese and Euro economies. The priority again for this year for most Central Banks will be the need to keep interest rates at or near record lows. The Fed for the past six-months has gone to great lengths to convince the market that tapering is not equal to a tighter monetary policy. Investors seemed to have finally bought into this because of the shape of the US yield curve. The front of the curve remains relatively low (US 2’s +0.39%), while the tail continues to back up in an orderly fashion (US 10’s +2.98%).
The Central Bank with the different monetary stance will be giving investors an opportunity and that’s the best they can hope for early in 2014. For the past two-years the various asset classes have been handcuffed by Central Bank actions, making it very difficult to find that “utopia investment trade.” In forex, both volume and volatility had been dramatically curtailed by Central Banks actions during H2, 2013.
The varying Central Bank monetary themes for 2014 will provide investment opportunities, especially when policy makers get a stronger handle on how best to implement their own monetary policy. For the Fed, this week’s U.S. jobs report will surely set the tone for the depth and breath of US taper for this year. On Bernanke’s exit it was easier to introduce a token taper last month, he managed to get the “ball rolling,” but how much momentum does the US economy really have?
An economy that is gaining traction will eventually lead to higher borrowing costs via higher treasury yields. This scenario goes a long way to support the “mighty dollar” throughout 2014. Last year against its ten largest trading partners the dollar happened to rally +3.5%. The varying economic trajectories amongst the G10 members should be capable of boosting the dollars value even higher than last year. If Central bankers don’t get to “handcuff” the forex space as they have been doing over the past 18-months in particular, there is a distinct possibility that both volume and volatility may be capable of making a much-anticipated welcome return.
In the US, stocks were the big winner in 2013. Despite starting out this year on the back foot – Asia currently leading the global equity market correction – stocks are very capable of having another stellar year in 2014. With major central banks beginning to set down on diverging paths in terms of monetary policy, consistent growth traction in the US could lead to the greatest “gravitational pull” story for this year, providing even more support for the “mighty buck.”
Even China’s growth story is beginning to change. The HSBC PMI Services data over the weekend for the world’s second largest economy managed to hold onto growth, but it was the lowest reading in nearly 32-months. Europe is not that different; this morning’s peripheral Euro-zone PMI Services continued its improving trend – Ireland and Spain reported 7-year highs. However, the core again highlighted the uneven economic recovery for the region as a whole.
Little will discourage the Fed’s current actions. Bernanke’s second term ends in a matter of weeks and this weeks US employment report will go a long ways in helping to decide how much US policy makers will pare back its monthly bond purchases – somewhere between $10-$75-billion. The market believes that the FOMC will continue to taper over the next several meetings before ending the program 11-months from now. The Fed will act alone, and will not be influenced from outside. The outsiders, the remaining G7 in particular are concerned that higher rates in the US will eventually drag their own domestic rates higher, threatening the more-fragile expansions elsewhere globally. Analysts will tell you that this is a very likely scenario because of the “highly correlated” capital market system that democratic economies run.
The ECB’s Draghi and company has been proactive against weak price pressures. Last November, Euro policy makers cut its benchmark rate to +0.25% “to shore up inflation now less than half its target of just below +2%.” Other headline data helps to support their recent actions. The Euro-zone Q3 GDP fell -0.4%, while October’s unemployment rate remains close to a record high (+12.1%). Reports like this certainly do not rule out further easing in the short term. There is a real possibility that the ECB may have to implement “negative” deposit rates or offer new long-term loans. Either course of action should put the 18-member single currency under pressure. December has been a horrid month for the weaker EUR short positions – they have mostly lost the battle, but not the war. Many have been squeezed out at most opportunities over the past few weeks, pressured even more so by lack of liquidity. However, this is a new week, New Year and soon to be a deeper market with more investors.
The Bank of Japan may be required to pursue a policy of more stimuli, especially since PM Abe’s government has raised the sales tax to +8% from +5% this coming April to curb its debt. Consensus believes the Japanese government will be required to boost its asset purchases to achieve their +2% inflation target. Short Yen outright against the dollar was the patience trade for last year. Those positions will again dominate forex talk for H1, with ¥110 being the medium term target.
Governor Carney is in a tough position. The BoE has already indicated that its benchmark rate will stay at +0.5% this year. However, relatively stronger data is pushing UK policy makers towards a stimulus exit. Just before Christmas, the BoE indicated that it would “dilute a credit-boosting program as housing prices, sales and mortgage demand all accelerate.” It may be time for the BoE to scrap its forward guidance and tell everyone how long they intent to maintain the +0.5% cash rate. UK policy makers have very much underestimated the their own economy’s economic strength. The unemployment rate could hit +7% this year rather than in 2016 when first reported. Sterling seems to have found some support after dropping -250-pts from its 2014 highs (1.6605). UK PMI data would suggest that the pound looks like a good bet at current levels.
Ok, the UK will stick, the ECB could ease and the BoJ may buy more assets, but who will be the first to tighten in 2014? The odds favor the Kiwi’s. Many expect the RBNZ to be the first to raise its benchmark rate this year, from +2.5%, “as accelerating economic growth and a housing boom stoke price pressures.” No matter what, the risk of a premature withdrawal of support (BoJ in 2000, ECB in 20008 and 2011) will leave policy makers relying more on “forward guidance” this year. They do not want to fall into the Carney trap. Being clear and precise with all policy messaging will avoid confusion or any investor surprises. Telling the public how long to expect low rates helps investors to restrain market-borrowing costs, while promoting investment. It’s not a new concept, but it’s a necessity. The FOMC has been successful in their messages – “tapering isn’t the same as tightening monetary policy.”
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