By Kathy Lien, Managing Director of BKAsset Management
Six years after the financial crisis and the European Central Bank is still struggling to turn around their economy.
As recently as December, they increased stimulus in a desperate attempt to revive growth and drive inflation higher. This illustrates how deeply entrenched the slowdown is and how poor of a job Eurozone policymakers have done this past year. In the third quarter, the Eurozone economy expanded by a mere 0.3%. During this same period the U.S. economy grew 2%. Inflation is low around the world but the approximately 10% slide in EUR/USD combined with the full scale QE program launched in early 2015 should have been more effective in boosting inflation, which ran at a 0.2% annualized pace in November – well short of the central bank’s 2% target.
2016 brings more challenges for the Eurozone economy.
While the ECB is comfortable with the current level of monetary policy they will need to extend bond purchases beyond September 2016. September is only a soft target and we can’t see a scenario where growth or inflation will improve enough 9 months forward to warrant a reduction in stimulus. Also, if inflation and growth do not make significant upside progress, the ECB may need to expand the program in the coming year. The ECB’s decision to provide additional stimulus in December reflected their sense of urgency and their overall concern about the economy. Their efforts are paying off as there have been signs of recovery in the Germany but meaningful risks lie ahead. The prospect of further weakness in emerging markets, particularly China, unstable geopolitical situations in the Middle East and Russia, high unemployment, stagnant wages are just some of the problems posing downside risks for the Eurozone in 2016. Countries in the region will benefit from the new round of stimulus, weaker euro and low oil prices but the benefits will be slow to come. France and Italy have not made much progress in terms of growth and while Spain is doing well it is only the fourth largest economy in the region. The fiscal position of most Eurozone nations is also very weak with only a handful producing a budget surplus in the past 3 years. The largest sector, financials will suffer from negative deposit rates. Debt levels are high and major progress towards reducing that burden is not expected over the next 12 months.
By Kathy Lien, Managing Director for BK Asset Management
2016 will be a defining year for the British pound – a year when politics will overshadow economics.
Considering that sterling ended the year near 7 month lows against the U.S. dollar, some of our readers may find it surprising that the U.K. was one of the best performing G10 economies. However according to the latest figures for the third quarter, the U.K. economy grew at an annualized pace of 2.1% which matches the pace of U.S. growth. In contrast the Eurozone and Japanese grew 1.6%, Australia expanded 2.5% and Canada contracted by 0.2%. There’s also very little debate that the Bank of England will be the next major central bank to raise interest rates. Yet sterling benefited from none of this and instead weakened versus the euro, Japanese Yen, U.S. and New Zealand dollars over the past 6 months. Part of the underperformance was driven by U.S. dollar strength but slow U.K. wage growth, mixed data and cautious policymakers has the market looking for rates to rise in 2017 and not 2016.
We believe the market is underestimating the Bank of England and the U.K. economy because 2016 should be a year of strong growth.
Consumer spending is the backbone of the economy and sales surged in the month of November. While wage growth slowed, labour force participation rates remain near their highest levels in 20 years and service sector activity is accelerating according to the latest reports. As the labor market tightens and inflation bottoms out, wages should rise as well. Slow Chinese and Eurozone growth poses a risk to the economy and the manufacturing sector but the U.K. is still expected to be one of the fastest growing G10 economies in 2016.
From the perspective of growth alone, the Bank of England should raise interest rates in the first half of the year. However there are 2 primary issues holding the central bank back – low commodity prices and the risk of Brexit. Oil prices could remain low for a large part of the year and as of November consumer prices are running at a 0.1% annualized pace, which is far short of the central bank’s forecast. Considering that the Federal Reserve raised rates with yoy inflation at 0.5%, the BoE may not need to see CPI above 1% before tightening monetary policy but they could be reluctant to do so until there is greater clarity on Britain’s position within Europe.
The greatest risk that the U.K. economy and the British pound faces in 2016 is Brexit.
1. UK Consumer Price Index (Aug 19)
2. New Zealand Dairy Auction (Aug 19)
3. RBA Semi-Annual Testimony (Aug 19)
4. Bank of England Minutes (Aug 20)
5. FOMC Minutes (Aug 20)
6. HSBC China Manufacturing PMI Aug Flash (Aug 20)
7. Eurozone PMIs (Aug 21)
8. Jackson Hole Summit (Aug 21)
9. Canadian Retail Sales (Aug 21)
10. US Philadelphia Fed Index (Aug 22)
There has been a lot of talk about the possibility of a U.S. government shutdown. Republicans and Democrats in Washington continue to clash on budget negotiations, raising the risk of the first government shutdown since 1995 during the Clinton Administration. Congressional leaders are in deep discussions and a shutdown could be avoided, but with the U.S. government telling federal agencies to be prepared to implement contingency plans, it is important for currency traders to be prepared as well by knowing how the U.S. dollar could react to the shutdown.
We have been down this road before 15 years ago and based upon the price action of the EUR/USD and USD/JPY at the time, investors are not too worried about the implications of a government shutdown on the economy. When the government was shut down in Nov 1995, both the EUR/USD and USD/JPY barely budged. When a second shutdown occurred during the Clinton Administration in December of that year, the dollar actually rallied against the Japanese Yen before normal government operations were resumed. The main reason is because any shutdown is expected to be so temporary that it will pose no risk to the U.S. sovereign debt rating. It will also not scare investors away from buying U.S. debt. The only major economic implication is that Federal workers won’t be paid during the period that the government is shut down. If an agreement isn’t reached by midnight on Friday, the government will shut down all non-essential government services.