Tags: euro | US | CLI | growth

Where Are All the Strong Currencies?

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Tuesday, 11 Feb 2014 12:35 PM Current | Bio | Archive

On Tuesday, the new Federal Reserve Chair Janet Yellen will face her first hearing of the week before the Financial Services Committee of the Republican-controlled House, where she will have the opportunity to let the world know if there is any chance of tapering the Fed's actual tapering of its bond-buying program and if that would be the case, what should have to have happened to the ongoing, albeit slow, still-ongoing U.S. recovery.

The second hearing is scheduled on Thursday before the Democrat-controlled the Senate Banking Committee.

On both occasions, she will read her "prepared" testimony, after which she will have to answer questions whereby she will probably try to "teach" economics, which should, I'm not saying will, enlighten the House and almost all kind of investors all over the globe. For the moment we have no other choice than wait and see if the Fed will actually intend to stay its tapering course and keep its monetary policy "stable" in the foreseeable future.

I'm really interested to learn how she replies on the more technical questions, like how she sees the degree of "spare" capacity in the U.S. labor market.

In the meantime on Monday, the Organization for Economic Co-operation and Development (OECD) released its latest composite leading indicators (CLIs), which are designed to anticipate turning points in economic activity relative to trend.

The CLIs for the United States, the United Kingdom, Japan and Germany continue to point to further strengthening economic growth.

Notwithstanding the still-good expectations on the U.S. economy, we are obliged to keep an eye on the fact there still may be questions about the debt ceiling Tuesday, with House Republicans planning to vote on increasing the limit Wednesday. I personally I don't expect a "clean" vote, which would certainly upset Democrats. Treasury Secretary Jack Lew has sounded the alarm bell of impending disaster on Feb. 27 if nothing is achieved. I personally don't expect any kind of disaster.

That said, Japan, which remains extremely important to the world economy as a whole, still faces a serious caveat because for now it remains impossible to foresee what the real impact will be of the consumption tax rate hike in April, which will be the first rate hike since 1997.

Long-term investors should keep in mind the consumption tax rate hike in Japan in 1997 resulted in a very bad experience — shortly after it was introduced Japan fell into a recession.

More encouragingly is the fact we see the CLIs for the euro area as a whole, and especially for France and Italy, and for Canada indicate a continuous positive change in momentum.

The CLIs for China, Brazil and Russia point to growth around trend, which, it must be said, is not sufficient to shield them from any serious global turmoil, if that would have to occur in the foreseeable future.

Coming back on the euro area for a moment, I think actual optimism and complacency on the single-currency area really conceal serious risks that still lurk under the surface.

There is still political risk that the elections to the European Parliament, which take place at the end of May, could show a much stronger-than-expected performance of the so-called euro-skeptics, which could, in accordance to recent polls, get up to 30 percent of the votes. If that were to occur, it could make the still absolutely necessary and still pending structural reforms extremely difficult to achieve.

On Monday, we also had French Minister of Industrial Renewal Arnaud Montebourg saying in interview in the French daily "Les Echos" he would like euro area politicians to engage in what he calls a "battle" to weaken an overvalued euro that is holding back France's economic activity and trade. Montebourg said a 10 percent depreciation of the euro could create 150,000 jobs in France alone.

Remember, in 2007, when the euro rose from a low of $1.285 to a high of $1.49, then President Nicolas Sarkozy's administration also asked for action to lower the value of the euro, but at that time, among other things, the Chinese were substantial buyers of euros. Maybe, this time things are somewhat different and Montebourg could be somewhat more successful than was Sarkozy in 2007. I think he has a fair chance of getting what he wishes for.

Interestingly, also on Monday, Swedish Finance Minister Anders Borg announced measures to weaken the too expensive Swedish krona in order to help its exports, but also, interestingly, to bring down internal debt levels by installing still tougher credit rules on the banks than those that are already in force and which have made so far the Swedish banks the best capitalized banks in Europe.

One could ask themselves: "Where are all the strong currencies, then?" I don't think it's a good idea to look in the direction of the euro for the rest of the year. Of course, I could be wrong.

In the context of well-capitalized banks in the euro area, I think it would be a good idea to keep an eye on November of this year, when the European Central Bank (ECB) banks' stress tests will become public. These results could easily set off a new sovereign debt scare and reignite various simultaneous crises in the Mediterranean euro area countries.

No doubt that some euro area banks will not pass the ECB stress tests. It's obvious that markets are currently disregarding all associated risks, particularly in the periphery countries.

Already, Daniele Nouy, chair of the ECB's supervisory board, said in an interview with the Financial Times: "We have to let some banks disappear in an orderly fashion, and not necessarily try to merge them with other institutions."

Last October, ECB President Mario Draghi said: "If they [the banks] do have to fail, they have to fail. There's no question about that."

Keep also in mind EU banks may be required to hold capital against their sovereign assets, which is a tougher approach than has been the case in the past.

Investors should expect a bumpy road ahead in the euro area, because there are too many "invisible" and "unknown" potholes.

It's up to any investor for themselves to decide how much risk they're willing or able to take on if they have euro-related investments.

The good news is that everybody still has time for trying to avoid this potential risk area by changing location. In my opinion, it's only a question of time before reality and logic come back to the forefront.

By the way, the latest OECD unemployment rate estimate for the euro area remained unchanged at 12 percent. Interestingly, Spain was down 0.3 percentage point to 25.8 percent, Italy down 0.1 percentage point to 12.7 percent, while the rates came in unchanged for France at 10.8 percent and Germany at 5.1 percent. One could say "divergence" in full swing.

Euro area youth unemployment rate remained extremely high in Greece, at 59.2 percent in October (the latest month available), Spain at 54.3 percent, Italy at 41.6 percent and Portugal at 36.3 percent.

In the United States, the unemployment rate decreased by 0.1 percentage point to 6.6 percent and in Canada it decreased by 0.2 percentage point to 7.0 percent.

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HansParisis
It's up to any investor for themselves to decide how much risk they're willing or able to take on if they have euro-related investments.
euro,US,CLI,growth
1196
2014-35-11
Tuesday, 11 Feb 2014 12:35 PM
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