Little to commend the Greenback
Drivers of economic activity in the U.S. seem to be improving, the employment market is buoyant, yet inflation, and this is highlighted by the insipid rise in hourly earnings, remains benign.
It has long been a “rule of thumb” that an employment rate of 5% was considered as full employment. That is to say that all who wanted to work or could work had jobs. The U.S. employment rate has been below 5% for several months yet the effect on the economy has been negligible.
The departure of Janet Yellen from the Federal Reserve is likely to usher in a more pragmatic attitude where macroeconomic data is taken at face value and not “second guessed” looking for something that isn’t there. Until there is a clear path for inflation both is source and direction, the Fed is likely to remain on hold and this will spell a lower dollar or the foreseeable future.
The full impact (or lack thereof) of the long-awaited Fiscal Reform will be understood but won’t be felt for some time yet. President Trump will likely outline an “America First” economic stimulus package at the State of the Union address, due to be given on 30th January.
Eurozone Rate Hike expectations heightened.
With German inflation data showing a move from 1.5% to 1.7%, chatter has started about a rate hike in the Eurozone happening far sooner than expected although those rumours have probably failed to reach the most important pair of ears, those of ECB President Mario Draghi.
Draghi remains committed to rates remaining low in the Eurozone as assistance is still needed by some of the weaker economies particularly in the face of a higher common currency which slows export growth. Until inflation is consistently “knocking on the door” of 2% for the entire region the ECB is unlikely to act. Even if German inflation climbs above 2% and the calls become deafening, Draghi will feel that continuing to be reactive will be the correct stance.
One further concern for the EU will be the elections taking place in Italy, a country renowned for chaotic politics. Four major opposition parties, each vying to be part of the coalition that will be formed following voting on March 4th, plan to introduce legislation regarding the creation of an alternative currency, to be used for cosmetic transactions only. This will heighten tensions between Rome and Brussels that have always been close to boiling point. If Germany returns to the polls the pressure for a higher common currency may abate a little despite longer term strength.
Sterling set to suffer from all sides.
There has been a lull in the news coming from London and Brussels regarding Brexit but that has only meant a breather for Sterling which is now facing the additional concern of widening of the interest rate differential between the pound and Euro.
Although there has been no official data yet, the consumer appears to have to a certain extent abandoned support for the economy over the Holiday period. Higher interest rates meaning higher mortgage payments and credit card bills will curtail spending yet the gap between UK interest rates and those of its G7 partners are likely to widen. This will bring further pressure on the pound and bring further inflation concerns.
There has been a certain amount of optimism around Sterling as the old year wound done, but this seems to be unsupported by the facts. Brexit is going to bring further chaos as the terms of a future trade deal are thrashed out. A further financial burden could easily be demanded as the price of access to the single market. The credibility of the Bank of England has been severely questioned by the wholly unnecessary and pointless rate hike last November. The 1.1250/1.1300 level versus the Euro and 1.3580 area against the dollar should be considered excellent points to initiate short sterling positions.