Economic data is notori-ously volatile. Each time an indicator is released, pun-dits rush to explain why it rose (or fell) and what it does (or does not) mean. Attempts to forecast eco-nomic developments can easily get bogged down into the minutiae of one month’s non-farm payrolls suddenly pointing in the wrong direction. A far better picture is likely to emerge by standing back from month-to-month shifts and trying to spot key themes.
For 2013 and 2014, there seem to be two or three of these. The themes for 2013 are ‘currency wars’ and ‘diverging growth’. The theme for 2014 is ‘heading for the exit.’
Currency depreciation
‘Currency wars’ refers to the attempts by a number of coun-tries – notably, but far from exclu-sively, Japan – to depreciate their currencies in the hope that a lower exchange rate will stimulate exports and kickstart growth. The key point here is that in a world where some countries try to lower their exchange rate and others do not, the strongest currencies should logi-cally belong to the latter group.
Logical – but by no means guar-anteed because the group of coun-tries who are not by word or deed trying to talk down the value of their money includes the United States (US), Canada, Australia, Sweden, Norway and the euro area (EA). Within this group, the euro is still likely to weaken due to recur-ring crises. This leaves the ‘three dollars and the ‘two crowns’ as most likey the strongest currencies in 2013. Within that group, the US dollar and the Swedish krona are likely to be the strongest, thanks to more broadly based economies, less commodity dependence and a better growth outlook.
The second theme – ‘diverging growth’ – refers to the fact that where the US economy is showing clear signs of recovery and there are some stirrings in East Asia; continental Europe and the United Kingdom (UK) remain in recession or are at best able to achieve sub–par growth. This is even true for Germany, hitherto the EU star per-former, which is now beginning to suffer from lack of demand in the rest of the single currency zone. By contrast the US should see output growth reach trend (estimated at 2.0%-2.5%) or even higher in the second half of 2013.
Diverging growth in 2013 should mean diverging central bank policies in 2014. So far, central banks have fol-lowed similar paths – with slight dif-ferences from economy to economy. This has consisted of ultra-low interest rates, injections of liquidity into banking systems, attempts to boost credit growth and – with the main exception of the European Central Bank (ECB) – Quantitative Easing.
However, while the ECB and the Bank of England (BoE) are likely to keep monetary policy loose in 2014, the Federal Reserve (Fed) faces a more difficult choice. If the US economy does grow at or above trend in the second half of 2013 and faster in 2014, the unemployment rate is likely to reach the Fed’s 6.5% target by mid-2014.
It is difficult to see how the Fed could then justif y a continued lt r a-lo o s e mone t a r y p ol ic y without giving rise to concerns about eventual inf lation. Instead, the debate is likely to centre on the Fed’s exit strategy. The best thing the Fed could do would be to raise its policy interest rate by the end of the year. Not neces-sarily by much; but even a 25 basis point (0.25%) increase would send a powerful signal the economy has recovered and that it is time to begin the process of normalising interest rates.
Of course, all this is subject to no surprise from that bane of all fore-casters – events. But that large parts of the world economy are recov-ering is at least reasonably good news – and good news for asset prices as well.
