The US currency is only 0.5% below the opening level of the year, looking at the DXY dollar index and has been on a rising trend for most of the week.
Whilst there are concerns with the turn in peripheral bond markets and the softer tone to equities this week, the FX markets have been in a ‘risk-off’ mood for most of the month to date, with the Brazilian real 5% softer and the Aussie nearly 3% lower.
There’s a debate to be had as to what extent this is down to the better US data and there has been more from Fed officials overnight suggesting that rates are likely to be raised before the end of 2014 – despite the previous pledge by the rate-setting committee.
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But equally key have been the perceived stretched valuations of some of the higher-yielding currencies, with Brazil being the most vocal and active in its fight against a stronger real. This week’s moves suggest bond and equity markets are only just coming round to the FX markets’ way of thinking.
Tough times for the Aussie. During the current month, the tone towards the Aussie has turned rapidly negative, in a manner not dissimilar to previous purges back in November and August. One of the major triggers for this mood change is the growing fear that China’s economy is slowing more rapidly than is consistent with a soft landing. With growth expectations in both China and Europe under scrutiny, base and precious metal prices continue to head lower, representing an additional tailwind for the AUD. Domestically, the non-mining economy is in recession, property prices are declining, the labour market is in the doldrums and there is every chance that the RBA will again lower rates before the middle of the year. Aussie bulls were also rattled by a WSJ report quoting a senior PIMCO portfolio manager claiming that the AUD could plunge to 0.90 this year. Also weighing on the Australian currency is the strength of the dollar, which these days is being buoyed by the perception that the US economy is on a firmer footing than other majors. Traders remain long the Aussie. The danger for them in the near term is a rapid decline towards parity.
Ireland slippage. Ireland has officially moved back into recession, GDP contracting 0.2% in Q4 of last year, with Q3 revised up from -1.9% to -1.1%. Despite this technicality, yesterday’s release is not all bad news. Nevertheless, there has been a definite shift this week towards focusing on the economic risks that currently prevail in the eurozone. Ireland has done better than most in making the required economic adjustments to regain competitiveness, with nominal wage costs lower vs. early 2009 in contrast to the increases seen in the rest of the periphery. But the economic impact has been fairly severe. The economy is nearly 12% smaller vs. the peak seen in early 2008 and the impact of the myriad of bad debts will continue to be felt for many years to come. Many workers are now leaving Ireland to find work abroad, either temporarily (repatriating money back) or permanently, with 40,000 leaving over the 12 months to April last year. Given the shared language and proximity to the UK, this is a bigger risk for Ireland than for other peripheral countries. Whilst Ireland serves as a decent model of how adjustments should be done, it’s also shows that this is a very long process.
Some perspective on the US jobs market. There are always two sides to any news story. A major consequence of the prolonged period of poor jobs growth from 2008-2011 was a massive decline in labour force participation. For instance, there has been a 2m increase over the past four years in the number of people who are not in the labour force but would like to work. Since October 2008, the number of people of working age who are not part of the labour force has jumped from 78.6m to 85.1m. As a result, the employment-to-population ratio has plunged from 62.7% at the end of 2007 to 58.6%. Most worrying has been the decline in participation by those of prime working age – between 25 and 54. With this segment the participation rate has fallen by two percentage points over the past five years to 81.6% last month. The US underemployment rate, which also captures those who are working part-time but would prefer to work full-time, is now 14.9%, up from 8% in the middle of last decade, although back in late 2009 it was above 17%. It should be conceded that part of the explanation for lower labour force-participation is due to the ageing population – in other words, a greater proportion of the labour force is concentrated near retirement age and, as they lose their jobs, they are more likely to ‘retire’. Also, part of the explanation for lower unemployment is the expiration of unemployment benefits for the long-term unemployed. There is an underlying assumption that, once the economy reaches cruising altitude and confidence is buoyant, then there will be a flood of discouraged workers returning to the labour market. Most Fed policy-makers assume this to be the case. If they are wrong, and should employment growth remain as solid as it has done over the past six months, then the unemployment rate might continue to come down more quickly than most expect.Get the 5 most predictable currency pairs