Since the beginning of this year we’ve seen fourteen central banks cut their policy rates in response to concerns about slowing growth and falling prices.
Amongst these countries several European central banks have also adopted negative rates, with the Danish Central Bank, Swiss National Bank and the European Central Bank embarking onto the unknown path of experimental monetary policy as central bankers attempt to avert a slide into deflation.
Thus far their attempts have been pretty fruitless, but given the reasons behind the falls in prices it is unlikely that moving interest rates will help, as Oil prices, along with other commodity prices continue to bear down on prices.
The fiscal adjustments in the euro area are also playing a part as the adjustment of unit labour costs between euro members states is likely to keep a lid on prices, with the worst likely to come from countries like Italy and France whose labour costs remain well above the euro average.
The key beneficiary of this rush to ease policy has been the US dollar which has risen over 17% against basket of currencies since the middle of last year.
The gains have been the highest against the commodity currencies of the Australian dollar and the Norwegian Krone with the Reuters CRB index losing 30% from its 2014 highs, peak to trough, as the slowdown in the Chinese economy, and the stagnation in Europe starts to hit demand for everything from consumer discretionary products to loans and business investment.
With the US shale revolution pushing US inventory levels to their highest since 1982, oil prices have slid back, despite the US economy appearing to stand apart from the rest of the global economy, raising expectations that the next move in US monetary policy could well be a rise in interest rates.
This divergence in central bank policy has been the main driver of US dollar gains over the past few months with the Bank of England also being forced to the sidelines after so much speculation last year, that they could be compelled to move interest rates higher as well.
While expectations of a Bank of England rate rise have disappeared into the ether for this year, the same cannot be said for the Federal Reserve, with a broader market consensus remaining for a summer hike.
There is one big problem with this consensus and that is the run of recent US economic data which appears to show that the US economy is in no way as robust as markets think it is, and for this reason a rate hike this year seems unlikely.
We hear an awful lot of chatter about the US economy being a fairly closed economy compared to the rest of the world, but even allowing for that argument, and the improvement in the US unemployment rate, it doesn’t disguise that fact that inflationary pressures remain benign and wage growth remains weak.
The FOMC stated that “underutilization of labour resources continues to diminish”, which seems a rather strange thing to say given that the labour participation rate sits at 35 year lows of 62.7%, suggesting that 93 million Americans who could work have given up looking, which would appear to suggest that the amount of slack still remains quite considerable.
Furthermore despite the fact that consumer confidence appears to be at multi year highs this optimism isn’t being reflected in the hard data with retail sales for the whole of Q4 down 0.2% while durable goods have also been disappointing, down 3.2% excluding transportation in Q4.
Last week’s disappointing Q4 GDP numbers would appear to reinforce this concern of a slowing economy, though the personal consumption number showed a sharp improvement to 4.3%, which appears completely at odds with the monthly retail sales and durables data.
Consumer spending was also down in December to its lowest level since 2009, which would appear to suggest that despite the fiscal boost of falling gasoline prices, US consumers remain reluctant to spend money. This should be a concern given that consumers make up nearly 70% of the US economy.
Yet despite this Fed officials continue to talk up the prospect of a monetary tightening in the face of evidence that price pressures could well continue to ease over the coming months.
Talk of normalisation of policy is understandable, but given what happened to the ECB in 2011 when they tightened rates prematurely, you would think that Fed officials would be a little more cautious.
If deflationary or disinflationary pressures persist in the coming weeks, it would be an extremely brave central bank that tightened policy in this sort of environment.
As it is the stronger US dollar has already started to punish US companies with a strong export bias, and if we start to see a weakening of the jobs numbers in the coming days as a result of layoffs in the US oil and gas sector, then that could quickly herald a sharp change in thinking as well as a sharp drop in the US dollar, as interest rate rise expectations get pushed out.
We’ve already seen in the ISM manufacturing numbers this week, a weak prices paid component, as well as a slowdown in the employment component.
If this week’s employment report reinforces these signs of potential weakness, along with continued weak wage growth, we could well start to see an unwind in some of those US dollar long positions, and all thoughts of a summer rate rise put on hold as the consensus comes around to the prospect of no rate rise this year.
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