A new era for foreign exchange
The constant stream of political structural events facing the world economy has defined a new era for foreign exchange in which forecasting and decision-making are increasingly challenging, according to HSBC global head of FX strategy David Bloom.
Analysts, policy-makers and investors have already heard from the UK’s Office of Budget Responsibility in the past week as the fiscal watchdog warned the economy was likely to shrink by 0.1 per cent this year compared to a prediction of 0.8 growth in March.
In the US, a power struggle between President Barack Obama and the Republican-controlled House of Representatives is under way over whether more than $600 billion in spending cuts and tax rises should be allowed to kick in on January 1 that will have the country staring over the so-called ‘fiscal cliff’.
Meanwhile, the European Stability Mechanism is waiting for a call from Spain, while Japan goes to the polls next weekend.
London-based Mr Bloom was in Malta for a few hours between Tuesday and Wednesday to address a business breakfast themed A New Era for FX.
“Why would anyone care for short-term data?” Mr Bloom told The Sunday Times. “Before 2007, we were more interested in economic cycles, yield curves and interest rates, and investors had relative strategies. There were no political risks at the time. Now there are political structural issues. Purchasing managers have to get through this year first before planning for 2013 – and the situation might not be resolved within the next four weeks. Managers need to hedge their risks and not think they can outsmart the markets.”
The worst problem lies in the US where there is concern that a Greek-style austerity situation will cause a cataclysmic collapse in demand and GDP. The debate centres on whether to extend $650 billion of temporary tax cuts and to increase debt by another $650 billion a year. Mr Bloom pointed out that if the fiscal cliff is resolved, equities will rise but the impact on the dollar is unclear.
The Spanish problem, Mr Bloom added, presents itself at a time when Europe is ready to deal with it through an institutional framework, the European Stability Mechanism and bond-buying programmes. The US fiscal cliff has meant that the market focus has not been on pressurising periphery bonds which is why Spain has not approached the ESM yet.
“The dollar is slowly eroding while the Europeans are on their way to exposing and dealing with all their problems,” Mr Bloom explained. “But it is done in European time: slowly, methodically, and through the institutions. It takes time. What has the US done to solve its problems? Nothing. It keeps borrowing Keynesian-style to try to get the economy going so debt will go down, but in fact the economy never picks up and debt continues to rise.”
Mr Bloom’s outlook on Japan is optimistic – it is a net creditor, owns its own bond market, and obviously cannot default to itself. He believes the yen will rise in value as the country has trillions in net external assets built over the past 40 years. The market is wrong to think the Japanese Central Bank will step in to take more action as it is against Japanese culture to do anything radical.
Put simply, the budget deficits underlying the current world order are the result of adults getting what they want and their children paying for it, Mr Bloom said.
“We are passing the problem on to the next generation. The last generations have outspent their future, and maybe we have as well. That is the essence of the problem. The solution is slow growth over a very long period. We must learn that we are not going to get rich at the rate we thought we were.”