Economic conditions improving…just not in the UK
2013 has brought with it a surge of optimism around the world with equity markets buoyant, the debt crisis calmer, and America avoiding falling off the so-called Fiscal Cliff at the eleventh hour. This has prompted some to suggest that 2013 could legitimately be branded as being the first “post-crisis year.” Unfortunately, the UK didn’t get the New Year’s Resolution.
So, with the spotlight firmly on the UK economy, it is perhaps no fluke that this has materialised in-line with improvements elsewhere. We do often see this in the currency markets and it is frequently referred to as the rotation of risk, with the eurozone, US and UK each taking the mantle to bear the brunt of pent-up markets.
With this in mind, it is perhaps no coincidence that fears in the eurozone died down towards the end of the summer last year, just as the US fiscal situation took precedent. The same can also be said for the UK’s recent woes coinciding nicely with not only a surge in optimism in Europe but also America surviving its debt dilemma.
In reality, not too much has changed – the ruthless currency markets have simply decided to highlight what we already knew- that the UK economy is very poorly indeed.
Spotlight on the UK economy, and it is not pretty
Make no mistake about it - the pound’s start to 2013 couldn’t really have been much worse.
January has seen it stoop to its lowest level against the euro in 14 months, and 5 months against the US dollar. To put this in perspective, the pound’s performance over January is its worst since the height of the crisis in December 2008 and its poorest ever against the euro since its inclusion in 1999 - all very depressing.
Sterling’s fall from grace has been rapid - you only have to go back a few months to find glorious talk of the UK’s safe-haven appeal, but the currency markets certainly have short, fickle memories. The reason for this is that the spotlight is firmly back on the UK economy and its incredibly weak fundamentals. A bizarre surge of optimism in Europe, coupled with America avoiding yet another debt debacle, has forced markets to once again sniff out the weak and unfortunately the UK currently seems to be winning the ugly sister competition. The euphoria of 2012 is now very much a distant memory.
News that the UK economy shrank 0.3% in the final quarter of 2012 acted as the main protagonist for GBP weakness and raised the questions over whether we actually ever exited recession - with the economy pretty much in the same place now as it was four years ago. The political debate is now raging over whether the government should consider easing fiscal policy to try and boost growth, given that a triple-dip recession is now a scarily real possibility. To add to this, given that the deficit is actually increasing rather than shrinking - it ballooned 7.3% on the financial year, there is now a compelling case that the UK should be stripped of its prized triple-A credit rating.
The UK high street is in crisis, with Blockbuster the latest casualty to join Comet, Jessops and HMV in administration since December. Consumers are choosing to save rather than spend, and David Cameron has concocted some great political instability by promising a referendum on the EU. Add to this, the incoming Bank of England Governor, Mark Carney, implied willingness to implement more quantitative easting (QE) when he takes control in July, and unfortunately the future looks decidedly bleak.
The euro, so strong…what’s going on?
So, the single currency is trading at a 14-month high against the pound and the dollar, and it has suddenly become fashionable to declare the debt crisis as over. Yes, the immediate sense of crisis has receded and the intensity of the problems diminished, but what has become apparent is that there is suddenly a huge disconnect between the eurozone’s hard economic data and global investor’s improved perceptions.
Whilst there have been a series of positives, for the most part it does seem that the euro’s recent run can largely be attributed to policymakers actively talking up the single currency. Head of the European Central Bank, Mario Draghi, in scenes reminiscent of his now infamous “whatever it takes” comments last summer, reiterated that he expects the eurozone to recover towards the second half of this year and that the “darkest clouds” have now passed. A Greek Finance Minister bold claims that he is “100% certain that 2013 will be the last year of recession for Greece” perhaps best illustrates how important a role confidence plays in the current climate.
So, with markets lapping this up, there is a growing sense that all of this euro strength could be more than a little artificial and that the economic establishment has suddenly become appallingly complacent and sympathetic. Perhaps markets are simply sick and tired of the debt crisis, but in the same way that sentiment may have become way too negative at the height of the crisis, it does seem that to some extent markets have concocted a largely imaginary recovery.
In reality, there is no reason that sentiment should have shifted as we have not seen any fundamental reforms. Economic data is still very grim, and the entire monetary union is almost certainly still in recession. Youth unemployment in Spain stands at a staggering 55.13% so it is no wonder that their economy contracted by 0.7% in the fourth quarter of last year. A French Labour Minister, who must have missed the “talk up the euro” memo, let on to the fact that “France is totally bankrupt”. Even the German economy, which, whilst still showing some signs of life, was battered into recession again, contracting 0.5% in the fourth quarter.
Are we finally about to see a shift in the USD?
The dollar has certainly had a mixed start to 2013, in part down, to distortions from the “Fiscal Cliff” but also because there are suggestions that the way the dollar reacts to certain US data could be about to change. As such, it is currently trading at a 14-month low against the euro, but a 5-month high versus Sterling, and for once its pricing is largely influenced by the value of its counter-parts.
By managing to successfully resolve half of the Fiscal Cliff at the eleventh hour (and kick the other half just about far enough down the road), it appears that the whole “risk-on/risk-off” regime which has dominated market thinking (and the dollar’s value) since the credit crisis appears to be unwinding. Over the past few years, strong US data has generally hurt the dollar - the premise being that the Federal Reserve will keep interest rates on hold forever, at rates close to zero thereby squeezing yield hungry investors out of US markets and into foreign currencies.
The reason we are seeing this shift is because the Federal Reserve, in response to an improving US economy, is slowly coming round to the idea of unwinding its extensive QE3 policy. This is by no means a guarantee, but the very fact that it is at least being openly discussed is significant, prompting some to speculate that we could see a move perhaps even as early as this year. With this rational in mind, we could potentially see the risk associated mantra come to an end, which, in theory, will mean stronger US data once again being dollar supportive.
The US economy, now with its warring politicians out of the limelight, is actually performing relatively well. Wall Street is roaring once again as companies defy gloomy markets, consumers are spending, and unemployment is slowly being tackled, prompting the Fed to expect moderate growth this year.
We did have a bit of a shock when GDP data came in disappointingly below expectations, revealing a 0.1% contraction, especially as the world’s largest economy shrink for the first time since the end of the recession. A closer look at the data however does suggest it needn’t be panic stations; it was a case of growth stalling at the end of 2012 rather than the beginning of another recession. The question really is, can it continue?
What lies ahead for GBP?
The threats to Sterling over the next few months are fairly self-evident.
The most immediate concern will revolve around growth. With the horrific GDP figure from the last quarter of 2012 now behind us, we can at least take solitude in the fact that it is at least out in the open. We will now, however, face on-going speculation that the UK economy will enter a triple-dip recession and the rebound that was anticipated in the first quarter of 2013 (continuing the economies zigzag pattern) could very well have been squashed by the snow.
With the Chancellors plans in tatters, it genuinely could be a matter of weeks before the UK is stripped of its triple-A credit rating. The plan that we had been promised, and that markets have believed in, has simply fallen apart, and it is understandable that faith has been lost. If this were to transpire, this really could be the final nail in the coffin, as if one major rating agency downgrades the rest will soon follow.
Add to this concern that a UK referendum will act as a barrier on any capital inflows (whilst not to mention cause great political instability) and that the Bank of England could once again become keen on more QE and it is no wonder that the pound faces such an uphill battle.
With this in mind, it is perhaps prudent not to panic and look at the markets from a slightly longer-term view. Yes, the UK is in a bit of a tough spot, but it is perfectly rational to suggest that the hammering the pound has taken recently is a little overdone, and it perhaps won’t be too long before we are all once again discussing the horrific situation the eurozone, because despite the recent cheer, fundamentally not much has changed.
One thing is for sure though and that is if we don’t see a significant uptick in UK macro-economic data to convince markets that there is still life in our economy, it is hard to see anything but further Sterling woes.
What lies ahead for EUR?
Moving forward, it is certainly hard to imagine how the euro’s recent run of form will be sustained, as there is surely only so long that policymakers can actively single-handedly support its value. However, whilst this may not make any sense, we do still have to be conscious of the irrational nature of the currency markets, and we would still not be surprised if this continued to flummox clients.
The market has certainly not accidentally missed the endlessly horrific economic data - it has merely chosen to disregard it for now. For the moment, data has certainly become irrelevant, and in the same way that poor data is not damaging the EUR, economic announcements that exceed market expectations (however rare they may be) are by-in-large not supportive either.
Unemployment figures in early February are expected to be truly dismal, showing that the jobless rate has hit 11.9%, which would put it at its highest level since records were first gathered in 1995. However as already mentioned, this will arguably continue to play second fiddle to how the overall market place regards the monetary union.
Until we see a marked shift in the way the Eurozone’s obvious problems are conceptualised, it is hard to see an immediate change in attitude. However, at some point we do expect the debt crisis to flare up again, and whilst it is difficult to predict what the catalyst will be, it is even harder to fathom how this complacency can continue.
What lies ahead for USD?
The next few months will likely prove pivotal in determining whether or not the dollar is now taking a more traditional approach to US economic data. As mentioned before, there is increasing talk that we could see a shift in the way it is priced, which will see it take a more conventional approach to certain announcements. For example, if strong US data continually prompted the dollar to appreciate (which is certainly sensible) it will make pre-empting its value a lot more rational; rather than simply being a shot in the dark.
If this does pan out, there is certainly scope for the dollar to gain ground given that its economy is slowly grinding forward which, when compared to the UK and much of Europe, is a significant achievement in the current climate. That said, this sudden change we have been discussing is certainly not going to happen overnight, and if US economic conditions continue to deteriorate, thereby prompting the Fed to consider extending rather than unwinding its QE3 program (which is certainly possible), we could well see old habits return.
Add to this the fact that asides from this, the dollar will always be greatly convoluted by its staggering safe-haven demand in risk averse markets, and its future still remains very uncertain. Therefore, moving forward the dollar will still always be sensitive to overall market sentiment both in the US and around the globe. We also can’t help but get the feeling that it won’t be too long again before we are all once again assessing America’s fiscal stance, with some suggesting that we have only averted the calamity for the time being.