Even though the FX market is usually considered as an esoteric asset class, it happens that a lot of opportunities were in currencies last year. I mainly think about the Yen and the Euro, but the chart shows the main currency performances against the Dollar.
(Source: Hard Assets Investors)
We saw a couple of weeks ago that the economy increased at an annual rate of 5 percent according to the third estimates, the highest print since Q3 2003 when GDP rose by an outstanding 6.9.%. In addition, we saw in October that the final numbers for FY2014 federal deficit was $486bn (or 2.8% as a share of GDP), $197bn lower than the $680bn recorded in FY2013 and the lowest deficit since 2008 as you can see it on the chart below.
On the top of that, the unemployment rate stands at a multi-year low of 5.8%, down 2.1% over the past couple of year. The only scary figures is US debt [like any other country], which now stands at a record high of 18tr+ USD, up 70% under Obama (10.6tr USD back in January 2009).
Another Good Year for equities…
I have to admit that with the Fed’s exit at the end of October, I was a bit anxious on the consequences it could have on the equity market, especially after the several ‘swings’ we saw (January, October). In my article Could we survive without QE (Part II with US yields), I added a chart (S&P 500) where you can see the impact on the equities each time the Fed stepped out of the bond market. Clearly not good.
But it didn’t. And after the 2013 thirty-percent rally, the S&P500 increased by another 11 percent in 2014 [and closed at records 53 times].
It looks to me that there are a lot of positive facts and the Fed can eventually start its tightening cycle. However, the collapse in oil prices will weigh on US policymakers’ decision in my opinion.
I think the question now is: which one will weigh more on US policymakers’ decision to tighten (or not)?
I strongly believe that the two main indicators the central bank is watching are the equity market and oil prices. An increasing equity market tends to have a positive effect on consumer spending (through the wealth effect). As a reminder, consumer spending represents 60 to 70 percent of GDP for most of the well-developed economies.
However, falling oil prices, with now Crude Oil WTI Feb15 Futures trading at $51.80 per barrel, is problematic. First of all, problematic for oil exporters’ countries (i.e. Chart of the Day: Oil Breakeven prices). We saw lately that Saudi Arabia announced that it will face a deficit of $38.6bn in FY2015, its first one since 2011 and the largest in its history (no projected oil price was included in the 2015 budget, but some analysts estimated that the Kingdom is projecting a price of $55-$60 per barrel).
I am just back from Kuwait City where I met a few investors there with a friend of mine (Business Developer in the Middle East), and most of them agreed that there were comfortable with a barrel at $60.
To me, falling oil prices reflect the weakening global demand and real economy effects. With the Chinese economy slowing down (GDP growth rate of 7.3% in Q3 is the slowest in five years), major economies back into recession (Triple-dip recession for Italy and Japan) and rising geopolitical instability, forecasts are constantly reviewed lower and problematic for debt stability [and sustainability]. I like the chart below (Source: ZeroHedge) which clearly explains that oil prices and global demand are moving together. In fact, lower growth projections combined with low oil prices and [scary] low yields are problematic for the Fed.
Moreover, falling oil prices is problematic as it will drive US [and global] inflation lower. The inflation rate is slowing in most of the developed economies: in November, UK inflation fell to a 12-year low of 1% in November, EZ policymakers are still working on how to counter rising deflation threat (prices eased to a 5-year low of 0.3%) and US CPI fell at the steepest rate in almost six years to 1.3%. Most of the countries whose central banks target inflation are below their target.
2015: New Board, new doves…
In addition, as you can see it below, the ‘hawks’ members – Fisher and Plosser – are out this year and this could change the tenor of debate within US central bank’s policy-setting committee.
(Source: Deutsche Bank)