BNY Mellon: Currency Relativity

Nov 7, 2018

By Neil Mellor Senior Currency Strategist, BNY Mellon

As investors ponder the possible implications of the US mid-term elections for the USD, it is a good time to remind them that the US is an oasis of stability compared with unrelenting economic and political problems in Europe.

The US economy has a distinctly a Goldilocks feel to it: near-full employment and moderate, stable inflation prevail despite the second longest period of growth since WWII. Put another way, there are worse positions for the Fed to be in when looking to normalise policy - like the one facing the ECB for example.

Indeed, we may deliberate the rate at which the eurozone is slowing: GDP growth hit its weakest level since 2014 in Q3 although Markit’s finalized PMIs yesterday suggested that Q4 may not have got off to as bad a start as the provisional data suggested.

Annual wage growth has picked up in perhaps the most positive development of late, but ironically, it has been matched by headline inflation – the product of higher energy costs which tend to sap incomes and growth.

But either way, what is hard to refute is that a pan-eurozone unemployment rate of 8.2% - with huge disparities therein – and a core inflation rate that has barely moved from 1.0% in four years, is a poor starting point for the normalization of extraordinary policy settings.

Without access to printing presses, slower growth may mean that governments see sharp increases in rollover costs and hence debt to GDP ratios, which have undoubtedly stabilised in part due a higher contribution to GDP from government spending.

Yet it is the disparities in trends and the EUR’s flaws that are most problematic to the ECB. We have written at length about Italy’s dispute with the EU, but recall that a principle motivation of its government is the modification of the growth and stability pact (which can only be bolstered by Italy’s near slide into recession).

While we focus on ‘fiscal profligacy’, the currency bloc’s principal creditor continues to run a tight budget which has translated into the largest current account surplus the world has ever seen. From 2020, Germany’s states will not be permitted to run any structural deficit at all.

To speak in anything other than relative terms about the US economy and its currency would be to gloss over some evident caveats – mid-terms besides: present similarities with the end of USD rallies-past cannot be ignored (as we have argued previously)