As 2011 dawns, financial markets appear more opaque than I remember them being in a long time. I had believed for the last several months that the dollar would continue to hold strong into 2011, particularly given the apparent recovery in the US economy — strong consumer spending this Christmas — and, of course, the permacloud over Europe.
And while that still seems to me to be the percentage play, recent market action — in particular the Australian dollar climbing above parity, and copper, the global commodity bellwether, pushing all-time highs — is giving me pause. Granted, year-end markets are thin and it is usually very suspect to base any medium-term decision on movements at this time.
But, as I said, the visibility is really poor. There are some certainties, of course — for instance, there is little question that the European problem is far from resolved. While Greece and Ireland have bitten the bullet and taken on ECB support, it is still nowhere near clear that they will be able to both impose severe spending restrictions and create adequate growth to prevent another cap-in-hand visit to Frankfurt. Again, markets have just started tickling Portuguese and Spanish bonds and it is surely just a matter of time before they put the union to even more stringent tests. And, of course, the biggest determinant will be how long the German electorate will agree to continue to be the check-writer of the last resort.
Something’s got to give.
The second problematic area is Mr Bernanke and his QE2. Risk assets — in particular, commodities and commodity currencies — have been rocking over the past month, driven by this next flush of liquidity and, of course, strong growth in China and India. The dollar has held its own — the DXY is still around 80 — but this is partly because the euro is so weak. Again, the US consumer seems to have come back to life, if the December sales figures and consumer confidence numbers are to be believed. However, the “strong” consumer recovery in the US is definitively based on “deals” and anecdotal evidence suggests that merchants in the US are expecting this to be the story of at least the next couple of years — sales will rise, but margins will be very, very tight. This suggests that the US cannot afford a weaker dollar, which will drive prices higher.
Unemployment, of course, remains the major issue, and, while it is really a structural problem — both in the US and Europe, most manufacturing is hugely uncompetitive — the solutions being bruited about are superficial ones that enjoy some sort of political possibility. Here, of course, a weaker currency would help, but the scale of weakness needed to render US workers as competitive as, say, Chinese ones, is so vast that using only this lever is a non-starter.
And, finally, of course, there is resurgent inflation in the fast-growing economies, notably China and India. Both central banks are on the job, which means that interest rates in these already attractive markets are going to remain high. This would continue to attract that free QE2 money being thrown about by the US Fed, creating serious asset bubble management problems in the East.
China has already taken things in hand — the Christmas day hike in interest rates and the government’s announcement that it would be open to buying Portuguese bonds make it clear that the Chinese are extremely concerned about the world economy, which they need to keep afloat if they are to continue their miracle. More importantly, they recognise that there is a vacuum in global leadership (and dineros) and are moving with characteristic speed and focus to take centre stage.
Having a strong godfather underpinning global growth is, of course, a huge plus, but it is also clear that rising domestic prices in China will keep upward pressure on the yuan. This means that, sooner rather than later, the days of the “China price” are numbered. While many global producers, certainly including companies in India, will heave a sigh of relief, this is going to be bad news for the US, which is the last place on earth that can live with higher prices.
All very unclear, isn’t it? Will commodity prices continue to rise, slowing growth globally? Will the dollar finally collapse under QE2? Will the euro survive?
Look for markets to jockey around nervously in the early part of 2011, before some event blows things out. My sense still is that it will be in the direction of a stronger dollar.
