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MACROECONOMICS

What is Driving the Dollar?

global markets, central banks, USD, What Driving,, Dollar, Macroeconomics, fx trader, forex

17 Feb 2015

There is a high degree of uncertainty in the global markets. How deep into negative territory can nominal bond yields fall?  Has oil bottomed? Are deflationary forces deepening? Will Greece remain within EMU, will the monetary union be stronger or weaker, as a result?

Returning to basics may be helpful in providing a ballast. The investment climate was shaped by the divergent economic outcomes from the different policy responses to the financial crisis. The US and UK are ahead of the other high income countries. Their central banks are expected to hike rates first, with the Federal Reserve going later this year, and now it appears likely that the BOE follows suit next year.

In the mean time, the ECB continues to ease monetary policy, and its sovereign bond buying program will begin next month and run through at least September 2016. The Bank of Japan continues its very aggressive unorthodox monetary policy.  It is expanding its balance sheet by 1.4% (of GDP) a month. The BOJ targets core inflation, which includes energy, and it then adjusts for the sales tax increase last April.  By its own measure, despite the unprecedented pace of monetary easing, price pressures have been moving in the wrong direction. Many expect further easing later this year.

Two elements have been called into question. First, the US economic growth has cooled after expanding around twice the pace of trend growth (labor force growth and productivity gains). The 2.6% pace in Q4 14 is likely to be revised lower, possibly below 2%.  Growth in the current quarter is tracking around 2.2% according to the Atlanta Fed's GDPNow model.

Second, the decline in oil and interest rates, and the adjustment in the foreign exchange market are lending support to the world economy. As we have noted, the euro zone's real sector and financial data have been improving. Money supply and bank lending have continued to recover. Last week Q4 GDP was reported at 0.3% quarter-over-quarter, which was a little better than expected. The flash PMIs for the eurozone will be reported at the end of the week ahead. It is expected to confirm the modest pick up in activity has continued.

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