With the decision in December to start tapering asset purchases from January 2014, the Federal Reserve has started to put some blue water between itself and its major peers in Japan and Europe, except perhaps the Bank of England, and importantly, between current policy and the five year-old experiment with QE. It’s worth noting that the Fed could reverse the tapering decision at any time if more anemic economic circumstances or excessively weak inflation warranted. But if the economy, now without the fiscal headwinds of 2013, can expand by 2.5-3% in 2014, and perhaps at the top end of this range or a bit more in 2015, then we should expect steady increases in nominal GDP growth and falls in the unemployment rate. This has already stirred expectations of a change in policy rates, and higher bond yields.
The Federal Reserve has insisted through forward guidance that it wants to keep policy rates stable until the unemployment rate has passed ‘well through’ 6.5%. Whether the December reading of 6.7% was as close to this threshold as it seemed isn’t clear because the data suggest the labour force dropped by 400,000 in December, driving the unemployment rate down 0.3%. The reasons are opaque, ranging from an end to extended unemployment benefits (pushing people out of the force) to an on-going decline in the labour force participation rate that may have both cyclical and structural causes. We shall just have to see what happened at the start of 2014, and then take a view about how soon 6.5% might be reached. But it places the new Fed Chair, Janet Yellen, on the back foot at the very start of her term of office. She doesn’t want the Fed to be ambushed into a tightening of policy that she and many colleagues still think is way premature. But the very fact that financial markets are having this discussion could be a bit of a tonic for the US dollar.
Other factors could help the US currency too.
Budgetary policy and complicated Washington politics have been a cause of weak US dollar sentiment from time to time, and may resurface in the spring when the statutory debt ceiling has to be extended. But agreement over the budget, for the time being at least, holds out the prospect of a more benign environment in 2014-15. The fiscal position in the US is, in any case, of limited concern for a while.
According to the Congressional Budget Office, the fiscal deficit in the 2012/13 will be around 4% of GDP, compared with a peak of 10% in 2009, and is predicted to drop to 2% of GDP by 2015. Federal debt held by the public is expected to fall from 72% of GDP to 68% by 2018. Under current programmes, though, the outlook will then deteriorate in the 2020s and 2030s, and this requires that the Congress act long beforehand. But for the next 2-3 years, the US fiscal position can be described as benign.
There has been a lot of discussion about if and how quickly the US is carving out a position of comparative advantage relative to Europe, Japan and China. The US is the only major power where the population is predicted to keep growing, and the pace of population ageing will be considerably slower than in Japan, Germany and China. Further, the US will become more important in the advanced group of countries over the next decades as its share of population grows from a quarter to a third, and its share of output from 37% to 54%.
These advantages are certainly not transparent or of immediate consequence, but other advantages are, such as the extraction of competitive gains from leading the charge towards new, advanced manufacturing technologies and towards relative energy independence, courtesy of the shale oil and gas revolution. The International Energy Agency expects the US to produce more oil (broadly defined) than Saudi Arabia by 2017. The US Energy Information Administration notes that the boost to domestic oil and gas production has meant that the share of net imports of liquid fuels in consumption has already fallen from 60% in 2005 to 33% in 2013, the lowest share since 1970. By 2015, it expects a further reduction to 24%. But whether or not the US achieves independence any time soon, the steady decline in the energy trade deficit is already fact.
So far the US dollar has been a bashful bull, rising mainly against a bunch of emerging market currencies, such as those of Brazil, Mexico, Russia, Turkey, Indonesia and South Africa and of course against the Japanese Yen, and commodity currencies like the Australian and Canadian dollars. But provided the US economy, with all its continuing frailties especially in the labour market, can continue to eke out growth of 2-3% and keep deflation at arm’s length, we may be witnessing the early stages of a US dollar surge that could last until 2015 or so.