Global Currency Clash ????

PERSPECTIVE

BRICS vs USD: the Dollar has won the battle but who will win the war? On the week that the Jackson Hole and BRICS summits coincided, we saw a clear jump in the world’s reserve currency after Jay Powell’s hawkish speech. Over the past year we have seen further evidence of two ever-clearer, opposite sides forming. The BRICS grouping is led and influenced mainly by countries the US has clashed with over recent history, such as China, Russia, and Iran. Since the global financial crisis of 2008, the Dollar index has pushed from a low of 71 up to a high of 114 and the message is clear from the East: they have had enough. After the US weaponized the dollar in the seizure of Russian USD assets in 2022, more talk has been coming – from China in particular – about forming a common currency to challenge Dollar dominance. Leading BRICS countries wish to end global dependance on the dollar in order to avoid being on the receiving end of weaponized finance in the future. The fact remains, however, that 88% of Forex transactions are conducted in Dollars, with USD accounting for 58% of global foreign exchange reserves. As we have seen over the past year, in times of global economic uncertainty, all roads lead to USD. And it is difficult to see the greenback being displaced by an alternative backed by countries that have not exactly embraced the rule of law or independent institutions, indispensable pillars of a trustworthy currency. Until the BRICS nations can convince the rest of the world that they can offer a safe, reliable alternative, the Dollar remains king.

?

US DOLLAR

• The US Dollar once again posted a strong week of gains with the DXY US Dollar index up over half a percentage point week-on-week. Markets were fairly muted until the Friday session, despite Thursday’s employment data showing once again that the US labour market remains incredibly tight. All eyes this week were on the annual Jackson Hole summit on Friday, a key market driver in which a number of US government departments collaborate and make speeches on the economy. The key speech every year is given by the Federal Reserve chair, in this case Jay Powell. Leading into the summit, markets were extremely keen to hear his comments on the state of the overall economy and the direction of inflation and interest rates. Powell reiterated that US inflation “remains too high” and necessitates the central bank either holding rates at their current level or raising them to bring inflation down to its 2 per cent target. Prior to the meeting markets had priced in cuts in Q2 2024, but after Powell’s comments these were pushed back a month into June 2024. The impact on US government bonds pushed yields on long-term debt to a 16-year high.
• Powell, did, however, stress that all the Fed’s decisions will continue to be data-driven and questions remain on the state of the economy, particularly its regional banking and commercial real estate sectors. The Fed will certainly not consider cutting rates until we see a significant weakening of labour market conditions. Federal Open Market Committee (FOMC) members do not, under any circumstances, want a repeat of the wage-price spiral of the 1970s. It seems the central bank is more willing to tip the economy into a recession, than allow inflation to get out of control. With unemployment still hovering near record lows, rate cuts certainly are not on the horizon right now. Markets will have their eyes on the monthly Non-Farm Payrolls report next Friday, a big under- or over-shoot relative to expectations could see large moves in the Dollar.
• Alongside the drivers of inflation, such as employment, a natural part of the Fed’s data-driven approach is of course to look closely at the inflation data itself. The Fed’s preferred measure of inflation, the PCE price index, will have a print on Thursday. Markets are predicting an uptick in PCE prices month-on-month. If results come in line with expectations this would reinforce Fed chair Powell’s rhetoric of ‘higher for longer’ and would more likely than not lead to increased US Dollar strength.
• Alongside hard economic data, nowcasting results from the Atlanta Federal Reserve suggest an extraordinary acceleration in third quarter growth. These results are based on statistical models that use economic data which updates more frequently than GDP to predict what GDP will be before the GDP statistics themselves have been compiled. These models have had a moderate degree of accuracy over the past several years and show annualised growth accelerating from 2.6% in Q2 to an astonishing 5.8% in Q3. If this proves to be correct, it can only add to worries over inflation and to the case for keeping US interest rates high, or even increasing them further.

?

ASIA-PACIFIC

• In China we have seen a relative data blackout after the PBOC announced, just over a week ago, that it would be limiting data releases moving forward. Alarm bells are ringing on the state of the world’s second largest economy with growth stunted, business activity at near record lows, price deflation setting in, significant stress in the property development sector, and rate cuts being implemented to boost growth. Due to the data blackout and the PBOC FX interventions, we saw CNY remain flat at a level as low as any it has reached against the Dollar since the currency was liberalized in 2010. The big news last week was the cut in China’s medium term lending facility to 3.45%, although this fell shy of market expectations and is considered too weak an intervention to materially impact China’s economic woes. In the week ahead, the extent of China’s economic malaise is set to be laid bare. Second-quarter corporate earnings reports are due to be released in the midst of a liquidity crisis and high-profile corporate debt defaults. Earnings will provide a clear picture of the real state of the economy and markets will put them under extreme scrutiny. As of Monday morning, Chinese stocks rose after regulators cut a levy on stock trades for the first time since the 2008 financial crisis, a move designed to dampen destabilizing speculative trading. A weaker than expected earnings calendar could, however, have disastrous repercussions with FDI collapsing and capital pouring out of the country. One thing we can expect from a foreign exchange perspective, however, is for the PBOC to tap into its vast reserves to support the currency. It also seems likely that, sooner or later, China’s leadership will announce much stronger measures to right the ship.
• JPY slumped to 146.6 against the Dollar on Friday after Jay Powell’s Jackson Hole speech. The BoJ is now under further pressure from certain quarters to tighten its ultra-loose monetary policy and help support its rapidly faltering currency. Japan remains the only major developed country not to raise interest rates since the pandemic as data still suggests a tighter monetary policy could lead to further deflation. Although prices driven by domestic demand are rising, recent positive inflation prints can be mostly attributed to imported inflation. The new BoJ governor, Ueda, has already taken the surprise decision to loosen controls on the government bond market – a cornerstone of its loose monetary policy. It remains to be seen if the BoJ will implement further measures, such as an interest rate rise, or if the BoJ will opt for another FX market intervention as we saw at the back end of 2022.
• In Australia, last week we saw the Aussie trade steady a touch above 0.64 USD. After a strong start to the year the Aussie is now trading nearly 10% down from its January highs of 0.715. The only data out of Australia last week saw both manufacturing and service PMIs miss expectations and push further into contraction. The Australian economy has deep links with the major buyer of its commodity outputs, China. Markets are awaiting further news out of China on corporate earnings and potential stimulus packages, which will likely be the main driver of moves in the Aussie for the foreseeable future. This week we will have a busier week of data and backers of the Aussie will be hoping for better news from the housing market and business activity after a slew of recent disappointments.

?

SOUTH ASIA

• INR was largely unchanged last week as it continues to hover around the 83 mark against USD. There were no data releases of note as the RBI continues its long running policy of a managed, stable downtrend of the Rupee.
• PKR saw a further drop of 1.8% last week as political woes continue to take their toll on the economy. After several recent incidents, news circled back to the murder trial of the still-popular ex-PM Imran Khan. It is expected he will be exonerated but social unrest is still high with over-inflated electricity bills and reports of lavish spending within the ruling party itself. This all comes at a time the consumer is being squeezed due to the terms of the IMF bailout in June. A further devaluation in PKR looks like a distinct possibility in the coming months.

?

?

MIDDLE EAST AND AFRICA

• More uncertainty is swirling around Nigeria Naira as the parallel market rate continues to widen from interbank following June’s devaluation. The official NGN/USD rate has held steady around the 770 level since the devaluation, as it appears the float of the currency is managed by the central bank, despite statements that the market would play a greater role. There is still a degree of worry around capital flight after GlaxoSmithKline announced it was discontinuing operations in Nigeria after 51 years. The newly formed government clearly has a lot of work to do in order to convince markets of its capability to stick to election promises around corruption and economic policies. If the parallel market rate continues to diverge from the official rate a further devaluation could well be on the horizon.
• Kenyan Shilling lost a further 0.5% last week as it continues its downtrend from the past two years. KES is now down 21.02% year-on-year and is showing no sign of stopping its slide. Since the Fed began raising interest rates, Kenya has struggled to keep up with its USD denominated debts, which has led to a liquidity crunch. With reports of cuts in Kenya’s benchmark interest rate to come and further rises from the Fed, it is difficult to make a case for anything other than further KES weakness for the remainder of the year.
• Over the last three weeks we have finally seen a stabilization in Tanzanian Shilling against the Dollar, following a near 7.5% plunge from March to August. As is the case in many of its neighbours, there is a severe Dollar shortage on the ground in Tanzania. Credible reports suggest the government is dishing out export credit guarantee schemes to support exports and demand for TKS. Since May this year the authorities have started purchasing gold, and by July about 400 kg had already been procured, a measure that is aimed at creating perceptions of a strong national reserve. On the other hand, the central bank has been selling hefty amount of Dollars to commercial banks at a reduced price in order to fight depreciation of the domestic currency. Complete data is not available, and the picture is somewhat confused, but this information points to a policy mix that involves using up Dollar reserves to support TKS at the same time as the portfolio of national FX reserves is somewhat rebalanced away from Dollar and towards gold.
• There has finally been some positive news for the South African Rand this past week, as it gained over 1.5% against the dollar. The Rand has been extremely volatile since reports on the sale of weapons to Russia in May pushed ZAR to record weakness against USD amidst reports of potential US sanctions against Africa’s second largest economy. Since then, South Africa has appeared to further strengthen ties with its BRICS counterparts, with several high-profile meetings of President Ramaphosa with each of the Kremlin and Chinese Communist Party leadership. Economic data in South Africa has been mixed at best over the past month and the fact remains that unemployment remains sky high at 32.6% with growth being extremely stunted compared to its African counterparts. If political and social issues cannot be resolved, it runs the risk of being left behind by more progressive African nations. One thing we can certainly predict here is more volatility.

?

EUROPE

• GBP remains the G10s best performing currency of 2023. After a series of inflation prints that revealed greater stickiness of inflation in the UK compared to other major economies and necessitated increases in the Bank of England base rate, the BoE’s interest rate differential with the Fed has all but been wiped out. The rhetoric from the BoE is very similar to their partners across the pond; both countries experienced devasting effects of wage price spirals and stagflation in the 70s and 80s and their central bankers are resolute in their desire to avoid a repeat, hence the very hawkish stance on bringing inflation down. There remain two big issues with the UK economy. Firstly growth: although dim predictions have been revised upwards, UK economic growth remains extremely weak, and this is exacerbated by the UK’s exit from the EU. Other potential trading partners are all feeling the pinch of a worsening economic picture and a period of stagflation seems all but certain if inflation cannot be brought down rapidly. Indeed, this week we have seen the first monthly contraction in the UK’s composite Purchasing Managers’ Index, a very strong leading indicator for growth. Secondly, the housing sector: unlike the US, the UK has a relatively high number of loan agreements due to expire in the coming 18 months. The maximum period for fixed term rates in the UK is 5 years, unlike the US where it is 30. Once these loan agreements move to a variable rate and payments spike, we could see a large shock in the housing sector that could tip the UK into recession and compound already-significant drops in house price indices. At that point we will likely see a reversal in expectations of BoE rate hikes, into cuts.? Markets will be watching GBP data to see if it can continue to beat expectations or if a downturn is on the way.
• The Euro is struggling to maintain levels above 1.10 against the dollar; last week it lost ground and is once again trading at 1.08. This came off the back of Jay Powell’s hawkish Jackson Hole speech and Wednesday’s data showing a larger than expected contraction in the Euro Area’s Manufacturing and Service sectors. A large interest rate differential remains between the Fed and the ECB with the Euro area’s inflation prints beginning to come down to more acceptable levels. The Euro area’s main trading partners, China in particular, appear to be very heavily affected by the worsening macroeconomic outlook. If this does take a further turn for the worst and the Euro area tips into a deeper than expected recession, we could well see big flows back to the Dollar and a significant Euro depreciation. Let’s not forget that it is less than a decade since the Eurozone sovereign debt crisis and that worries still linger over a number of European economies and the sustainability of the single currency itself.

?

OTHER NEWS ?

• Turkey’s central bank has sharply increased interest rates in one of the clearest signs yet that its new central bank heads have decisively broken with years of unorthodox policy in an effort to stem runaway inflation. The bank’s monetary policy committee on Thursday lifted the one-week repo rate by 7.5 percentage points to 25 per cent, far exceeding the 20 per cent forecast by economists. TRY posted its first weekly gain against the dollar in 2023 as a result, strengthening over 5% on Thursday alone, although it gave up some of its gains after Fed Chair Powell’s Jackson Hole speech.

?

?

CHARTS OF THE WEEK

Last week, we looked at long-run US macroeconomic data and interpreted it in light of macroeconomic theory to try and get inside the minds of the Fed and better understand how they see the arguments for and against further interest rate rises in the US. This week, we build on this theme, focusing on one of the most eye-catching economic news stories to come out of the US this week: the extraordinarily strong third quarter GDP growth predicted by the nowcasting model employed by the Atlanta Federal Reserve.

This model consists of a set of statistical models fitted to historical data, which predict components of economic output using explanatory variables where the data series updates more frequently than GDP itself. The prediction of the overall model is a simple aggregate of the predictions of the component-level models. This is not a forecasting model in the traditional sense, rather it is a ‘nowcasting’ model that aims to estimate what is happening with GDP growth in the current quarter even though the GDP data itself has not yet been compiled.

The predictions of the model for Q2 2023 were accurate: annualised GDP growth of 2.6%. More recent releases of model predictions are showing something astonishing: annualised GDP growth in the third quarter of 5.8%. If true, this would point to remarkable resilience in US output expansion and ongoing tight labour market conditions, which in turn portend stickier inflation and potentially further increases in interest rates.

The trouble with these nowcasts is that market commentators are discussing them as if they were fact, as if the US economy had in fact grown at an annualised rate of almost 6% in the third quarter and as if this definitely pointed to hotter labour market conditions and further hikes in interest rates. The reality is that the quarter is not over yet, and modelled estimates are usually less reliable than hard data. So, while nowcasting is a significant advance and we should pay close attention to this leading indicator and what it implies, we shouldn’t treat it as fact either.

Looking back over history, our chart this week shows the comparison of mid-quarter predictions from this model with actuals when they became known. It is clear that the model has some predictive accuracy, but also that it has some error, and that this error was large during the Covid pandemic. The Pearson correlation coefficient between predictions and actuals in this data is +0.29. If we remove five problematic quarters during the Covid pandemic, this rises to +0.44. To a statistician, this is a model that is OK but not great. A model with no predictive signal would have a correlation coefficient around zero. One that tended to predict in the wrong direction would have a correlation coefficient somewhere between zero and minus 1. A really great model would have a correlation coefficient more like +0.8 or +0.9. An (implausible) perfect model would have it at +1.0. So, while there is serious signal here that the US economy may be running very hot and in line for further interest rate increases, there is also evidence that nowcasting technology has further progress to make and shouldn’t be treated like fact.

PERFORMANCES AGAINST US DOLLAR

THE WEEK AHEAD

?

Monday, Aug 28th ?

• Australia Retail Sales

?

Tuesday, Aug 29th ?

• Germany Consumer Confidence
• US House Price Index
• US JOLTs Job Openings/Quits

Wednesday, Aug 30th? ??

• Japan Consumer Confidence
• UK Consumer Credit
• UK Mortgage Lending Data
• EU Economic Sentiment
• EU Consumer Confidence
• US ADP Employment Change
• US Q2 GDP Growth Rate

?

Thursday, Aug 31st

• Japan Inflation Rate
• China Manufacturing PMI
• EU Inflation Rate
• ECB Monetary Policy Meeting Accounts
• US PCE Price Index
• US Initial Jobless Claims

?

Friday, Sept 1st ?

• EU HCOB Manufacturing PMI
• Canada Q2 GDP Growth Rate
• US Non-Farm Payrolls
• US ISM Manufacturing PMI

??????????????????

?

?

?

?Hubpay Limited 2023. This document is a marketing communication from Hubpay Limited. The information in this report is provided solely for informational purposes and under no circumstances does this communication constitute an offer or a recommendation to buy, sell or otherwise deal in any particular investment product or security. All information in this report is obtained from sources believed to be reliable and we make no representation as to its completeness or accuracy. Hubpay Limited is incorporated (registration number 000004051) under the laws of the Abu Dhabi Global Market (ADGM). We are licensed and regulated by the Financial Services Regulatory Authority (FSRA) for Providing Money Services under Financial Services Permission number 190024.