East Capital: The transatlantic tide
Marcus Svedberg, chief economist at East Capital comments on the outlook for the US and euro zone economies.
The state of the European and American economies has improved quite considerably lately and we are confident the tide has turned for the better. Europe has averted the tail risk of disintegration and is now recovering while the US economy is back to its normal buoyant self.
We believe that the benign development in the two largest economies in the world (the euro zone is larger than China and Japan combined) has not been fully recognized. The better than expected macro backdrop in the US is clouded by the anticipated Fed hike and the problems in China while the development in Europe has been distracted by the situation in Greece and Ukraine.
In this brief, we will analyze the macro situation in the short to medium term, with a special focus on the implications for emerging markets.
The economic situation has diverged a lot in the US and the EZ since the global financial crisis, but the growth trajectories are not as different as is often assumed. The US economy is, obviously, doing better but both economies have been accelerating since the beginning of 2013 and the growth differential will decrease over the coming years. Perhaps more importantly, the tail risks of deflation and euro zone disintegration have been reduced significantly.
Monetary policy will most likely remain very loose on both sides of the Atlantic, at least for another year, even though the Fed has stopped its asset purchasing program and may hike rates this fall.
But growth is not only supported by a low base and monetary stimulus. There is virtually no price pressure. Inflation bottomed out in January – thus reducing the deflation threat – but remains very low with CPI rising 0.2% yoy on both continents in July.
The lower oil price does not only help to keep inflation down, it is a great fiscal stimulus for the real economy. The IMF believes lower prices will boost US growth by 0.8-1.0pp and EZ growth by 0.3-0.4pp per year in the coming five years.
On top of this, Brussels and Washington are negotiating a landmark trade deal (The Transatlantic Trade and Investment Partnership) that could boost GDP by around 0.5pp per year.
There are thus plenty of reasons to be carefully optimistic on growth even if there are still challenges on both continents. We are particularly concerned about the increasing nationalism and populism, which are exacerbated by partisan polarization in US politics and high unemployment levels in Europe, although we doubt it will have a direct market impact.
The euro dollar
The euro dollar exchange rate is on the one hand the hardest but at the same time the easiest currency pair to forecast. It is hard because it is a crowded and extremely liquid trade that reacts on virtually every macro developments. It thus fluctuates a lot, but it is also easy as it tends to move within certain ranges.
The USD should, in theory, strengthen a lot since the US has stopped printing money and will start to raise interest rates while the ECB will leave rates and print money for at least another year. But we do not believe the USD will appreciate very much and the exchange rate should not move out of the 1.00-1.20 range it has been trading within this year.