Market Economics | Interest Rate Strategy - BNP PARIBAS ...

Judging Currencies by Liquidity
• The assessment of global liquidity will
remain important for the judgement of
currencies. We regard global liquidity growth as
at risk and cite financial sector regulation, EMU
stability concerns and Asian tightening of
monetary conditions as the main factors to
watch.
• Reduced global liquidity will be an outright
bullish USD factor. Should equity markets
decline, the EUR will drop hard.
• Commodity currencies are extremely
bullishly positioned. China absorbing liquidity
will undermine commodity prices. China’s CPI
release on 10 May will be trend-setting.
• Any post-election sterling rally should be
sold. Sterling undervaluation talk has no
substance taking into account the degree of
private and public sector leverage.
Risk-off strategy remains valid
Currency markets will have to deal with four big
themes going forward. Global liquidity, financial
sector regulation, EMU stability issues and the pace
of monetary tightening in EMKs will affect the
performance of risky assets directly and indirectly. At
first glance, these themes seem to be independent
topics, but they are not. In fact, global liquidity
conditions – hence the performance of various asset
classes – will be impacted by the structure of
upcoming financial sector regulations, the decline of
monetary velocity due to the weakening confidence
in-EUR denominated assets and the pace of
tightening in emerging markets in general and China
in particular. All these factors bode poorly for liquidity
conditions, suggesting sticking to the disinvestment
strategy that we spelled out three weeks ago.
Deficits, deficits, deficits
Importantly, the current economic cycle is different in
nature from previous cycles witnessed since WWII.
This cycle is all to do with balance sheets in
conjunction with global imbalances – very different
from economic downturns triggered by
overinvestment in capacity or inventories. Economic
upswings starting from a new equilibrium level
between investment and savings can develop into a
prolonged period of prosperity but, this time round,
aggressive policy measures including quantitative
easing and a fiscal expansion never witnessed
before during peace time have pushed economies
back on to the growth path. However, imbalances
have never been adjusted. In fact, the aggregate of
16
14
12
10
8
Chart 1: Total Net Borrowing Needs of the
Sovereign Sector (% of GDP)
6
4
2
0
Euro area
United States
United Kingdom
2003-08 average 2009 2010 (estimate) 2011 (estimate)
Source: IMF, BNP Paribas
120
110
100
90
80
70
60
50
Untied States
Households
Non-financial
corporates
40
00 02 04 06 08 10
Source: IMF, BNP Paribas
Chart 2: Credit to GDP (%)
120
110
100
90
80
70
60
50
Euro area
Non-financial
corporates
Households
40
00 02 04 06 08 10
120 United Kingdom
Non-financial
110 corporates
100
public and private debt in industrialised economies is
now higher in absolute and relative-to-GDP terms
than in 2007. The conclusion to draw from this
observation is straightforward. Industrialised
countries do not have the resources for strong,
domestically driven growth. Instead, the growth
impulse will have to come from outside, requiring a
higher level of competitiveness. This can either be
achieved by adjusting to higher productivity levels or
by allowing currencies to depreciate. Within the
group of industrialised nations, the US probably has
the most flexible economy, leaving Europe and
Japan lagging behind. Chart 3 shows that the current
advance of the greenback is underpinned by US
productivity gains. When we project USD strength
within our G10 currency analysis, we mean a
stronger USD in the context of the currencies of other
industrialised nations. Indeed, we expect most
emerging-market currencies to outperform the USD
over the next few years, only interrupted by periods
90
80
70
60
50
Households
40
00 02 04 06 08 10
Hans Redeker 7 May 2010
Market Mover, Non-Objective Research Section
61
www.GlobalMarkets.bnpparibas.com