Analyst Interview: John Kicklighter Talks Risk Trends, Euro, USDJPY
• Recent economic data coming from China suggests a slowdown in growth; is it serious enough for investors to be so worried? Do you think the PBOC might be planning another reduction of its reserve ratio requirement in an attempt to stimulate lending?
China has a seriously difficult balancing act that it is trying to maintain, and I don’t think that they will be able to keep it together forever. The slowdown in economic activity is indeed concerning, and it will likely trend lower for some time (though it will not necessarily come close to contraction). Through trade data, an opening of financial boarders and structural reforms to fortify domestic consumption and living standards; we see that the country is making the transition to an export-dependent economy to one that is more balanced. This carries long-term benefit, but in the short-term it dampens one of its primary advantages. A slowdown in domestic health is another serious problem because it contrasts the still-swollen lending bubble. So, now they have to balance whether they support the economy and risk leveraging the bubble, or tighten liquidity and exacerbate an already troubled growth outlook.
• Do you think that the disappointing March NFP result might push the Fed into adopting additional stimulus in the nearest future? How long do you think the outperformance of the safe haven currencies, prompted by the lower than expected NFP data and EU debt crisis worries, might last?
I don’t think that one month of data changes the consensus on a decision like that. The data was still positive (added jobs), but it does slow the expected time frame for hitting targets for the unemployment rate – the gauge for one of the central bank’s dual mandates. I’m generally a skeptic of additional stimulus from the Fed. There still seems a hearty speculation of a QE3 where the more likely approach would be a shifting of assets that keeps the balance sheet otherwise unchanged (like the Operation Twist to take on longer-maturity Treasuries, or switching to real estate backed derivatives). Even that brand of a stimulus effort would disappoint if the market is pricing in QE3. However, stimulus is now a global consideration. If the Fed falls short, we still have the European, Japanese and Chinese central banks to fill in. If expectations of global stimulus rise, risk appetite will rises as well. We’re at a critical point because we have put in a remarkable correction in risk trends, but it isn’t a full trend yet.
•Will the budget cuts recently presented by the Spanish government help the country avoid a bailout?
No. The austerity effort they are making is impressive, but it is to comply with EU rules rather than to balance financial stability with economic health. With the drastic spending cuts, the economy is going to pitch the economy deeper into recession (or at the very least lengthen it). And, when we reduce growth, we reduce tax revenue – which can contribute to a deficit just as surely as increased spending does. If they avoid a bailout, it will be due to extraordinary efforts by policy officials (like active purchases of government bonds by the ECB or a form of LTRO).
• Now market is focusing in Spain and doubts about its solvency, before it was France... Do you think the debt crisis could hit really France?
France was a concern because panic was peaking due to regional concern and it is considered a member that simply cannot suffer a similar situation as Greece or other peripheries have and keep the Euro Zone intact. If the situation region-wide deteriorates significantly, France can certainly find itself in trouble. On the other hand, they have taken steps to improve their sovereign and banking-sector health. I think the more immediate concern from a market perspective is the situation with Italy. As the third largest economy in the region and a yield that is steadily rising against the backdrop of a eye-watering debt load, that is the immediate concern we need to focus on after Spain.
• Do you think the ECB stop bond buying measure it a good strategy?
I think the ECB’s decision to halt the SMP program will probably be reversed. This is a crisis management tool that is readily available and much more flexible – though it also has shown lesser influence. With Italian and Spanish yields ominously rising back towards that feared 7 percent level, the risk is very high. If another swell in financial crisis fear proves sticky, I suspect this program (along with other efforts) will return.
• If the Trend is your friend... What is the trend in $USDJPY?
There are technical and fundamental considerations to that question. If you look back at three years of USDJPY price action, you’d say the trend is clearly bearish. However, turns have to occur sometime, and a new trend has to always go through a period of ‘tentative’. To feed a new bull trend, we need fundamental drive. The factor that pushes most in bears’ favor is an unwinding of risk trends. With risk aversion, we have carry unwind and thereby yen bids. However, there is little carry interest to be found in a long USDJPY exposure beyond speculative positioning for expanded yield in the future. That means, such a risk aversion move will be limited in its influence here. Under other scenarios, the USDJPY looks attractive for a bull run. If risk trends recover (slowly or rapidly) over the long-term, the dollar has the carry appeal advantage. If there is extreme risk aversion, the greenback is the better safe haven. And, in general, the pair is coming off record lows – so there is a lot of room to recover.
--- Written by: John Kicklighter, Senior Currency Strategist for DailyFX.com
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