Thursday, Jan 02 - Outlook 2014

Asad Rizvi

I am not sure if the performance of global stock market should be taken, as benchmark for economic recovery as stock market of Japan, USA and Europe made record gains that undoubtedly outpaced global economic growth. However, since 2008 financial crisis, which is considered worst after 1930 crisis, it was comparatively a much stable year, as some of the major global issues were forcefully managed by unconventional monetary and fiscal policies. 

Europe, USA, Japan and others were compelled to take extreme measures to halt recession, stimulate economic activity and address unemployment. This is why if we take a glance at the ratio of the size of balance sheets, it will provide us better sense and the cause of economic recovery in the respective economies that was possible at the expense of depositors money and through excessive printing of money in the name of extremely easy money policy. 

ECB successfully managed to reduce the size of its balance sheet by nearly 25 pct. By doing so it has comfortably positioned itself and should have no difficulty to inflate its balance sheet when it is required to inject liquidity for credit expansion or is faced with another crisis, as the European problem remains unresolved issue and hence, the respite is temporary.  Whereas Bank of Japan’s growth has surpassed 40 pct and FED by nearly 37 pct to USD 4 Trillion. 

FED tapering is going to be another huge event of 2014. I would link taper to two economic events growth and jobs, and inflation. The falling unemployment rate will push inflation higher at a faster pace. Quick inflationary condition means FED cannot hold low interest rates for longer duration, as promised. 

Tapering is necessary, as recent shrinkage of deficit is encouraging because it will help in reducing FED’s appetite to buy bonds aggressively. Secondly, the size of FED’s balance sheet has risen to an alarming high level, as there is no plan/strategy to reduce the size. 

Inflation may be lower than the 2 pct target rate, but with economy growing at a faster pace, combined with excessive liquidity injection, this may lead to higher inflation at an undesirable pace. Therefore, reduction in asset purchase amount will help to keep a check on unnecessary growth. 

Though tapering may pose huge risk to the borrowing emerging economies due to spillover effect, as we saw meltdown in Turkey, Brazil, India, Indonesia and South Africa in the last quarter of 2013.

Hence, it would be more appropriate for FED to switch back to conventional policy stance that would lead to better money management and it will also help to portray true economic growth and inflationary picture, as gradual withdrawal of bond purchase will help in moping excess liquidity from the banking system, which is a surely burden for FED.

The credit for Euro-zone economic recovery goes to Germany, as would continue to prop up regions weak economies. Spain and Ireland performed well, but France and Italy remains a threat. If US economy continues to performs, this may help exports from Euro-regions to grow. Similarly, projection of global growth rate of 3.6 pct from 2.7 pct expected growth in 2013 is good news for European exports.  

But there are many risks to the Euro-zones economy, as European policy makers are at constant risk of facing tough times from Germany on policy matters.  European banking system is still a troubling issue, which poses risk if not addressed. Risk of deflation remains a big threat and ECB will be in injecting liquidity to avoid tightening condition and inflation economic condition.

No economy can grow at a constant 10 pct, but China that enjoyed 3-decades of strong growth is struggling to grow at 7 pct. Many analyst may that China’s biggest problem is political and not economic. I think they all live in fool’s paradise, as its growth averaged over 10 pct for 2-decades and still enjoys strong growth beating all developed economies, since many years. 

But I suspect that the decade’s old growth pace in China may have caused damage. It probably could be the exceptional size of shadow banking in China, which is mother of all the ills. When there are 1.35 billion people in country, it is bound to face with hurdles that could be in many shapes. This is why when the Peoples Bank of China steps in to take corrective measures, as there is shortage of cash and hence, interest rates surges to record high levels unless its Central Banks injects liquidity.  The country is faced with two major problems, over heating of economy and low growth, as the most populous country cannot afford low growth that could b disastrous. So the bottom-line is that off-balance lending is the biggest threat to Chinese economy that surely cripple global economy if goes unchecked, as some of the estimates suggest that size of hidden risky assets courtesy shadow banking is USD 2 Trillion. 

Similarly, Japan’s opted for its old recipe, quantitative easing (QE) by further inflating the size of its balance sheet. Last year, Shinzo Abe Japanese PM decided to spur inflation and growth through excessive injection on money. Japan is faced with huge challenge, as BOJ is required to inject liquidity at regular intervals and the government has to introduce reforms for continuation of growth or else the exercise will be futile.

Overall conclusion is that initially US Dollar may not be able to make big strides due to lack of confidence and better economic performance by other economies, but USD will ultimately make a flip, due to FED tapering, US growth and possibly due to re-emergence of economic uncertainties in Europe and the emerging economies.

GOLD @ $ 1205.30 = There two ways to look at gold, Analytically and Fundamentally. I am a strong believer of fundamental happenings, which is always helps to determine the trend. Though there are some exceptions, we are living in peaceful world. Iran issue is over for next 6-months. The world is overcoming the financial crisis. European Currency, which is 24.2 pct in terms of currency composition of FX Reserves and has a 39 pct share in daily trading, does not pose any threat to the world economy. Global Central Banks are not buying gold in haste to reduce their Currency exposure. Chinese growth of over 10 % for 3-DECADES Fizzled out, now they are faced with Liquidity problem, though there is good demand for gold in China. Indian Gold buying has dropped by almost half. FED is in unwinding process and this should pose more threat to the Yellow metal. Inflation in Developed Economies is too low. Therefore I have every reason to believe that gold will take pounding this year unless there is another financial crisis. Then why Buy Gold ?
This year I am expecting gold to make new lows, as break of $ 1280 is required to challenge $ 1325 or $ 1375, which should be the turning point for gold Bulls. However, strong resistance is around $ 1280-00, which may not surrender. On the downside, break of $ 1105 will open gates for deeper fall, as $ 1010-30 support zones will be challenged. Break of support level risks for a possible test of $ 875.

EURO @ 1.3767 = Though there are some concern about low inflation in the Euro-zone region that demands for more stimulus package. High unemployment rate and growth in Germany does not speak too well for rest of the economies.  ECB must be aware that strong European currency is not sustainable for its economy, as it hinders export from weaker European economies. Strong currency also keeps a check on inflation, as Europe faces threat of deflation.
Euro will enjoy strength due to currency flow towards Europe and shrinkage of ECB balance sheet by nearly quarter percent, which results moping of liquidity from the banking system are helping investor’s sentiment towards EURO. Central Bank buying of EURO for Forex Reserves is also creating demand for the European currency. Hence, Euro may enjoy strength for some time, but two major factors i.e., FED tapering and ECB stimulus package will force investors to consider shifting their investments that will add pressure on Euro. Political uncertainty in Europe could also be one of the causes to depress European currency.
Initially, I am expecting 1.3550 to hold or else fall could extend towards 1.3320 zones, which is less likely to happen. Break of 1.3940 will open doors for 1.4280 or possibly 1.4450, before fall occurs. Caution is suggested around 1.4280, as fall will happen for a test and break of 1.3120 or 1.2895. Dip will occur on of break of support level of 1.3440.
GBP @ 1.6541 = Pound Sterling’s recovery started during later part of 3^rd quarter of 2013 on belief that BOE’s stimulus package has started to produce desired result. Growth in Housing, Manufacturing and Services has been at a very fast pace. The confidence level is on the up as retail sales data shows good demand for goods and overall the employment is shaping up well. Risk to economy is possible housing bubble due to foreign investors demand. The risk to economy will be possibly global slowdown especially in Euro-zones, which is the largest trading partner. Acceleration of inflation should not happen, as it may reduce the ability to buy. BOE policy makers have already taken action to arrest housing bubble by reducing stimulus package.  However, I believe that there are many risk attached to UK economy. GBP gain is also due to fewer investment opportunities, as US Dollar, JPY, SFR, Gold, US Treasury Bonds, Nordic, Aussie and Loonie is not very attractive. This is why Pound is receiving extraordinary support from investors and may enjoy strength for a month or two. I do not see continuation of trend in longer run, as investors will soon make a shift in their strategy that will see selling of pound Sterling.
As long as major support level 1.6240 holds Pound can potentially make some more gains. Break of 1.6690 is required for extension of move towards 1.6940. I will remain cautious if 1.67 breaks, as there is a risk for fall towards 1.5890. Break of 1.5750 may accelerate fall towards 1.5380.

JPY 105.30 = Japan is faced with a daunting task to provide stimulus, as incentive to encourage growth. Providing liquidity and creation on inflation along with fiscal package is the only alternate for continuation of current trend or else Japan’s growth momentum could backfire. Possibly VAT rise will help inflation to pick up. Like other economies Japan’s economy too is dependent on global growth. China’s slowdown will be bad news for Japanese economy. So there is plenty of risk, as Japan exports are too dependent on foreign growth.
However, unlike other currencies, USD will make gains with intervals and corrective moves will often occur.  JPY has many support levels, as its needs to push beyond 106.90-20 zones for 109 or else Yen could test major resistance levels of 103.40. Beyond 107, after every 100 pip move JPY will give resistance. If JPY breaks 109 before June, it could head towards 112. Meanwhile, if JPY is able to break major resistance level it may test 101.50.

AUD @ 0.8994 = Australian Central Banks stance is clearly Dovish, as there is a possibility of rate, which I also hindering investors to put their money is Aussie. China slowdown is a big factor, as Australian economy is too dependent on Chinese growth. RBA understands the cost of strong AUD that it had to pay. Australia attracts tourist and foreign student that also suffer due to strong currency. Lower interest rate also makes currency less attractive for investors. I think Aussie is likely to remain in lower 80’s unless inflation picks up and makes currency attractive for investors.
On the upside protection is at 0.9280, which should not surrender or else AUD will test 0.9450. Bias remains on the downside, break of 0.8605 will encourage for more losses that can extend up to 0.8180.

 

DISCLAMER : The commentary/information presented is not intended for trading purpose. The idea is to exchange views with the members/readers. Therefore, I accept no responsibility or liability for any losses incurred due to position taking.