We believe the main catalyst for macro events and currencies this year will be the differentiated monetary policies of the central banks.
As we have seen in January, some central banks are already being tested, such as the Swiss National Bank, which has the potential to make this year more volatile than normal.
The growth differential between the United States and most other developed markets has resulted in monetary policy divergence. While the US Federal Reserve is on a path towards normalisation, both the Bank of Japan and the European Central Bank will be increasing the size of their balance sheets.
Inflow of funds looking for higher-yielding dollar assets should continue to support the greenback this year. Meanwhile, with policy rates low globally and weakening inflation data, countries are becoming increasingly reliant on their currencies to boost their economies.
A contraction of the US current account deficit since the 2008 crisis is also providing a structural shift to the dollar. China’s export-led model is reaching its limit, while the US energy renaissance and gain of competitiveness for the US economy are supporting dollar strengthening.
We believe that the dollar’s outperformance in 2014 might prove to become the beginning of a bull cycle that could last for a number of years.
The euro’s path has a direct connection with the ECB’s policies. Starting quantitative easing represented a new opportunity for the ECB to align inflation and currency.
The region will benefit from a weaker currency, as this will represent a something of a tailwind for domestic consumption and companies which have a euro cost base.
However, we do note that while the spot is weakening, the trade-weighted euro is depreciating more slowly, and this is a key potential factor which might benefit the recovering European economy.
The ECB is helping the European recovery. Despite implementing QE a bit late [deflationary pressures were already in place] the magnitude, open-endedness and willingness to buy negative bond yields make the programme powerful.
As we mentioned, the main transmission mechanism of the programme is through the currency, which has been affected significantly already in the first quarter. What is now required is for countries to continue to implement structural reforms, while the ECB support is present.
We have recently seen progress with structural reforms in Italy. If proper implementation follows, the effects will be positive for markets and growth.
Greece and Russia remain potential risks. The situation in Greece is less worrying than at the beginning of the year, however a solution has not yet been found.
Eventually, more flexibility may be needed – not just by changing budget targets, but potentially also by introducing a different form of debt instruments.
While negotiations take place, capital controls are still not excluded, as happened in Cyprus.
Overall, Europe is experiencing a mini-renaissance, driven by the lower euro, oil, lower yields, less fiscal drag and a stabilisation to positive pickup in credit growth. Consumer sentiment and demand are picking up with good numbers in both retail and car sales. This will make Europe grow about 1.5 per cent this year. It will be important for the momentum to continue into 2016 so Europe can experience a self-sustained recovery.
Cesar Perez is the global head of investment strategy at JP Morgan Private Bank.
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