The FINANCIAL — Cautious Optimism & Modest Gains Given superior growth expectations, the diminished likelihood of a fiscal cliff “apocalypse scenario,” and the Federal Reserve’s activity being largely priced in, the Greenback is poised to moderately outperform the likes of the EUR, JPY, CHF, and GBP in the coming year.
Meanwhile, an environment of increased risk appetite, and the hunt for yield sets commodity and emerging market currencies up to advance against the big dollar during 2013. In particular, the CAD and MXN, which could see additional benefit from the pass-through of optimism on the American economy.
Thus, based on the weight of its constituents, the USD index looks ready to stage modest gains by the end of 2013. The latter half of the year is likely to offer up the majority of gains, with fiscal and macro concerns hampering progress in the first part of the year. As 2012 winds down, the US economic situation gives rise to cautious optimism for 2013. The general consensus amongst economists and bankers is for approximately 2% growth in the coming year. The key drivers of this outlook are: stabilization in the labor market (particularly in the service sector), a building recovery in housing, and supportive monetary policy.
2012 saw unemployment in the United States continue to trend lower, now regularly printing in the low 7% vicinity, on the back of strength in the service sector, which makes up over 80% of the US labor market.
The Institute for Supply Management (ISM) Non-Manufacturing survey, a good proxy for the service sector, held levels well above 50 (the threshold for expansion) throughout 2012, a trend expected to continue into 2013. After a period of expansion in 2010 and 2011, the Manufacturing Survey conversely trended down toward 50 through 2012, a few times printing below that key level.
Going into 2013, the manufacturing side is expected to deteriorate, as weakening export orders and soft domestic spending take their toll, but its impact on unemployment will be largely mitigated by its relatively small size. 2012 was characterized by a firmer housing market in the US. This was driven by loosening lending requirements, historically cheap mortgages, and more balanced supply and demand.
Mortgage prices are likely to remain where they are for the foreseeable future, given the Fed’s position on increasing the benchmark rate. Add to that economic optimism, price tags still below pre-crash 2007 levels, and easier to obtain mortgages—thanks to banks that have been re-capitalized with government stimulus.
These factors point to more modest gains in housing and related industries in 2013. The final key piece of the American economic outlook is supportive monetary policy via the Fed’s easing programs and low interest rates. Chairman Bernanke recently took unprecedented steps at to reassure financial markets that he wouldn’t be pulling back monetary stimulus too soon when he tied economic indicators to Fed initiatives.
Traditionally, policy and rate guidance are calendar based, however, as part of Bernanke’s more transparent Federal Reserve, he pledged near-zero interest rates and asset purchases until the unemployment rate stabilizes under 6.5%, and inflation projections for coming years are above 2.5%. Essentially Bernanke promised markets that it wouldn’t be the Federal Reserve who preemptively derails the recovery—he’ll leave that to the politicians.
The economic impact of “paying the bill” in a couple of years, when the position on the Fed’s balance sheet needs to be unwound and interest rates start to rise, remains to be seen. However, we can deal with that in the 2014 outlook next year. The crux of the position outlined above is the idea that President Obama and his administration come to some sort of agreement with Republicans on the fiscal cliff. A failure to arrive at any sort of deal, and the resulting “fiscal cliff apocalypse” is projected to have an anywhere from a 2–4% drag on gross domestic product (GDP), effectively plunging the American economy back into a recession.
It seems unlikely that either political party can afford to be seen as responsible for that scenario, and it is thus unlikely— One can always trust politicians to be self-interested. This isn’t to say that a grand bargain ahead of the deadline is likely. In reality, there will probably be some temporary “Band-Aid” compromise ahead of year end, and in such a case, some aspects of the fiscal cliff could be triggered. However, for the reasons just outlined, both parties would be quick to seek a solution in such a situation, and thus it is unlikely to result in a serious drag on the economy.
That being said, when the dust from the government fiscal/budget fiasco settles, there is all but sure to be spending cuts to some degree. This is factored into the baseline model, in which the first part of 2013 is characterized by uncertainty and fiscal tightening, while the latter part of the year sees modest growth as the key theme, thanks to continued monetary accommodation and constructive trends in both the labor and housing sectors.
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