See Search Box
lower down this column for searches of Finfacts news pages. Where there may be
the odd special character missing from an older page, it's a problem that
developed when Interactive Tools upgraded to a new content management system.
Finfacts is Ireland's leading business information site and
you are in its business news section.
President Obama meets with the BP Oil Spill Commission Co-Chairs, pledging accountability for BP and government officials who have been too cozy with the oil industry over the years, Tuesday, June 01, 2010.
In the wake of the European sovereign credit crisis, the US dollar has jumped significantly against the euro; it has risen by 9% in little more than a month, and 18% since December 1st. Richard Berner, a managing director, co-head of Global Economics and chief US economist at investment bank Morgan Stanley, says the surge has triggered worries that a stronger dollar will undermine US exports, will prove deflationary and will depress corporate earnings. He says markets have vented those qualms in sharp declines in risky asset prices, in a flight-to-quality bid for Treasuries, and in a plunge in inflation breakevens measured in the TIPS (Treasury Inflation-Protected Securities) market. Unless the dollar retreats significantly, many fear it will raise the odds of much slower growth. However, Berner doesn't see the 'strong' dollar as a threat to the US economic outlook.
On Monday, senior Federal Reserve officials were upbeat about the US economic recovery despite the Eurozone debt crisis. “Right now, the prospects for continued growth in the U.S. remain relatively solid,”Charles Plosser, the president of the Federal Reserve Bank of Philadelphia, told a news conference during a Bank of Korea conference in Seoul. “I hope, I anticipate at this point that the US won’t have a double-dip recession.” He added that the European crisis “raises some clouds on the horizon” and that the Fed would have to “be cautious” in response.
Charles Evans, president of the Chicago Fed, said the US recovery is “well under way” but still-low inflation means the central bank should keep rates very low “for an extended period,” in line with its official policy statement.
“Inflation is severely under-running price stability, so it’s still appropriate to keep an accommodative policy,”Evans told reporters in Seoul. “But if the situation turns rapidly, policy will need to respond more quickly.”
The debt crisis in Europe has moved back the expected date of a Fed rate hike to 2011.
Evans said the European crisis would likely damp US exports to a small degree but that for now it wasn’t likely to have a big impact or change the outlook for Fed policy.
Fed Chairman Ben Bernanke, addressing the Seoul conference by video, said the world’s central banks will exit their economic stimulus policies at different times, weighing local factors as they seek to be neither hasty nor tardy in tightening.
“Because economic conditions vary, the appropriate timing of the exit is likely to differ across countries,” Bernanke said. “To guide these important decisions, each central bank will have to carefully monitor economic developments in its own jurisdiction.”
Both Plosser and Evans cited recent improvement in the US labour market as promising signs for the broader recovery and predicted the improvements will continue. Plosser said many people may be surprised by how fast employment bounces back, while Evans said that if inflation expectations should surge, the Fed would need to respond quickly - - shifting its current emphasis on promoting growth.
Edward Lazear, former chairman of the President's Council of Economic Advisers (2006-2009), shares his economic outlook with CNBC:
Richard Berner says fears about the strong dollar are overblown. First, while the euro has weakened a great deal versus the dollar, the greenback has strengthened only modestly on a broad, trade-weighted index basis (the TWI). The Fed's broad index has risen by about 4% since mid-April and by 6% since December 1st. Second, growth is far more important than currency movements in driving trade, prices and profits, and MS see only modest risks to global growth. Finally, much of the dollar's recent strength reflects a flight-to-quality bid symptomatic of - - and idiosyncratic to - - the European sovereign debt crisis. While the MS FX team expects the euro to decline to 1.16 against the dollar this year, it expects the dollar to weaken again versus AXJ (Asia ex Japan) and other currencies, leaving the broad dollar TWI little changed for the balance of the year and into 2011.
Exchange rate pass-through has declined:The economist says the influence of currency movements on the macro outlook is best analyzed in terms of trade-weighted indexes that cover trading partners. Regardless of the metric used, the ‘pass-through' of nominal exchange rate changes to import prices and thus to trade and inflation has declined over the past two decades. Several Fed economists in a 2006 paper found that the decline is a global phenomenon. Across G7 currencies, their work suggests that exchange rate pass-though to import prices has declined to 40% over the 1990-2005 period from 70% in the 1970s and 1980s, and in the US, it has declined to only 30%. That is, a 10% sustained depreciation in the dollar might, other things equal, boost the import price level by 3% over a 2-3 year time period.
Declining exchange-rate ‘pass-through' may reflect good monetary policies and the globalization of markets and production that has promoted ‘pricing to market'. That is, exporters not wanting to surrender market share have absorbed currency changes in their profit margins or hedged their currency risk. Pass-through also varies with the cyclical state of the global economy and inflation expectations; as the economy strengthens, pass-through may increase.
The ‘stronger' dollar won't undermine the trade outlook:In turn, the influence of import prices on US trade and inflation is less important than economic growth at home and abroad and other factors influencing inflation expectations and slack in the economy. In an earlier report, MS estimated that the elasticity of real exports with respect to non-US GDP alone is about 2 - - implying that, other things equal, 5% growth abroad will yield 10% growth in US exports. In contrast, MS estimated the elasticity of exports with respect to the real effective exchange rate to be one-third as large.
Moreover, MS says strong growth in overseas domestic demand will boost US net exports and add materially to growth in US output in 2010 and 2011. Domestic demand in the fast-growing economies is driving their growth, and US exporters will be increasingly leveraged to that rapidly growing pie. Indeed, the share of US exports going to Asia ex-Japan, Latin America and Canada has risen significantly in the last decade, thanks in part to these countries' faster growth. Despite the global recession, the share of US goods exports going to those destinations rose from 69% of the total to 73% over the past five years, while the share of US services exports going to those economies also rose 4 percentage points to 46% over that period.
Richard Berner says: "To be sure, weakness in European and Japanese growth will restrain overall overseas demand, but those areas are less important than in the past: The share in US exports of goods delivered to Europe and Japan has been steadily shrinking; recently to 27%. Moreover, we have long expected sluggish growth in both Europe and Japan, and if anything, growth in each at the dawn of the sovereign crisis has proved more robust than expected."
Dollar not a deflation threat; inflation still poised to bottom soon:The economist says the recent collapse in inflation breakevens signals growing concerns that a stronger dollar in concert with the sovereign debt crisis would promote deflation. There is broad agreement that a stronger dollar can contribute to lower inflation, both through its direct influence on import and commodity prices and via its indirect impact on inflation expectations. The interplay among them is important: While a stronger dollar and falling commodity prices will primarily change relative prices, like those of imports and energy goods and services, they can also influence both inflation expectations and inflation itself.
MS says the fundamentals for pricing power are gradually improving, even though retail core inflation is edging lower, courtesy mostly of the deceleration in US apartment and owner equivalent rents. Slack in housing, goods and labour markets is peaking or has peaked, companies continue to cut capacity, demand continues to improve, and the Fed remains committed to fighting disinflation. The combination of those factors has lifted operating rates 500bp (5%) from their lows, and more is clearly coming. As a result, the data at early stages of the processing pipeline support the story of eventually higher, not lower, inflation. Core intermediate wholesale prices rose at an 8.3% annual rate over the past six months. And in spite of the dollar's recent move, strong global growth is pushing up import quotes for consumers and businesses. Non-petroleum import quotes rose by 3.3% in the year ended in April, and import prices for consumer goods excluding autos rose by 0.4%.
University of Chicago finance professor Eugene Fama, widely known as the "father of modern finance," discusses whether the government is the biggest risk to economic recovery:
Dollar doesn't threaten near-term earnings outlook:Berner says with one-third of corporate earnings coming from overseas, the dollar's influence on corporate profits has never been more important. There is no mistaking the channels: A weak euro will cut profits earned in Europe when translated back into dollars. Moreover, just as the dollar's long decline boosted the earnings and cash flow of US affiliates abroad by making them more competitive in the markets they serve, a stronger dollar will erode that edge.
But several factors reduce the importance of a stronger dollar versus the euro on earnings. First, earnings from European affiliates of US companies are less important than in the past. According to MS equity strategist Jason Todd, such results in 1995 comprised 14% of offshore earnings, but at the end of 2008, the share had fallen to only 8%. Second, limited exchange rate pass-through suggests that the change in end-market pricing in Europe will be significantly less than the extent of the exchange rate change.
In addition, just as with exports, currency translation effects are less important than the influence of growth abroad on overseas earnings. MS continues to expect strong global growth of about 4.7% this year. US domestic earnings fundamentals, moreover, are getting stronger as the push from global growth has spurred the jobs and income growth that is essential for a sustainable recovery. Finally, rising operating leverage continues to boost margins as expansion allows companies to spread fixed costs across a wider revenue base. Margins have risen by 100bp over the last year, reflecting significant corporate capacity reductions that have enabled companies to exploit that operating leverage. Industrial capacity declined by a record 1.3% over the past year, and the boost that gave to operating rates helped sustain margins.
Richard Berner says that the bigger challenge to earnings will come in 2011, when overall growth is expected to slow and operating leverage to fade. In part, the forecast of slower growth reflects the assumptions that policymakers will begin the exit from accommodative monetary policies and that European fiscal austerity takes effect. In addition, it reflects the effects on growth of the increase in long-term yields expected by MS, as private credit demands clash with still-massive Treasury issuance.