On Monday two weeks ago we saw the biggest daily gain for the renminbi for more than a decade and on Monday of last week we saw the biggest single day decline for sterling since October 2009. Behind the decline in sterling was obviously speculation about the UK leaving the EU. Whilst we are sure the upcoming vote is providing the catalyst, other factors are likely to be helping with sterling’s decline.
In our view, the direction of capital flows that we have been witnessing over the past few years, is driven by the unwinding of QE by the Fed combined with the tightening of monetary policy in the emerging world. This is reducing the amount of “liquidity” in the financial system, making it harder for current account surplus countries to keep their currencies from appreciating and for deficit countries to prevent their currencies from depreciating. Japan has one of the world’s largest current account surpluses and despite negative rates has seen its currency gain by more than 6% against the dollar already this year. Meanwhile, the UK has the world’s second largest current account deficit and has seen its currency decline by just under 6% against the dollar in the space of just two months.
In the long run we believe that net foreign asset positions (effectively cumulative current balances) are the single most important driver of currencies, something the accompanying chart proves quite clearly. It’s not just the yen that we would expect to continue to appreciate, but also the Chinese renminbi which has the world’s largest current account surplus of any nation ever recorded since records began. Sterling on the other hand, looks set to breach 30 year lows against the dollar in the next few weeks.
This week we have moved our probability for a US recession within the next 12 months up to about 25%; that is up from a 10-15% chance in December last year. But of course, this still leaves us with a 75% chance that a recession can be avoided. Manufacturing has been hurt by the fall in crude, down 72% since June 2014, but has also been struggling with the strong dollar, up 22% according to the Bloomberg dollar spot index, since mid-2014.
An indicator we watch closely is the US ISM data, both the Manufacturing PMI and the Non-Manufacturing Index (NMI). Of the two, the manufacturing index has proven to be the most reliable in predicting recessions and is a key component of our global growth model. As the charts accompanying this text show, our global growth model shows a worrying prediction for further declines in global growth.
Intriguingly the global growth model looks very similar to a chart of Chinese import growth so next week we will explore the possible linkages between the two in more detail.