Beware Conflating 'De-Dollarisation' With Weaker Dollar

Forex

Summary:

Even if the U.S. dollar's singular dominance as global currency of choice is in fact ebbing, it may not automatically lead to a weaker dollar exchange rate - and could periodically mean the opposite.

A Federal Reserve less worried about the overspill of its monetary policies to the rest of the world is a central bank more inclined to extreme tightening and easing. And a less dollarised global economy could potentially free the Fed to stay locally focussed - for better or worse - and keep inflation lower over time.

Throughout 50 years of the floating exchange rate era, debate has raged about what 'exorbitant privilege' the United States gleans from the dollar being the world's reserve currency, and numeraire since French leaders first used that phrase.

The big advantage of large dollar reserve holdings alongside wide commercial usage and trade in dollars overseas was clear. U.S. firms avoided added currency volatility in dollar-invoiced imports such as energy and commodities while Washington effectively enjoyed subsidised borrowing as other nations banked precautionary or windfall dollar savings back in Treasury bonds.

The strategic muscle of being able to limit use of the world's most pervasive currency for political reasons - clearer than ever in recent years - was another.

But many have also argued over the years that the dollar's international role often constrained the Fed from conducting policy most appropriate to the domestic economy - due mainly to fear that extreme moves may shock an integrated world financial system with the economic backwash hitting America's economy anyway.

Right now, a similar argument could be made with Fed policymakers chomping at the bit to tighten ever further as a way to drag inflation back to target just as other areas of the world, such as China, are struggling economically, wary of falling prices and looking to ease.

Were that divergence to widen and cause dollar-related stress, might the Fed be minded to tread more cautiously? Or if the cost of dollars were less an issue for the rest of the world than it has been for decades, would it plough on regardless?

So-called "de-dollarisation" has been the subject of endless speculation since the geopolitical re-alignments that followed the pandemic and the freezing of Russia's foreign reserves after it invaded Ukraine last year.

Even though reductions in dollar holdings and usage have been relatively small despite higher perceived sanctions risk, the BRICS group of Brazil, Russia, India, China and South Africa - and already heavily-sanctioned economies such as Iran and Venezuela - have certainly urged carving dollars out of trade and investment ever since.

But the issue is typically read in markets as a reason to bet on a weakening dollar exchange rate - or even to pump alternatives such as gold or crypto tokens.

It may not necessarily work that way - especially if it leads to a tighter Fed, higher bond yields and lower inflation over time. Beware Conflating 'De-Dollarisation' With Weaker Dollar_1

Beware Conflating 'De-Dollarisation' With Weaker Dollar_1

'Oasis'

One of the clearest examples of Fed hesitation was when Alan Greenspan's team cut rates three times in 1998 despite a briskly growing U.S. economy and developing tech boom, arguing the United States could not remain a 'oasis of prosperity' in a global emerging market storm and credit jolt that the Fed's sharp tightening of 1994 had arguably whipped up.

By late 1999, the Fed had quickly reversed all of those cuts and was then forced to tighten three further times to a peak of 6.5% - eventually pricking what had by then become a runaway dot.com bubble.

Of course, that was a global economy riven with fixed dollar exchange rate pegs that supercharged the transmission of Fed policy, most of which have since been dismantled.

And the Fed now has many other tools - such as multilateral dollar swap lines - to ease stress.

But it wasn't the only time Fed policy was clipped or influenced by dollar pressure overseas.

Before taking up her current role as Treasury Secretary, Janet Yellen recalled her time as Fed chief and claimed that when the prospect of Fed tightening in 2015 led to massive capital outflows from China and unnerved world markets, it forced the Fed to pause its rate hike campaign.

The opposite has also been true.

As the Fed embarked on quantitative easing for the first time after the great financial crash in 2008, there were howls of protest from emerging powers such as Brazil about the United States embarking on 'currency wars' to weaken the dollar for trade gain.

Yellen also recounted G20 meetings as Fed chair in which criticism arrived whether the Fed was easing or tightening, with complaints mostly about extremity in policy moves, and the Fed was "sensitive to these concerns".

Fed studies - including one from Fed board economists on 'spillovers' late last year - show a much bigger exchange rate impact from Fed tightening in their model of 'dollar dominance' than a benchmark situation without it - suggesting much less overseas impact in the latter and more scope for higher rates.

"Central banks around the world do take into account these spillovers and internalize them," they said. "But policymakers have a tough balancing act to manage."

At the very least, a world less sensitive to the dollar because it uses it less for trade and reserves may also be a world of structurally higher U.S. interest rates - and maybe a more volatile one to boot.

That may be a world many countries prefer if they are sure of viable alternatives - but may not mean a weaker dollar. Beware Conflating 'De-Dollarisation' With Weaker Dollar_3

Beware Conflating 'De-Dollarisation' With Weaker Dollar_3

Source: KFGO

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Justin

Central Bank

Economic

Artificial intelligence is likely to be among the most transformative technologies of our time. The nature of the vast changes ushered in by AI – most notably potential efficiency gains in both white- and blue-collar occupations – can partly explain the attention the technology has garnered, particularly on the heels of developments in large language models such as ChatGPT.

Although the technology itself is wholly new, the macroeconomic challenges associated with AI are not. History provides ample evidence that, while AI is unlikely to spur joblessness or mass unemployment, the likelihood of rising inequality is high. And this brings with it a host of monetary and macroeconomic considerations that will impact economists and central banks alike.

What are the macroeconomics of AI?

A common starting place for economists is to study previous technological revolutions – most notably the industrial revolution and the early 20th century technological transformation (railroads and glassware, for example). Both of these periods coincided with significant growth in labour productivity. Both boosted growth and quality of life for subsequent generations. And both of these moments were replete with contemporary discourse that fretted about the ‘end of work’ and the prospect of widespread unemployment at the hands of new machines.

We now know that previous major technological revolutions did not induce mass unemployment. And so, it often becomes tempting for economists to dismiss such technophobic angst as having been completely misguided. Efficiency gains allowed households to save money due to the lower costs that emerged from more efficient industries (agriculture, for example), which led to the creation of new occupations.

There is currently no evidence to suggest that the economics of AI are substantively different from those of previous technologies. AI promises to greatly expand the scope of what occupations can be made ‘digital’, which may boost productivity and encourage a reallocation of labour towards new industries or occupations, which are best performed by humans. It marks an extension of existing trends in digitalisation – present since the 1980s – as opposed to something entirely distinct.

Rising inequality

Yet to dismiss concerns about technological disruption would be a mistake. More contemporary economic analysis has shown that living standards for many working- and middle-class Britons declined considerably during the industrial revolution. Rather than boosting standards of living, the productivity gains spurred by industrial technology led to a de-valuing of labour (often accompanying worsened working conditions), the decline in labour’s share of income, wealth accumulation among capital owners and a consequent rise in economic inequality.

Both the 20th century and early computerisation technological shocks coincided with similar deteriorations in workers’ livelihoods and an often-intolerable growth of inequality. In the early 20th century, the rise of inequality and decline in working class living standards, which defined the ‘gilded age’, were kindled by highly concentrated oil, rail and automobile industries. The early computerisation shock that began in the 1980s was smaller in scale, but highly disruptive to many middle-wage occupations. And from 1980-2014, it was responsible for roughly 33% of the growth in wage inequality that emerged in the US.

Economists like David Autor, Claudia Goldin and Daron Acemoglu have uncovered the mechanisms that have allowed technological shocks to widen inequality. They describe a process of skill-biased technological change, whereby technology shocks tend to primarily displace ‘middle-skill’ workers and lead to growth in the share of low- and high-wage labour. This makes sense: middle-wage jobs are often slower to emerge and more desirable for firms to automate.

When technological shocks occur, workers tend to find that their labour is either complemented or devalued. Those that are able to work with the emerging technologies to enhance their output experience wage premiums. Those whose occupational tasks can be completely or partly replaced by machines see wage stagnation and often a decline in their real wages.

Early evidence suggests that AI kindles SBTC dynamics, which will widen inequality, just as the early computerisation shock did. And so, while the fears of joblessness and unemployment are misplaced, the prospect of rising inequality should be a concern for everyone, particularly in a moment when countries like the US and UK have already experienced a bifurcation of wealth and income since the 1970s. The further growth of inequality would be socio-politically corrosive and disastrous to long-term economic growth, financial stability and a common-sense notion of economic fairness.

AI and central banks

The advent of AI is also beginning to influence central bank decision-making. For over a decade, monetary economists have explored the possible erosion of the Phillips curve, which defines an inverse trade-off between inflation and unemployment. Yet the curve no longer seems to provide an accurate depiction of the relationship between employment and price stability.

A major reason for this has been the reduction in worker power ushered in by the computerisation SBTC shock, which played a role in decreasing labour bargaining capacity. This leads to lower price growth, even when unemployment is low.

AI is also further kindling market concentration. Previous technological revolutions have tended to coincide with the rise of market power by a small number of individuals and firms. The same has been true of digitalisation and is true again of AI, which tends to rely on expensive talent and computing costs.

The testimony of Sam Altman, chief executive officer of OpenAI, in US Congress was a welcome public acknowledgement of the very real threats posed by an under-regulated AI. Yet policy-makers should be wary of corporate regulatory capture and the establishment of guardrails to innovation that allow only the most well-funded ventures to succeed.

The macroeconomic challenges for central banks will be to preserve a healthy economy amid distortions of labour markets that coincide with AI. The benefits of widely deployed AI are potentially significant, taking the form of improved productivity growth after decades of sluggishness. And yet the economics of AI point to an unmistakably disequalising bend, which has implications for how monetary policy should assess countries’ economic health, interest rate deliberations and the vulnerability of middle- and working-class households.

Each large-scale technological shock has coincided with a significant growth of inequality and period of intense dislocation and disruption. Policy-makers and economists have a fleeting moment right now to make sure it doesn’t happen again.

Source:Julian Jacobs

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Owen Li

Economic

Eurozone view: weak growth with falling inflation

Eurozone growth disappointed in the first quarter. While falling energy prices and rising wages should support consumption, the soft Chinese reopening, tighter monetary conditions and looming US recession will weigh on growth and bring the economy close to a standstill by year-end. It is mainly services that are currently thriving. The manufacturing sector is struggling with excess inventories while construction is hampered by higher interest rates. It is therefore not surprising to see that services inflation remains quite sticky, while there are budding deflationary pressures in the goods industry. But the further weakening of growth over the course of the year should bring inflation down towards 3% by year-end. As the ECB wants to see a clear decline in core inflation before ending the tightening cycle, 25bp rate hikes seem likely in both June and July, with an additional one in September a genuine risk.

Where we differ

With our 0.5% GDP growth forecast for both 2023 and 2024, we are definitely below consensus (0.6% and 1.0% respectively) and far below official forecasts (for instance, the European Commission foresees 1.1% for 2023 and 1.6% for 2024, quite similar to what the ECB is pencilling in). With our 5.4% inflation forecast for 2023 and 2.5% for 2024, we are close to consensus, but below official estimates, especially for 2024. Market forwards indicate rates plateauing at a level around 50bp above today's level in the second half of the year, with a first rate cut in the second quarter of next year, exactly in line with our predictions.

Goldilocks after all?

We might be overly pessimistic about the growth outlook. With wages picking up and inflation coming down on the back of further falling energy prices, consumption growth could accelerate in 2024, certainly if you also pencil in a decline in the savings ratio. The weakness in manufacturing might also be short-lived: once the inventory overhang has been corrected and consumer demand for goods picks up again, manufacturing should become a driver of growth. If at the same time the US manages a soft landing and Chinese growth gathers momentum, net exports could also support the expansion.

Finally, with the European recovery plan gaining traction, public investment should add to growth. This would be a kind of goldilocks scenario, with growth accelerating and inflation falling in 2024.

A deeper downturn is still a genuine risk

On the other hand, it is certainly possible to come up with a stronger downturn scenario (bear in mind that we haven't pencilled in any negative growth quarters for the next two years). What we find a bit strange, is that in the official forecasts, it seems as if tighter monetary policy does have very little effect after all – even though the ECB's (admittedly somewhat discredited) models are forecasting a significative negative growth impact of monetary policy, both in 2023 and 2024. Also, in the past, it has been very hard for the eurozone to decouple from the US. Therefore, a US recession might hit the eurozone more than we currently anticipate.

On top of this, throw in the possibility of a credit crunch: falling house prices and an inverted yield curve will make banks a lot more cautious. So, even though we are already more bearish than the consensus, we cannot dismiss the possibility that growth turns out to be even weaker. Of course, that might allow the ECB to cut back rates a bit more strongly over the course of next year.

Source: ING

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Damon

Economic

Persistent inflation could prompt RBA to hike again

The June Reserve Bank of Australia (RBA) meeting is a tough one to call. The RBA recently confused markets with its reversion to a more hawkish stance, even as inflation was weakening, and now the fall in inflation has reversed, there is a reasonable argument for it to hike again this month. However, the quarterly CPI data still seem to carry more weight than the monthly series at the moment, so some forecasters expect the RBA to wait until the August meeting when it will be able to respond to second-quarter CPI inflation.

Our forecasts are for inflation in July to have fallen to 5.2% year-on-year, but the second-quarter rate will still probably be in excess of 6%, so the RBA could well argue a further hike was needed then to ensure that inflation was falling fast enough. But with inflation rising again in April, it is going to be very hard for the RBA to sit on the sidelines in June, so a low conviction 25bp hike is our call this month, but we wouldn't be shocked if the central bank decides to pause.

Philippine trade balance to stay in deficit on soft electronics exports

April export data is set for release next week and we could see both imports and exports remain in negative territory. Imports are expected to drop on a year-on-year basis on shrinking energy imports, while exports could face another month of contraction due to soft demand for electronics. The Philippine export sector is dominated largely by electronics, and weak global demand for smartphones and gadgets will likely impact the overall Philippine export sector. The trade gap is forecast to remain in deep shortfall ($5.1bn) which points to pressure on the Philippine peso in the near term.

Inflation readings from Indonesia and the Philippines

Headline inflation numbers for both Indonesia and the Philippines will be reported next week. We believe headline inflation will continue to cool on a year-on-year basis as favourable base effects help push the headline number back toward target. Core inflation, on the other hand, could prove to be tricky as domestic demand for both countries remains robust. Core inflation in the Philippines may inch lower to 7.5%YoY (down from 7.9%) while Indonesia may even see core inflation inch up to 2.9% from 2.8% previously. Moderating headline inflation gives both Bank Indonesia and the Bangko Sentral ng Pilipinas space to maintain policy settings, however, we don't expect central banks to consider cutting rates just yet given the pressure on their respective currencies.

Singapore retail sales could manage to post growth

Singapore retail sales are expected to remain in expansion, although slowing from the pace reported in March. Elevated inflation is likely sapping some consumption momentum. The sustained increase in visitor arrivals however may be helping to provide retail sales a decent lift, especially for department store sales and services related to recreation. We expect retail sales to be subdued in the near term with a potential rebound should inflation decelerate towards year-end.

Source: ING

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Justin

Central Bank

Economic

Forex

What has been happening lately?

As we have been highlighting in recent previews, the BoJ remains in an uncomfortable position. With the largest central banks being very close to completing their rate hiking cycle, the BoJ is still looking for the light at the end of the decade-long tunnel. Its outlook was looking brighter a couple of months ago but, unfortunately for the BoJ, inflationary pressures globally appear to be abating. This was also evident at the recent Tokyo CPI print for May that surprised on the downside. So, how can the BoJ embark on some sort of monetary tightening with inflation on a downwards path?

BoJ Governor Ueda has repeatedly highlighted the fact that the Japanese inflation rise is due to external, cost-push factors. Domestic demand has been playing a secondary, much weaker role, compared to what we have seen in other countries, tying the BoJ’s hands. The way out of the current deadlock is the consumer sector, thus raising the importance of the recent strong, above-inflation wage increases. The BoJ is expecting these increases to have a material impact on consumer spending and consumer sentiment going forward.

Amidst this challenging environment, there is increased nervousness about the BoJ’s next move. The market has gotten used to the ultra-loose monetary stance with the yen being the traditional funding currency for carry trades. Therefore, a change of policy by the BoJ or even adoption of a more hawkish stance is expected to have a stronger impact, especially on the FX markets. The ECB was quite vocal about this possibility at its most recent Financial Stability review. It was also highlighted that a wave of yen repatriation could create an investment gap in the European and US bond markets.

Stronger Earnings Growth Could be Signal BoJ Has Been Waiting For_1

Plethora of data but two releases stand out next week

Understandably, next week’s focus will be on Tuesday’s figures and, to a lesser extent, on Thursday’s releases. The final GDP print for the first quarter of 2023 and the current account figures for April, both released on Thursday, are critical pieces of the economic puzzle, but as described above the focus is squarely on domestic earnings and spending.

The year-on-year change in the labour cash earnings is forecast to moderate even further to 0.5%. If confirmed, this would be the lowest print since February 2022, and a potential signal that the optimism after the recent wage agreements might have been premature. Similarly, the overall household spending data for April is expected to show some improvement but remain in negative territory. A positive set of data figures on Tuesday would be greatly welcomed at the BoJ halls, but probably not by the bond markets.

Can the yen finally recover some of its 2023 losses?

The 15-year high at 151.61 in euro/yen appears to have somewhat energized the yen bulls as they have been trying to stop this pair’s advance. Their effort has been fruitless up to now, but the formation of a double top pattern could be the answer to their prayers.

Should the data releases surprise to the upside and sentiment turn in favour of the yen, we would see a retreat towards the 148.39 level and a retest of the 147.22 level. A break of the neckline of the formed pattern at 146.13 could result in an even stronger correction. On the other hand, an upwards break of the 149.77 level could open the door for a higher high, above the recent 151.61.

Stronger Earnings Growth Could be Signal BoJ Has Been Waiting For_2

Source:XM

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Justin

Central Bank

Economic

For many of those involved in implementing central bank digital currency platforms, the goal is the same: financial inclusion. While most households can access some form of digital payments, there are still 2.5bn people globally who do not have bank accounts. Without a bank account and, subsequently, no payment history to show, credit for this population is not guaranteed and they may fall victim to paying high interest rates.

By covering all three types of financial institutions engaged in wholesale and retail CBDC – central banks, commercial banks and non-bank financial institutions – GVE’s CBDC platform provides real-time gross settlement for all users. It has the capacity to make 5.8tn transactions annually, which is enough to cover the 8bn individual and 300m corporate customers around the world.

Beyond the goals of financial inclusion, platforms like GVE also consider cost savings. Most fintech companies build light infrastructure on top of global brands like Visa and Mastercard by taking margins of between 10 and 15 basis points of the transaction value. By providing RTGS for all users, it is possible to bypass global brands, which enables platforms to substantially reduce the cost of payments.

Credit card companies, together with card issuers in each country, typically charge a total of 2.5% brand and issuing fees on transaction value in addition to the card readers’ fee and acquirer’s fee. This increases the payment cost. As merchants and companies have accounts with banks, GVE – together with all banks co-operating with GVE – does not require acquirers, further reducing the cost of transacting.

Another important priority for CBDC platforms is the green transition. According to Ajay Banga, president of the World Bank, central banks spend between 0.5% to 1.5% of their gross domestic product every year on printing, securing and distributing cash. To transport this cash to bank branches and ATMs, over 100,000 armoured vehicles are used by banks. New digital systems seek to eliminate the fuel consumption and carbon dioxide emissions of these cars.

Finally, one of the most important considerations for CBDC platforms is security and privacy protection. The public key infrastructure, an encryption method used in most areas of banking, is becoming increasingly vulnerable as quantum computing technology advances. GVE has patented a key management cybersecurity platform, which manages 2,000 separate keys for each user. Such platforms have the security infrastructure that could be the solution for services that require a high level of privacy protection under data regulations, such as electronic medical records. Spending can be only monitored by the bank that has opened the account. This is the same level of privacy protection available now, but the more sophisticated system will deter bad actors.

Source:Koji Fusa

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Devin

Energy

Europe's largest economy is also one of the region's most aggressive advocates for shifting energy systems away from fossil fuels, and leads the continent in emissions reduction targets and investments in renewable energy supplies.

However, Germany is also home to Europe's largest chemicals sector which churns out plastics, paints, acids and other key inputs that are critical to manufacturers and heavy industries that form the backbone of the German economy.

And as most chemical plants run off natural gas or coal, and use crude oil as a major feedstock, Germany's plans to phase out use of fossil fuels over the coming decades represent a potential existential threat to the entire chemical sector.

Ensuring the continuing viability of such an important segment of the German economy even as the country's energy system is retooled will be a key test for policymakers and business planners over the coming years.

Critical Stability

An ill-managed collapse of the chemicals supply chain could deal a heavy blow to the rest of Germany's manufacturing economy, which relies on an abundant array of affordable inputs to generate its own products.

The sector is also a major employer that sustains large raw material and end-product supply chains, so any downturn could pose significant unemployment risks across Europe.

That said, a successful shepherding of the chemicals industry through the country's energy transition, including enabling chemical producers to decarbonise their own energy supplies and outputs, would sustain a vital competitive advantage for Germany's overall economy.

In addition, an updated and low-emitting chemicals sector that generates suites of critical products for other industries could become a vital export earner for Germany, which has ambitions to develop global leaders across the energy transition spectrum, including in the recycling of plastic waste.

Tough 2022, Trying 2023

Before embarking on any modernisation drives, however, Germany's chemicals sector must first recover from a torrid 2022, when surging power costs caused chemicals output to drop by 10%, petrochemical production to fall 15.5%, and for one in every four firms in the sector to incur losses, according to the German Chemicals Association (VCI).

Sharply lower business activity also caused a drop in chemicals consumption last year, but as economic activity recovered in 2023 a lingering shortage of key chemical products has pushed German chemicals prices to near record premiums over those supplied by other producers.

German prices of polyvinyl chloride (PVC), used for pipes, wire insulation and by the construction sector, are currently trading at nearly 90% more than the same product on offer in South East Asia, according to data from Polymerupdate.

Germany Energy Transition Faces Key Chemical Sector Conundrum_1

German high impact polystyrene, used for signs, packaging, toys and furniture, is trading at a roughly 50% premium to Asian prices, while linear low density polyethylene, used for bags and wraps, is trading around 80% above prices offered out of the United States.

Even prices of vinyl chloride, the main base ingredient to make PVC and other products, is trading at a rare sustained premium over Chinese vinyl chloride prices, which historically have been more expensive than German prices, Polymerupdate data shows.

Damage Done

The sustained high prices of German chemical products over international rivals have two important damaging consequences.

Firstly, the high price tags have had the effect of undermining the German chemical sector's hard-won reputation as a reliable and cost-competitive supplier of critical products, while showcasing the global reach and cost advantages of rival suppliers in other markets.

Germany Energy Transition Faces Key Chemical Sector Conundrum_2

Secondly, the high chemicals costs have hurt cost-sensitive consumers, including manufacturing businesses that have also been hit by high energy bills and are looking to keep costs in check in order to ensure their own survival.

Many such businesses are in an especially delicate state in Germany, which was Europe's largest importer of Russian natural gas and which continues to wrestle with power prices that remain well above long-term averages.

Every major industrial segment, from basic manufacturers and machine makers to the producers of high-end cars, have been hit by steep jumps in producer prices in Germany, according to VCI data.

Germany Energy Transition Faces Key Chemical Sector Conundrum_3

Producers of bulk commodities such as metals, paper goods and petroleum products have been hit especially hard, and saw producer prices jump by 26.5%, 29.8% and 40% respectively in 2022.

These same companies are typically major consumers of goods produced by Germany's chemicals sector, but are currently ill-equipped to pay premium prices for industrial inputs that can be easily acquired much more cheaply from other suppliers.

If the German chemicals sector is to ensure its own long-term future, it must somehow win back any business lost among commodity manufacturers by driving product prices steadily lower relative to rival offerings.

German chemicals makers must also develop and showcase their own green credentials so as to lock up demand from higher-margin climate-conscious customers who are under pressure from their own consumers and investors to ensure clean supply chains.

On its own, the chemicals sector may struggle to both cut costs and clean up its own product lines and emissions footprints.

But with strategic aid from government and industry bodies, Germany's chemical producers could undertake a major overhaul that could ensure its continued central role at the heart of the German economy even as its own and its customers' energy systems steadily shift away from fossil fuels.