How the dollar’s weakness is the rest of the world’s problem

Forex markets pose a threat to a synchronised recovery needed to validate stock prices

by: Mohamed El-Erian


The greenback has dropped dramatically this year as the reality of Republican political dominance has unfolded


While Americans visiting Europe find that their dollars buy less, the recent sharp weakening of the world’s reserve currency is a lot less of a problem for the US and much more for the rest of the world, where it increases already complex economic and policy challenges. It also continues a “hot potato” syndrome that highlights the underlying structural fragility of the global economy, as well as undermining the foundation crucial to solidifying and sustaining elevated asset prices.

Commenting on a dollar that had appreciated by 5 per cent from the time he won the elections to the end of that year, incoming President Donald Trump warned in January that the currency was “too strong” as it hurt the ability of US companies to compete internationally. Since then, the greenback has depreciated steadily, touching a 33-month low during Friday’s trading session in what amounts to a 9 per cent decline in the trade-weighted index so far in 2017. It has been a broad-based move against the currencies of both advanced and emerging economies, even some that maintain managed pegs with longstanding ties to the dollar, including China’s, which in the last few days, however, has started to resist.

The primary driver of the dollar’s decline has been a narrowing of the differential in market expectations for economic growth and monetary policy. During the past few months, actual and expected growth has picked up in Europe and Asia, both in absolute terms and relative to the US.

Concurrently, with the implied market probability of a December hike having fallen sharply (to below 30 per cent), traders have aggressively pushed back to June of next year material expectations of the next Federal Reserve hike — this at a time when they have also been internalising signals from the European Central Bank that it may move as soon as next month in announcing plans to reduce large-scale asset purchases.

While some segments of American households and companies will suffer from the recent depreciation, the overall economic impact is likely to be favourable. By enhancing price competitiveness, it provides a tailwind for economic activity and job creation. It is supportive of financial markets, given that companies in the S&P 500 derive a significant portion of their revenues from abroad.

Also, at the margin, it increases the chances of the Fed progressing with its “beautiful normalisation” after an unexpectedly prolonged reliance on experimental unconventional measures — that is, restoring policy rates and the balance sheet to less extreme and less distortive levels without derailing growth and causing financial instability.

The picture is less rosy for the rest of the world. Most economies now have to contend with a stronger headwind to growth and, in the case of Europe, downward pressures on an inflation rate that the central bank worries is already too low. With continued delays in implementing the much-needed set of pro-growth policies, this serves to weaken the cyclical growth impetus and amplify the effects of structural impediments to higher and more inclusive growth.

The dollar’s round-trip over the past 10 months also brings into sharper focus an important dimension of today’s currency markets. With limited exceptions, such as Germany, there are very few countries able to absorb and navigate easily a sustained period of sharp currency appreciation — and this for a simple reason: compensating growth engines are still too weak. As such, rather than be part of an orderly growth-enhancing global rebalancing, currency moves nowadays involve too many zero-sum elements that can also fuel economic nationalism.

John Connally, when Treasury secretary in President Richard Nixon’s cabinet, famously told his European counterparts in 1971 that the dollar “is our currency but your problem”. With the structural fragility of today’s global economy, and with continued overreliance on monetary policy, this dictum could easily be generalised to many currencies experiencing a sharp depreciation.

Until this situation is resolved through more comprehensive and better co-ordinated policy responses, currency markets will pose a threat to the solidification of a synchronised global recovery needed to validate stock prices around the world in a durable manner.


Mohamed El-Erian is chief economic adviser to Allianz and author of the book “The Only Game in Town”

Retirement accounts

Does ageing explain America’s disappointing wage growth?

WHEN America’s unemployment was last as low as it has been recently, in early 2007, wages were growing by about 3.5% a year. Today wage growth seems stuck at about 2.5%. This puzzles economists. Some say the labour market is less healthy than the jobless rate suggests; others point to weak productivity growth or low inflation expectations. The latest idea is to blame retiring baby-boomers.

 

The thinking goes as follows. The average worker gains skills and seniority, and hence higher pay, over time. When he retires, his high-paying job will vanish unless a similarly-seasoned worker is waiting in the wings. A flurry of retirements could therefore put downward pressure on average wages, however well the economy does. The first baby-boomers began to hit retirement age around 2007, just as the financial crisis started. And since 2010, the first full year of the recovery, the number of middle-aged workers has shrunk considerably. They have been replaced partly by lower-earning youngsters (see chart).

Researchers at the Federal Reserve Bank of San Francisco think this could explain disappointing wage growth over that period. They split earnings growth into the portion caused by pay rises, and the portion caused by people joining or leaving the workforce. From mid-2012 until recently, changes to labour-force composition have reduced income growth by about two percentage points. By comparison, in early 2007 the drag was less than one percentage point.

 

For those in work continuously, pay is rising just as fast as it was then.

 

Does that mean the labour market is running hot? Not so fast, says Adam Ozimek of Moody’s Analytics. He points out that the number of workers aged over 55 is growing, not shrinking, as a fraction of the workforce. What is more, statistically controlling for ageing barely changes estimates of aggregate wage growth, according to his model.

 

So what is going on? The San Francisco Fed’s researchers also note that many low earners have recently joined the labour force (such workers are usually the last to benefit from economic expansions). Growth in low-skilled jobs can hold back average wage growth. But this explanation does not imply that the labour market has fully recovered, because more people may yet be tempted to look for a job. In fact, Mr Ozimek denies there is a wage puzzle to begin with. Replace the unemployment rate, which counts only those who are seeking work, with the fraction of 25-to-54-year-olds who are jobless, and wage growth is exactly where you would expect it to be (at least according to Mr Ozimek’s preferred measure of pay and benefits).

 

Another problem with the ageing explanation is that it is not just wage growth that has been disappointing. Inflation, too, has been puzzlingly low this year: the core consumer-price index, which excludes food and energy, has undershot forecasts for five consecutive months. Ageing cannot easily explain low inflation. True, retiring baby-boomers reduce firms’ wage bills. But if older workers earn their high pay through high productivity then firms’ unit costs should not fall as retirements rise.

 

Ageing is too often overlooked as an explanation for economic trends—politicians routinely promise that the economy will grow as fast as it did before baby-boomers started retiring and the workforce began to shrink. Yet when it comes to wage growth, the effect of ageing is probably modest.

 

Policymakers should not hide behind it. Despite low unemployment, the labour market is not yet simmering.

In North Korea, Perception Is Reality

By Jacob L. Shapiro

This undated photo released by North Korea’s official Korean Central News Agency (KCNA) on Aug. 26, 2017, shows military exercises at an undisclosed location in North Korea. AFP PHOTO / KCNA via KNS / STR/AFP/Getty Images

A Surprise Lift From China for U.S. Steel

China has crushed U.S. steel producers, now the industry might get a boost from its long-time rival

By Nathaniel Taplin

World’s biggest banks square off over Noble credit default swaps

Goldman and JPMorgan among groups embroiled in dispute over claim settlements

by: Robert Smith and David Sheppard in London



There is more than $1.2bn of CDS written on Noble’s debt, according to ISDA data © FT Montage


The plight of heavily indebted Noble Group is pitching some of the world’s biggest investment banks against each other in a tussle over credit default swaps written against the troubled commodity trader’s borrowings.

Goldman Sachs, Nomura and hedge funds who stand to gain from having bought CDS protection on Noble are facing off against JPMorgan, BNP Paribas and other traders. It is shaping up to be an important test for reforms made to the $10tn CDS market a decade after it was widely blamed for exacerbating the financial crisis.

The dispute rippled through debt markets in London and Asia last week after banks and funds served notice to sellers of CDS protection, which pays out in the event of a default. They claimed that a recent extension to Noble’s loan repayment terms amounted to a debt restructuring.

The move was unusual, as the CDS market has agreed since the financial crisis to rely on the rulings of the International Swaps and Derivatives Association (ISDA) to determine when a company is in default, seeking to avoid widespread confusion or drawn-out legal disputes.

But earlier this month the ISDA committee responsible for deciding on the status of Noble’s debt said it was unable to determine if the Singapore-listed commodity trader was in default or not, creating a vacuum that allowed bilateral claims to proliferate across the market. It is the first time ISDA has dismissed a question of default without making a ruling either way.

There is more than $1.2bn of CDS written on Noble’s debt, according to ISDA data, and banks and hedge funds often hold offsetting positions or hedges in the same products.

This meant that, after the first claim was filed early last week, it forced a chain reaction of claims and counterclaims that spiralled through the market, with one source saying 12 institutions had triggered notices of default. The net total owed by sellers of CDS protection on Noble could be up to $157m.

“Notices were flying all around the city,” said one hedge fund trader involved in the CDS market. “They wanted to be below the radar on this but the banks receiving the notices were obviously freaked out.”

JPMorgan and BNP Paribas, which are said by traders in the CDS market to stand to lose in the event of a Noble default, have now filed questions with ISDA to move the process back in front of the industry body’s so-called determinations committee, which will meet on Tuesday.

Goldman Sachs, Nomura, JPMorgan and BNP Paribas all declined to comment on their CDS positions. ISDA also declined to comment.

In the absence of a ruling from ISDA, banks and funds that have bought or sold Noble CDS are essentially flying blind, with no precedent to follow, except how the market operated pre-2009.

“It’s like the whole last 10 years of market development have been put to one side,” said Nigel Dickinson, a derivatives lawyer at Norton Rose Fulbright.

“Because the ISDA determinations committee mechanism was supposed to avoid problems like this — market participants would ideally not need to trigger credit protection bilaterally.”

ISDA introduced the determinations committee system eight years ago in response to the chaos that credit derivatives caused in the financial crisis, after the mass triggering of protection linked to subprime mortgage bonds had to be settled between financial institutions bilaterally at the peak of the crisis.

The $85bn bailout of AIG by the US government came after the insurer almost collapsed due to CDS exposure.

Noble was once Asia’s largest independent commodity trader but its large debt load and questions over its accounting have taken the Hong Kong-based company close to the edge. Despite embarking on a shrink-to-survive plan, its share price has fallen 95 per cent since early 2015 and it is on life support from its lenders.

The quarrel over Noble is the latest in a string of controversies in the CDS market.

The collapse of Spanish lender Banco Popular sparked a dispute over the payout on CDS due to a dispute over legal claims against the bank.

The ISDA determinations committee has also faced criticism for being made up of representatives of the same banks and investors that stand to lose or benefit from their decisions.

Going back to the old system of bilateral settlements, however, raises the prospect of more disputes and expensive court cases. Senior bank CDS traders say there is little appetite for a return and are looking for ISDA to make a call.

“The CDS market has made a lot of enhancements over the years,” said one person familiar with the business. “Moving to a determinations committee framework has definitely been a positive move.”