The most immediate danger to the
US dollar is quite clearly posed by QE3. The US Federal Reserve’s monetary
policy outlook should be a little clearer after Bernanke’s speech in Jackson
Hole this afternoon. If it is not, then the Fed’s meeting and press conference on
September 13th should yield plenty of clues.
Whilst data over the past month or
two suggests that US economic growth is recovering from its slumber in the
first half of 2012, there is plenty of uncertainty ahead with the US ‘fiscal
cliff’ drawing closer.
What is the fiscal cliff? The end
of 2012 will see tax cuts come to an end and spending cuts dramatically, which
are expected to weigh on US GDP dramatically. Tax cuts that will expire include
a 2% payroll cut for workers and tax breaks for businesses, while tax hikes
related to President Obama’s healthcare law will also kick in. The Congressional
Budget Office estimates that the effects of all this could be a reduction in US
GDP by a staggering 4.0% in 2013, while two million jobs could be lost resulting
in a 1.0% rise in unemployment. So with the fiscal cliff capable of plunging
the US economy back into recession, the stakes are extremely high.
The US economy is faced with
taking the pain and addressing its fiscal position in an early but huge hit, or
spreading the pain over a longer period in order to safeguard a still fragile
recovery (a familiar debate to followers of the UK political approach to
austerity). As last year’s ‘debt ceiling’ debacle demonstrated, deadlock in the
US political system can cause huge delays to major policy decisions.
In addition, this fiscal cliff
issue comes in the context of an election year, so there will be no decision
made on how to approach tax and spending moving forward until the leadership is
determined in early November. A stop-gap measure to delay the tax rises may
well come before the end of the year but you can be confident that any decision
that is made will come right down to the wire.
What are the implications for the
US dollar? Well, as ever there are two sides of the coin. The concerns over the
US economy and the fears of recession could drive the dollar down in line with
its deteriorating economic fundamentals. Contrastingly, the threat to the world’s
largest economy could see the market flood back into the safe-haven US dollar.
Inevitably, both strategies will be adopted but which truly prevails is
uncertain.
Our bet is that the US dollar will
be hurt by the fiscal cliff issue. This will likely be the case whether the US ‘goes
over the cliff’ or whether delaying tactics are adopted. The can-kicking that
has been evident in the eurozone has been a major weight on the euro over the last
couple of years and the market response to more of the same from US
policymakers will be the same.
However, the fiscal cliff is by no
means the sole point of focus for the financial markets in the second half of
2012. Of course, this all comes as the eurozone debt crisis reaches new levels
of seriousness. Indeed, we doubt that the fiscal cliff issue will be enough to
stop the EUR/USD pair dropping significantly below $1.20 by the end of the
year. The fiscal cliff will weigh on the dollar, but not to the same extent
that the debt crisis will weigh on the euro.
Richard Driver
Currency Analyst
Caxton FX
