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Pak rupee outlook linked with strength of leading currencies

The impact of free fall of rupee

In the recent months Pak rupee has depreciated significantly. This has on one hand increased debt servicing and on the other hand pushed inflation rate in the country. Depreciation of rupee is adding to the cost of imported goods and eroding competitiveness of the locally produced goods. The United State, European Union member countries are major trading partners of Pakistan. Therefore, any movement in the value of these currencies as well as parity with local currency has to be closely watched.

2018 was a phenomenal year for the US dollar. Currencies of the emerging market were hit the hardest by the rise in the dollar value, but major currencies also lost their value. In the last 2 months the tide has shifted with the dollar falling against all of the major currencies. As 2019 begins, the big question is, will the greenback unwind all of its 2018 gains?

A number of factors will inhibit global economic growth in 2019 because volatility is rising, stocks are falling, borrowing costs are increasing, credit is tightening, housing is slowing and earnings growth is weakening. These trends are likely to continue to dampen growth in the near term. 2019 will also be a year filled with economic and political challenges in the US. With the stimulus from tax cuts fading, the weakening economy, decline in stocks, rise in interest rates and divided Congress will keep President Trump’s hands tied.

While meaningful legislation may be delayed, it could also force Trump to secure a trade deal with China, infrastructure reform or middle income tax cuts. The US economy is slowing, unemployment rate is at a 48-year low and wages are growing at its fastest pace since 2009.

Inflation is on target, gas prices are low and all of this translated into strong spending. Reportedly, between November 1 and December 24, retail sales rose 5.1 percent, which is the strongest pace of growth in 6 years. The sell -off in stocks has not affected consumer demand.

Monetary policy could also pose a problem for the dollar in 2019. The Federal Reserve raised interest rates last year but that will change as other countries move to normalize monetary policy more aggressively. The Federal Reserve is likely to increase interest rates in the first half of the year, which could lend support to the dollar but less tightening is needed. At their last meeting, Fed Chairman Jerome Powell said that no future rate decisions are predetermined and everything is data dependent. If the economy continues to slow, they’ll delay raising interest rates. If it were to stabilize and start to turn upwards, they’ll be inclined to move more quickly but as things stand currently, they’ll be more conservative than aggressive with rate hikes. The greenback will remain under pressure until data or the Fed Chair gives investors a reason to believe that a rate hike is coming and it will be so there’s also opportunity to the upside.

Upcoming development in eurozone

As 2018 progressed the situation in Europe both on the political and economic fronts grew darker by the day. The same populist waves that swept over UK and US made their presence felt on the continent with Italy electing a radical new coalition that challenged the eurozone budget rules, France seeing week after week of rebellion in the streets over new taxes and Germany’s Angela Merkel seeing her grip on power diminish to the point where she decided to not run for party leader again. The political upheaval came at the worst possible time for the region as the economy began to slow materially into the second half of the year. Business sentiment were hurt badly by Trump’s trade war rhetoric which was directed not only at China but at EU as well.

By the end of the year growth had slowed to 1.6 percent while sentiment readings plummeted. The policymakers in the region are finally beginning to realize that a monetary union without a banking and fiscal union is an untenable structure and cannot be held together by the thin thread of authority of ECB. If the global economy faces a slowdown in 2019, the pressure on EU authorities to unify some of these functions will grow.



Despite a clear slowdown in economic conditions, the ECB is determined to bring Quantitative Easing to an end and has no plans to change the schedule of the taper. The central bank terminated all new buying of bonds in December. Although rates in the region remain generally low, credit conditions in the periphery are likely to tighten both from the impact of tighter monetary policy and the perceived greater political and economic risks in the region. That could pose a challenge to policymakers, especially if the PMI readings slip below 50. The situation is further complicated by the fact Mario Draghi will retire in October of 2019 and barring a severe market disruption the ECB is unlikely to change course and provide much stimulus to the economy. Monetary policy is likely to grow even less supportive of the economy in the region which could exacerbate the slowdown and could push the region into a contraction by the second half of the year.

Brexit to dominate pound

Brexit story will dominate pound trade as markets are still in state of uncertainty as to how the UK exit from EU will unfold. If the meaningful vote fails, UK legislators may opt for a second Brexit referendum, which would also be viewed positively by the market as the prospect of overturning the Brexit vote has risen markedly since the first referendum in 2016. With only a few months to go before the March 15th deadline, the prospect of a second referendum could create chaos in UK politics and volatility in cable is sure to rise with every new poll headline. With no agreement in sight UK policymakers could simply exit the EU without any deal a choice that is unpalatable to all sides and one that could plunge UK into a deep recession as it loses access to key services such as transportation and pharmaceuticals.

In UK, the monetary policy has been on hold due to Brexit considerations. Even if Brexit is resolved in the most benign way for the UK financial services sector, with UK essentially continuing to have full access to EU financial markets, the Bank of England (BoE) is likely to remain on hold for quite some time in order to insure that credit conditions remain conducive to growth. Should a hard Brexit happen, the BoE will find itself in a near impossible situation as it will face the need to open the credit spigot while at the same time battling what could be a crippling inflation shocks. The very likely drop in the currency will only add to the woes and exacerbate the situation. In contrast to the current conditions where a drop in the pound actually proved stimulant by making UK industry competitive as it enjoyed all the benefits of a unified market, the post hard Brexit scenario would bring the worst of both worlds by making goods and services more expensive for UK consumers while shutting off key markets for UK businesses.

Economic challenge for Japan

As regards economic conditions in Japan in 2018, the year started off on a strong note with GDP growth improving and even posting a very powerful 3 percent read in Q2 of the year -one of the very few nominally positive quarterly readings in Japan’s multi-decade struggle with deflation. However, despite continued massive monetary infusion from Bank of Japan (BoJ) growth faltered as the year progressed and global events negated much of the central bank stimulus. The trade war tensions between US and China hit Japan particularly hard since the country is a major exporter of both consumer and industrial goods. The drop in CAPEX in China is likely to hurt Japan’s key machine tools sector even harder and the country’s exports saw a very sharp decline in growth from 12.2 percent at the start of the year to just 0.1 percent by the end of 2018. Therefore, 2019 looks particularly challenging for the Japanese economy as the fight against deflation shows little sustained success, while global growth trends look particularly ominous for the export driven economy. If risk aversion flows continue to irk financial markets, the rise in yen will make conditions more difficult for policymakers who are pretty much out of options at this point.

Unlike its other G-3 counterparts the BoJ remains resolutely dovish in its monetary policy stance as it continues to pump money into the economy. In fact it hinted that it may allow rates to turn negative once again as JGBs once again become harbors of safety. At its latest meeting members noted “Long-term yields should be allowed to temporarily turn negative to keep monetary policy ultra-loose.” They added, “Attempting to bring interest rates back up (via market operations) would tantamount to monetary tightening.” The BoJ is clearly struggling with renewed bouts of global risk aversion which not only dampens demand as export growth slows, but also strengthens the yen as many high risk carry trades that utilize the ultra-cheap financing of yen rates are unwound. This creates dual pressures on deflation and can overwhelm the Quantitative Easing program that the bank has in place. With BoJ already owning more than 43 percent of the JGB market and an estimated 75 percent of the ETF market there is little more that the central bank can do to further stimulate the economy. BoJ’s worst case scenario is a prolonged global slowdown that would create a long de-risking cycle strengthening yen further and thus wiping out all of the central bank’s efforts over the past four year to revive inflation. With policy generally out their hands, Japanese monetary authorities can only hope that other G-3 central banks respond proactively and ease conditions to avoid a synchronized global recession.

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