“There is building optimism that the European Central Bank will finally take decisive steps to bring the European debt crisis to an end,” says Harvinder Kalirai, chief strategist at BCA. “But it is not yet clear that Europe has broken out of the crisis/response cycle of the past three years.” He says that means another market riot should not be ruled out.
Kalirai notes that while Europe is in recession, the rest of the world economy is also struggling.
“Indeed, recent data indicate that Chinese growth is still slowing and our Chinese GDP model is not forecasting a bottom yet,” he says. “With money and credit growth sluggish, the Chinese authorities remain behind the curve and will need to ease policy much more aggressively.”
Meanwhile, US growth remains below trend, but is not weak enough to elicit additional easing by the Federal Reserve. In addition, as the Fed waits for more economic data, the “fiscal cliff” draws ever closer.
| Narrowing US trade deficit set to boost dollar? |
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| Source:BCA Research |
Furthermore, the sharp narrowing in the US trade deficit is a troubling sign.
“Arithmetically, a smaller deficit does lift GDP,” says Kalirai. “However, the US trade balance is extremely cyclical and it only narrows in a meaningful manner during recessions.”
He notes the shrinking US trade deficit also implies a tightening in liquidity conditions, as fewer dollars are flowing into the global financial system.
Kalirai says that is usually problematic for global risk assets and risky currencies, and supportive for the US dollar.
“For these reasons, we advocate waiting for evidence that policymakers are getting ahead of the economic slowdown before raising risk exposure,” he says.
“An upside breakout in gold prices, a bottom in the global leading economic indicator and an upturn in Chinese money-supply growth would provide sufficient signposts that cyclical support is building for risk assets.”