Twixt England, Australia and here
The words we’re most likely to hear
Are jobs need to be
Created you see
Elect me or they’ll disappear
The thing that these fellows don’t say
Is government gets in the way
Of companies which
Do try to enrich
Themselves, and thus hire and pay
The fundamental fallacy that is pushed by President Obama, PM Rudd of Australia and Ed Miliband, UK’s Labour Party leader, is that the government creates jobs. We hear it incessantly in every political campaign from leaders and politicians on the left side of the spectrum. It is, however, false. Companies create jobs, at least the ones that are meaningful. Government jobs serve one of two purposes: defense, which is meaningful but a small proportion of those created, or reallocating the value created by the private sector to the areas desired by the government in power. There is no value creation and therefore no permanence attached to these positions. I am reminded of this again this morning as the weaker than expected jobs data from Australia overnight was a blow to PM Rudd’s reelection campaign. Aussie fell on the release initially and was trading quite poorly until the Chinese Trade data was released ninety minutes later. Those numbers showed both exports and imports climbing significantly more than expected (by 5% and 11% respectively) and indicate that the Chinese economy is not slowing further but rather is stabilizing after its recent slowdown. Again, one data point does not a trend make, but the news was clearly positive for Australia and Aussie jumped on the report. It is now trading back at its highest level this month, although it remains down more than 14% since April.
But back to jobs and their connection to the FX markets. There is no argument that significant unemployment is both a short and long term negative for an economy. The erosion of skills that occurs, the stress on the public finances and the general malaise of the unemployed population are all very real and very problematic. (Just look at Spain and Greece) The question is how do policymakers deal with the situation and what are the most effective solutions. And the problem is that in the current situation across most developed nations, policymakers have not been able to address the problem effectively. In most cases this seems to be a partisan issue, where the most likely solutions, like freeing up the labor market from its many restrictions, are anathema to the party in power. And the proposed solutions, like raising the minimum wage, are exactly the wrong medicine for the problem. The more a country pushes this type of process, the worse it is for that economy and by extension the currency attached. So here in the US, for example, we have that exact situation in place. Calls for a higher minimum wage, dismissiveness towards potential job creation of major private projects, like the Keystone XL pipeline, and a weakening currency. As I continue to try to understand the FX market, I look at US monetary policy, which while still quite easy has pretty clearly reached an inflection point as to the extent of that ease. They will be tightening soon with the taper. Fiscal policy could hardly be considered tight, although the sequestration did tighten it somewhat. The economy is showing signs of more stable growth and the employment situation, at least as measured by the Unemployment Rate, is improving. And yet the dollar remains on the defensive. Arguably, amongst the major currencies, the situation in the US is the best of the bunch. So why is the dollar soft? I cannot attribute it all to the misguided ramblings of the president with regard to his ‘jobs’ ideas, but underlying investment decisions are clearly predicated on expectations of future policy. The US may not seem as attractive an investment destination if the government continues to interfere more broadly than it has historically in the labor market. I mean when it comes to real investment like building factories and production capabilities, labor market policies matter a great deal.
And when it comes to the FX market, changes in perception of government policies matter a great deal. Remember, markets respond to changes in relative policies, not absolute measurements. So if a country tightens monetary policy, or fiscal policy or labor market policy relative to what it had been doing, that is the catalyst for market movement. And arguably, tightening labor policy is akin to tightening fiscal policy, which has historically been a currency negative. I am beginning to think that the G10 governments are addressing fiscal policy issues through other than direct means, like labor policy, as the channel to address them directly is too politically difficult. I have a feeling we will be seeing much more in the way of this type of market intervention as we go forward, mostly to the detriment of the currencies involved.
Aside from Aussie’s rally, the rest of the G10 space has been pretty dull. The BOJ did nothing, as expected, left their economic assessment unchanged and the yen is modestly higher. BOJ Governor Kuroda went on record saying the sales tax hike was necessary and important, and more importantly implied that the BOJ would support the economy with further monetary ease when it comes into effect. Again, it is hard to see this as a yen positive, but market momentum remains for a stronger yen right now.
In the EMG space, Brazil made new lows yesterday, trading up to 2.3162 at its worst and continues, in my view, on toward 2.50. While the China news will be seen as a positive, it will not be enough to stop this trend. INR also benefitted from the China news, rallying a bit, but remains within one Rupee of its record low. MXN, ZAR, KRW and the other larger currencies in this space have all rallied modestly overnight although this appears to be more general USD weakness rather than specific currency strength. Today’s Initial Claims data is not likely to have a substantial impact, so as we continue with summer markets, I expect the dollar’s slide to extend a bit further. Ultimately, I am still a dollar bull, but the market is telling us that being bullish the dollar right now is the wrong trade. So receivables hedgers, take advantage of this dollar weakness as I am convinced it will dissipate as we head into the fall.