Your weekly economic update from the team at FXD Capital
Signs are emerging that interest rates for corporate and personal savers may have bottomed out earlier this year and are starting to creep up. The natural reaction to this would be to assume that the ramifications of rising yields in the institutional bond market have pushed up borrowing costs for banks, and thus, savers get their just rewards. While to some extent that may be true, the short-term effects of rising yields will mostly implicate institutional borrowers mulling over debt issuances.
The reason behind rates creeping up is down to old fashioned supply and demand. Especially in the UK, the glut of mortgage borrowing fuelled by a rampant property market has made banks all pause in unison and question whether they need to shore up balance sheets. In a competitive market, where the most reliable business to print is retail mortgages, banks increasingly find they are also competing for stable long-term retail funding. Consequently, the best buy 12-month fixed rate for personal savers has moved up 20bps since April to 0.85%.
Similar effects will be seen in the 95-day notice range in corporate deposit markets, albeit with more flux for negotiation.
Will USD remain the world’s preeminent reserve currency? The question periodically crops up, especially during periods of USD weakness, of which we are in the throes of one right now. USD dominance exists due to its status as the currency of the world’s largest economy, one blessed with a liquid and stable financial system. While the Bretton Woods diktat of a post-WW2 world gave USD an unfair platform to assume dominance, history shows that the largest economy sets trade terms, and the US had already surpassed the UK in that regard earlier on in the 20th century.
USD is in the spotlight right now due to the heightened threat of domestic inflation, which will erode the value of debt holdings. Such an outcome would benefit corporations and the government, but not investors, hence the recent exodus from USD denominated assets.
While the US is less interventionist in foreign policy than it was back in times like the Cold War, this alone would not be a reason why trade will cease to denominate in USD. When the euro launched 22 years ago, USD constituted 71% of total central bank reserves worldwide; the figure now stands at 59%. Bear in mind that the US represents 25% of world GDP, so the imbalance of USD is still relatively significant versus the US’ economic footprint.
Calls for the end of USD dominance usually precede unrealistic predictions of shifts to Chinese renminbi, cryptocurrencies or post-apocalyptic gold-based barter systems. Such outcomes range on the plausibility scale and will manifest over generations, well past our lifetimes.
RMB has gained 10% against USD over the past year and currently sits at its highest level over three years. For the past couple of decades, China has targeted a weak RMB to stimulate its export-led growth. Yet, as China’s economy matures, it’s natural that the government will allow RMB appreciation to control inflation and pivot to domestic-led demand.
It should be seen as a good move for countries to diversify currency holdings and hedge their bets more. Indeed, this is a mantra that any corporate treasurer worth their salt would follow! Over time a slight increase in trade denominated in Euro and RMB should be expected, especially if the former issues more EU-backed debt and the latter makes its financial system more free-market.
One justification behind the predictions of runaway inflation is that specific sectors have experienced apparent labour shortages as economies open back up. The lack of applicants for roles in the service sector, especially hospitality, is resulting in wage growth and pricing pressure as employers struggle to fill positions.
Yet despite these calls, countries are still operating far from full employment. The US, in particular, is still 10 million jobs short of its pre-pandemic level. So why would there be labour shortages? Indeed, with the reliance on precipitous gig economy roles, one could argue that hidden unemployment masks even worse employment figures?
The troubles experienced in sectors like hospitality are likely to be short-lived due to a perfect storm of conditions. With sectors opening up en-masse in unison, mobilising labour is always going to be difficult. In addition, furlough schemes and pandemic assistance packages create perverse incentives. For some, the initiatives have reduced workers’ desires to go out and work. Once they start to end in the second half of the year, the dust should settle, and a more realistic picture will emerge.
Although the UK may experience more pain in this regard, Brexit’s effect on reducing foreign labour supply will result in a new state of play appearing. The UK’s post-Covid and post-Brexit “new normal” will paint an interesting picture.
All the best for the week ahead,
Our weekly column is written by Alex Graham, Economic Advisor to FXD Capital. Originally a bank treasurer, Alex’s weekly roundup intends to provide a conversational, top-down view of what is going on in world macroeconomics and how it impacts business on the ground level.
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