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Diverging policies among major central banks will fuel the dollar rally

Nov 16. 2015
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By SPECIAL TO THE NATION

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THE STRENGTH of the US economy will compel the US Federal Reserve (Fed) to raise interest rate as early as this December. Conversely, the other major central banks, namely the Bank of Japan (BoJ) and the European Central Bank (ECB), will likely face press
In the US, the October employment report was way ahead of expectations. Specifically, the non-farm payrolls, which reflect the pace of hiring in the month, rose by 271 thousand jobs, the biggest increase since December 2014. The robust job report underscored a strong rebound from a recent weakness that kept the Fed from raising rates in September. 
In addition, the unemployment rate declined to 5 per cent, a level at which many economists consider a full employment level for the US. 
In Europe, the ECB hinted more easing at its last meeting in October citing the weak outlook for inflation. Expectation of additional measures from the ECB has been rising as the third quarter GDP growth figures in the eurozone, which have been released last Friday, came short of forecasts and decelerated from the second quarter.
In Japan, the BoJ kept the size of its asset purchase programme unchanged in the October’s meeting. The decision was against the market expectation of further easing, but going forward, the pressure to act could be mounting. Japan’s economy plunged back into recession in the third quarter as GDP remained in contraction for the second straight quarter. The outlook for inflation could also be weakening as support from weak yen dwindles unless BoJ eases further. 
The divergence in policies could most likely create upward pressure on the dollar and US bond yields. It also runs the risk of creating turbulence in emerging market currencies, similar to what happened during the “taper tantrum” in the third quarter of 2013. Volatility in emerging market stocks and bonds could rise in tandem with currency market. Most vulnerable are countries that run large current account deficit and hold small foreign reserves such as Brazil, South Africa, Turkey, and to lesser extent Indonesia and Malaysia. 
Japan and Europe equities could offer haven from strong dollar as weak yen and euro help support earnings due to the gains in foreign exchange conversions. Technically speaking, DAX, STOXX600 and Nikkei225 are trading with positive and rising correlation to the dollar. In addition, the rising chances of more policy actions from the ECB and the BoJ will likely give boost to the markets. 
 
Komsorn Prakobphol, the author, is head of Strategy at TISCO Economic Strategy Unit. He can be reached via www.tiscowealth.com or komsorn@tisco.co.th.
 

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