Some good thoughts from Morgan Stanley analyst Sophia Drossos on the tight link between Asian and US economies, and implicitly why you should be freaked out if Mr. and Mrs. American consumer ever tire of spending..
The main message from the BoC and other central banks
seems to be that the external environment is becoming more
positive as the drivers of the global recovery broaden out.
Increasing strength in the US economy is augmenting the
strong growth observed in EM, suggesting more durable
prospects for the global economy. The influence of improved
US growth can be seen indirectly in some of its trading
partners. Indeed, the rebound in Canada, Mexico and AXJ
economies hints that the US economy may have more
forward momentum than many currently believe. Decoupling
was disproved during the financial market crisis as EM
economies succumbed to the growth slowdown in the
developed world. If decoupling didn’t hold on the way down,
why should it hold on the way back up?
Though it is true that Asian growth has led the global
economy out of the recent recession, historically, AXJ growth
is very tied to US growth too. As Exhibit 1 shows, AXJ growth
has a strong relationship with US growth. Strong trade ties
between the two regions help to explain a significant portion
of this, as US consumption fuels the Asian production cycle.
This point is underscored by the strong relationship between
AXJ exports and US GDP. It is notable that industrial
production (YoY basis) in some of the US’ main trading
partners has rebounded to pre-recession levels. Given this
production is typically bound for developed markets, and the
US comprises the largest part of that, circumstantial evidence
of the improvement in the US economy continues to mount
Our US economics team projects US GDP at 3.25% this year,
strong enough to trigger Fed rate hikes in Q3. While many
market participants continue to doubt the sustainability of the
US recovery, the circumstantial evidence is building. In that
vein a repricing of US growth and interest rate differentials is
likely. Long USD/JPY (target 109 by end-2010) and short
EUR/USD (target 1.24 by end-2010) offer good ways to
position for an upside surprise in US growth prospects. In
addition, we suggest going long currencies with strong trade
ties to the US, such as MXN and CAD. We still favour long
CAD vs short AUD given that the global growth engine is
likely to be increasingly powered by the US economy rather
than Asia this year. With a lot of good news priced into AUD,
it is likely to cede ground to CAD.
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