2015 Watch Items

After reading half a dozen economic and market forecast newsletters for 2015, I have a few items that I think will be of interest this year. I have created a graph to keep track of the numbers and will occasionally write an update. The choices I made were because of an expected change in the United States, an indicator that is a consequence of that change, two currencies in a depreciation war, and finally another indicator of the consequence of that battle.

I’ll start with the expected change in the United States. The Federal Reserve has been signaling it will begin raising interest rates in the first half of 2015. I have read guesses of the meetings between March and June. I expect the market to react as the language from the Fed draws that range down to a single meeting as we move through the year. My indicator of choice on how the market is reacting is the spread between the two-year constant maturity treasury and the ten-year constant maturity treasury. The upper left graph on the link shows the ten year history of this subtraction. 2014 began with the spread at 261 basis points (a basis point is 0.01%). 2014 ended with a spread of 151 basis points.

When the Federal Reserve begins raising interest rates, the yield on the two-year should begin to rise. My expectation is there will not be a similar rise in the ten-year yield. Thus, this indicator should continue the pattern of declining toward 100 basis points. That basically would mean two rate increases of 0.25% from the Fed assuming the ten-year yield does not change. If this indicator moves even lower than that, I will need to begin watching the ten-year yield. If it falls in response to the rate increases, the market is indicating the economy cannot handle the Fed taking away the punch bowl and the potential for an economic slowdown in the near future is something causing investors to rush to the relative safety of treasuries.

Thus, my first watch list item is the spread between two-year treasuries and ten-year treasuries as a proxy for the expected rate increases from the Federal Reserve.

My second indicator is a consequence of that expected rate increase. The US dollar has been strengthening against a basket of currencies composed of our trading partners. Of all of the developed economies in the world, the US seems to be the strongest and it certainly is the only one to have a central bank indicating rates will be increasing during 2015. Because of those two items, capital has been flowing into the US and that is showing up in the value of the dollar. At the end of 2014, the USD was at 85.0. Over the past ten years, the highest value seen was 87.4. The lower left chart shows how much the dollar moved in 2014. A continuation of that move would indicate the continued relative strength of the US economy even with the Fed raising rates. A switch in the trend would indicate doubt of the ability of the economy to handle the rate increase.

My second watch item is the level of the USD as a proxy for the relative expected strength of the US economy as the Fed raises interest rates.

My third watch item is the battle of two currencies as both economies attempt to devalue their currency in order to improve their economic prospects. Here in the US, we are more likely to hear about the cross currency level of the US dollar to the Euro or the US dollar to the Yen. What I am interested in is the cross currency of the Euro to the Yen. The Japanese government has been aggressively increasing the monetary base of the Japanese economy and the Yen has been depreciating against the dollar. Meanwhile the Euro has been slowly depreciating in anticipation of a potential increase in its monetary base. Because the European Central Bank (ECB) has not yet acted, the effect has led to a relative cheapening of Japanese goods compared to European goods for us in the US. The newsletters I have been reading talk about the ECB working to devalue the Euro to make it competitive with the Yen.

The third graph is in the lower right. An increase in the line indicates the Euro is strengthening relative to the Yen. While there wasn’t much change in the indicator during 2014, there was a large change in 2013. 2014 ended with the line at 146.8. I don’t know how this will turn out because there are two moving parts. I do know the Japanese Central Bank (JCB) will continue its program, but at what point does the ECB begin its program?

My third watch item is to see if the Euro – Yen cross currency indicator maintains a degree of stability during the year. With the JCB continuing its program, an ECB program to maintain cross currency stability will have an impact on the value of the USD and continue to push the level above 85. That means the value of the dollar will be impacted by the change in Federal Reserve policy, expectations of economic growth in the US, and the continued expansion of the monetary base in Japan and the likely expansion of the monetary base in Europe.

My final watch item is the consequence of the currency war between Europe and Japan. For many years, my alternative currency was gold. The commodity was always the leading indicator of potential inflation. I have decided there is so much weakness in the world’s economies that inflation will not be an issue during 2015. Instead I think there is a greater risk of asset forfeiture and currency devaluation because of national defaults that citizens will take the initiative to move some of their savings from their local currency into something international. Historically, that was gold. Now I think Bitcoin has replaced gold as that international medium of exchange. Gold has three factors that have worked against it — it is heavy, it can be easily seized at border crossings, and the value is locally based rather than truly international based. Bitcoin, as an internet based currency, has none of those shortcomings.

There are three countries that are seeing extreme changes in the interest rates of their sovereign debt — Venezuela, Russia, and Greece. I would expect to begin hearing stories of how citizens in those countries have begun moving their savings out of national banks and into Bitcoin as a hedge against the devaluation of their currency (which to consumers means inflation) and the seizure or tax of their assets. A tax on wealth has already occurred once in Cyprus. The idea it could occur again seems improbable to me but only because I find it an abomination. Desperate governments can do truly awful things to their citizens if they think the repercussions from their citizens are less onerous than the repercussions from the market.

My fourth and final watch item is the value of Bitcoin. The currency has been around long enough to be known and the infrastructure for exchanging the currency as well as buying goods and services is growing. I expect 2015 to mark the year that Bitcoin becomes widely used and the path of the average consumer towards its use become a story of popular media.

My plan is to provide updates occasionally throughout the year. I sometimes consider the silliness of waiting for a calendar year change to suggest a reset to our thinking because change is constant and our planning needs to be flexible to that change. Maybe inflation does become a thing in 2015. At some point, I will need to change what I am watching and bring in a measure of inflation. Until then I will stick with these four indicators and watch the continuing development of national debt and slow growth in world economies.

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Author: dmcnic

Educated as an economist, I now work as an Analytical Professional for a manufacturing firm. I have have a second job as a part-time lecturer at the University of Washington in Bothell. While all baseball interests me, the Mariners are my home town team. Married with one dog.

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