US: Why is good news so bad?

Obviously the US economy has been the biggest news item in recent weeks, given the bloodbath on global share markets and rollercoaster currency movements that followed the US Federal Reserve’s suggestion that a gradual wind-down (or tapering, as it has become known) of its QE stimulus programme may soon need to be implemented.

On the surface, the panic caused by a mere suggestion that stimulus will be eased out, because the US economy appears to be returning to health, seems illogical – and indeed this reaction may well have been overstated. However, the underlying concern is that a removal of stimulus now may actually lead to deflation in the world’s largest economy, given doubts as to whether the economy can continue to grow without help from the Federal Reserve.

The US dollar has been on an upward march recently against virtually all global currencies on the back of positive economic data. Some economists fear that winding down the current level of stimulus, which will add even further upward pressure on the dollar, may harm the nation’s exporters and damage the still fragile business and consumer confidence.

Supporting this view in the final weeks of June has been concerns over the Chinese economy, where growth in recent months has continued to disappoint, and question marks have appeared over the health of Chinese banks. Given that China’s strong rates of growth have supported the global economy through the crisis years since 2008, a credit crunch and/or stalling of growth could reverse the improvements being observed in the US and elsewhere.

Despite this new sense of uncertainty, conditions remain in place to support the US dollar from giving up its recent gains, particularly as it will benefit against the China-dependent resource currencies.

Expect markets to be hanging on the edge of their seats in the second week of July ahead of Fed chairman Ben Bernanke’s appearance before the Senate Banking Committee. Market watchers will be keenly looking for any further hints about when he will seek to begin winding back QE which, if forthcoming, could see the dollar lurch yet further ahead.