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The U.S. labor market is on the right path to closing the gap on the long-term average participation rates. I believe that the key difficulty has been the increases in wages, which have been running below inflation until recently. Thus, it is a very slow recovery, but over the last 50 years annual year on year change of the non-farm payroll has been around 1.8% and during the last twelve months it is 1.7%, which is the same number for the last 3 years.
Hence, there is a steady recovery in the labor market, but what is important that it had not been generating real wage growth until very recently. Moreover, pace of employment creation is not as fast, as you would like to see in the early stages of the recovery. In my opinion, it is now going on too long for us to call it "the early stage of recovery". Thus, it is average growth from a poor base, but it is steady. However, I am not sure if we should expect things to get a whole lot better than the existing pace of employment creation.
Federal Reserve Bank President James Bullard expressed his concern about the low inflation rate, however, he pointed out that it is poised to go higher, back towards the 2% target. Do you expect the inflation rate to meet this estimate in the foreseeable future and what measures should be taken to achieve it?
In my opinion, consumer price inflation is likely to head higher, and it is going to be pushed upwards from the existing level over time, but it is going to remain very low by historical standards. It would take a lot of upward pressure on wages, in particular from the falling unemployment rate to change that, given disinflationary forces globally.
Speaking of measure that can be taken - weaker currency will do it quicker than some gauge, However, faster wage growth will do it more rapidly. I believe the reality is that the Fed is already creating an enormous amount of asset price inflation, in order to try generating consumer price inflation. Personally, I am not sure how much should we worry about the consumer price inflation and the amount of demand that would be necessary to create in the US economy, to get higher inflation, but the current consumer price level is healthy for the economy.
What will be the main drivers for the U.S. Dollar during the year of 2014?
Global risk aversion (or lack of it) has been the main driver of the Dollar in 2014. The Fed is running monetary policy that is designed to have a weaker currency, with policy rates near zero despite a nominal growth rate around 4% at the moment. Thus, we have an exceptionally accommodative monetary policy, which is typically associated with the weaker greenback. At a time when investors are in yield-seeking mode, money continues to flow out of the United States into other currencies.
The other side of that is in 2015, as the Fed finally gets around raising interest rates. By late 2014 we may see stronger growth and expectations of the Fed raising interest rates faster than currently anticipated. That should support the Dollar in due course, though in the very short term. The greenback would appreciate if we were to see global risk aversion return due to stress in the Chinese economy or substantial escalation in the events happening in the Ukraine. However, I do not believe that the Fed is going to do something to make us buy the U.S. Dollar this year.
What are your forecasts for EUR/USD and USD/JPY for the Q2 and the end of this year?
We anticipate the EUR/USD pair to trade around 1.37 in the second quarter and 1.32 by the end of 2014. Talking about the Yen, we forecast the USD/JPY pair to reach 104 level in the Q2 and it will rise to 108 by the end of this year.