Monday, May 9, 2011

Economic Perspectives: Forex, UK Elections, Paki-US Relations, Middle East Violence, Inflation in China and Commodity Prices

By Grant de Graf

Forex markets continue to experience high volatility, accompanied with concern over how Greece will restructure its bailout package. This has been the cause of some weakening in the Euro, which suffered losses last week that extended beyond 3%. Although most economists see changes in the bailout package as inevitable, many question the long-term sustainability of Greece, to meet its obligations under current economic conditions.

In the United Kingdom, the Liberal Democrats, the coalition partners to the ruling Conservative led government suffered heavy losses, fueling calls for the resignation of Deputy Prime Minister Nick Clegg. Sterling has experienced a heavy battering over the past few months and many see current levels as an attractive entry point for upside potential, providing that economic growth levels can achieve some level of traction.

Reports suggest that the Pakistan -U.S. relationship rift is widening, as many politicians question the justification of U.S. aid to Pakistan, if in fact allegations prove to be true that the country provided Osama bin Laden with sanctuary. Given the U.S.' need to retain Pakistan as a strategic partner and Pakistan's level of instability with most of its neighbors, it is unlikely that calls from either side of the fence will fundamentally change the current relationship, or the level of aid.

Religious clashes in Egypt over the weekend suggest that a long-lasting peace solution is not yet in sight. Sporadic violence in Syria continues and a protracted war in Libya between Gadaffi and revolutionary forces appears probable.

Taliban fighters flooded southern Afghanistan's main city at the weekend, seizing key buildings to stage attacks on government agencies in a two-day battle that brought Kandahar to virtual collapse, highlighting the insurgency's strength. What this means is that although President Obama has clearly indicated his intent to begin the withdrawal of troops from Afghanistan this year, any consideration for significantly reducing budgeted expenditure on the war effort in that area will be a challenge, unless there is a significant change in foreign policy.

Pressure on wages in China, threatens to imperil the price advantage that it has enjoyed as an exporter of cheap goods. Politicians have long argued that the Chinese Government's manipulation of its currency has artificially allowed the flow of "cheap" goods to international markets. Irrespective of these sentiments, upward pressure on wages will result in higher production costs, which could well eliminate this advantage. This dynamic is a matter that is likely to be the subject of much discussion this week, as U.S. and Chinese officials meet in Washington.

Commodity values across the board, including crude, have weakened in the past week, bringing to an end the out of control spiraling rise of commodities across the globe. Higher prices have impacted inflation indicators, especially in Europe, resulting in a series of interest rate increases by central governments. This has caused the Euro to strengthen, as traders bet on interest rate differentials to skim profits. Speculation that the European Central Bank will no longer immediately respond to rises in inflationary expectations as it has in the past, by increasing interest rates, has more recently led to a softening of the Euro. Although commodity prices have retracted from their highs, high volatility in the short-term, should still be expected.

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