Forecasts for productivity trends

A TFP boom in Japan emerged relative to the US appeared to lead to huge yen appreciation during the 1970s, and 80s.

>> What happens to the key currencies?

There’s understandably lots of focus in the FX market about the outlook for currencies over the next day, the next week, the next month, perhaps even the next year. Beyond that, there seems far less interest. But in the Standard Bank’s view, it is important to try to bear in mind what the long term might bring as it could also influence our thinking about the near term.

The Standard Bank mentions this in the context of the one currency that’s really been moving this year – the yen. If you look at the conventional – and short-term – reason given for this, it is all to do with monetary policy. In fact, it seems that 90% of what currency market players talk about in the context of any currency is to do with monetary policy.

The yen’s weakness, for instance, is widely put down to the fact that the Bank of Japan has not tightened monetary policy while all around it have, notably the Fed. The corollary of this is that, as the Fed probably eases later next year and the BoJ tightens, so dollar/yen should slip. But what happens after that? For this might help explain what’s going to happen to the yen over the coming few months, perhaps up to a year, but what happens when all of these monetary policy actions have been taken? How can we predict the yen from there? The answer in Mr. Steve Barrow, Head of Standard Bank G10 Strategy’s view is that you cannot.

In other words, basing currency forecasts on projected monetary policy only has a limit ed shelf-life; probably no more than the next 6-12 months. So how can we look further out? An approach that we use, that seems quite interesting in the case of dollar/yen right now, is to look at productivity trends and, in particular, forecasts for productivity trends. Why do this?

Mr. Steve Barrow thinks it is useful because, at the end of the day, an economy’s prosperity rides on its productivity, in particular what’s called its total factor productivity (TFP). For this measures that part of an economy’s output that is not generated by increases in labour and capital. In effect, it measures the efficiency with which the factors of production are being used. Countries that are more productive in this sense than others should, all things equal, enjoy better growth in living standards and this, in our view can be key to long-term currency strength. It can, for instance, produce lower inflation, strengthen trade, improve fiscal conditions and so lead to a better performance from stock and bond markets.

>> US dollar will remain volatile

These are all things, in Mr. Steve Barrow’s view that are likely to strengthen currencies over the long haul – or lead to weakness if TFP is poor. Moreover, studies appear to suggest that it is not current TFP that’s important but future TFP. A TFP boom in Japan emerged relative to the US appeared to lead to huge yen appreciation during the 1970s, and 80s. But then, the last 10-20 years have seen Japan slip back when it comes to TFP and the dollar has rebounded, hitting its best levels against the yen since 1990.

However, the key now is not the current TFP deficit that Japan is suffering, but the outlook for TFP in coming years, even decades. But how can we project this? It is not easy at all. One solution is to trust that stock market performance provides a guide to sentiment surrounding TFP, amongst other things, on a more micro scale.

For instance, relatively strong US TFP in recent years, decades even, has seemingly been ‘forecast’ by surging stocks, particularly the Nasdaq during innovation booms, such as the dot.com rally. Of course, we could be on the verge of another of these if the AI boom turns out as many expect. However, if we look at Japan we do think there are many factors here that point to stronger TFP ahead, not least rising wages, new innovation – and the surging stock market. If these things do prove a harbinger of TFP catch-up by Japan, we should find that any rally in the yen against the dollar does not just last through the upcoming monetary policy cycle but beyond as well.