Surely something will have to give?

Views From the Marsh - David Owen

An unfair generalisation perhaps, but the OECD as an institution publishes very solid analysis, but consensus looking economic forecasts, whilst the IMF is much more focused on the risks and the tails of the distribution.

Often the trick is to see whether there is something in the OECD Economic Outlook that could potentially trigger a very different outturn. As ever, institutions like the OECD (alongside forecasts presented by central banks, including later today, the ECB) have to take a “neutral” view of asset prices, including importantly exchange rates.

But it is here that fault lines, and imbalances at a global or regional level, can suddenly trigger a regime change - be it a sudden move in exchange rates (for example, when sterling was ejected from the ERM), or a significant widening in spreads (as, for example, was illustrated by what happened with the euro area crisis, on the back of the substantial imbalances that built up inside the system, prior to the GFC) - that leads to a very different outturn.

Identifying imbalances that could trigger a regime change is one thing, getting the timing right (this year, next year?) an altogether more difficult problem, as many investors know only too well to their cost. Another issue is that the actual trigger for a regime change can come out of left field.

Moreover, the longer a state of the world persists - for example, the very low volatility seen for several years in a row running into the GFC, followed by rates being nailed to the floor for several years after it - the more people buy into the argument that this is the new normal, or forget what the old normal looked like.

Group think - for example, the UK Treasury believing, alongside some of their advisors, that if sterling were to leave the ERM, UK rates would end up higher; or Harold Wilson when he became UK PM in 1964, not taking account of the Triffin paradox that strongly suggested that a sterling (the dollar’s first line of defence inside Bretton Woods) devaluation would ultimately be inevitable; or European policymakers turning a blind eye to the substantial funding gap, and off-balance sheet vehicles tied to US housing, that had been allowed to build up inside their bloated and complicated banking sectors - can also become part of the problem.

One of my abiding memories of running into the GFC was the hubris that was much in evidence at a dinner hosted in the private dining rooms of RBS, to celebrate 10 years of BoE operational independence with Mervyn King, just before RBS bought ABN; a point that has also been made by the FT’s Chris Giles who also attended the dinner (see his article here).

What we also know with the foreign exchange market is that for a long time, nothing much happens, and then suddenly there can be a significant repricing, as the market adjusts to the “new” fundamentals (which were often there all the time, but had been ignored) - see charts below.

What immediately leapt out when looking at the OECD’s Economic Outlook published this week was the persistence of global imbalances, especially the US twin deficits.

On their forecast, the US current account deficit is still put at 3.4% of GDP in 2026, combined with a US government budget deficit of 8.1% of GDP (including 4.4% of GDP of net interest payments), with general government debt rising to 128.8% of GDP.

Part of the reason for only a modest improvement in the US current account deficit is that the effective nominal level of the dollar is actually assumed to be slightly higher in 2026, than in 2024, and only 1% lower than in 2025. This further weakens US export growth and limits the improvement in the overall current account that would have been generated by weaker import growth.

But those deficits would require financing.

Could a stablecoin dollar coin be part of the answer?

By all accounts this is sufficiently of concern to the ECB, for them to warn about capital outflows from the euro area to the US.

We will be writing more on all such matters, but the BIS (the central banks’ central bank), highlighted in a recent paper (see here) how the growth in this new asset class was having a growing influence on the short-end of the US yield curve (see charts from the BIS below).

But, what can quickly flow in, can quickly flow out. Indeed the BIS find with analysis of daily data from 2021 to 2025 “evidence of asymmetric effects: stablecoin outflows raise yields by two to three times as much as inflows lower them".

And, that has not really been during a period of much of a significant repricing in the dollar, which could obviously impact the holdings of international investors/speculators, when converting back into their own currencies. The BIS authors also expressed concerns about spillovers to US money market funds, particularly during liquidity crises.

We now turn to the BoE, including observations about Catherine L. Mann’s speech on QT (where we beg to differ), ahead of a keynote speech by Megan Greene “On the Monetary Policy Implications of Differences in Central Bank Balance Sheet Management”(at our friends at the NIESR, Tuesday 24 June)…………….