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Monday, December 23, 2013

The Global Industry: Honda, the US and the Taper

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...bond markets reacted to the taper with a yawn...

The "taper" in practice started with a whimper not a bang. Instead of purchasing a $1.02 trillion SAAR the Fed reduced its purchases to $0.90 trillion – that is, $900 billion. Yes, the announcement suggested additional reductions at each FOMC meetings in 2014, but cutting purchases by $10 per month in several steps means the Fed is still poised to purchase another $500 billion in bonds, while promising to keep short-term interest rates at 0% until we get substantially lower unemployment or higher inflation, which in practice means well into 2015 if not beyond. In reaction, bond markets reacted to the taper with a yawn – rates at all ends of the maturity spectrum, from 1 month to 30 years, shifted 2-4 basis points at long maturities and actually fell out to 3 years. There's no sign that the markets whose entire focus is interest rates expect any effective change in monetary policy. (Indeed, I read it as saying that bond markets don't think taper or its lack matter – while stock prices are driven by the story of the hour and not by data.)

...the US is becoming an export base...

So what's with "global" and "Honda"? First, the dollar has appreciated relative to the yen – Japanese are looking at their domestic interest rates and judge that parking their money in dollars is the better choice. But if Abenomics works, their interest rates will rise. (And if it doesn't, the decline of Japan's domestic auto market will accelerate; see an older post here on the interaction of a falling and aging population on the demand for cars.) But even if the yen stays at its current level, Honda will find it increasingly hard to recruit workers in Japan, and will find little reason to bet on the yen's exchange rate for deciding where to make global models. In that context, it is important to note that Honda has adopted English as its global language, replacing Japanese. Quietly, Honda has also reached the point where it develops market-specific products (for "market-specific" read "North America") in Ohio.

But the dollar has depreciated relative to the Euro and the Chinese RMB, and has strengthened (or at least not weakened) against the Canadian dollar and Mexico peso. The yen exchange rate is an outlier. In that context (Takanobu) Ito, Honda's CEO, notes that the company is expecting its North American operations to export 30%, up from the current 6%-7%. BMW already exports 70% of the output at its Spartanburg SC plant; I expect others to gradually shift in the same direction. Toyota noted that it will export 7,500 Corollas to the Caribbean and Latin America from Mississippi in its initial year of production there, hardly an impressive number but meaning that these vehicles won't be exported from Japan. If you Google firm by firm you'll find similar stories for Ford, Nissan and others. So the word on the street matches US International Trade Administration's analysis of Trends in Motor Vehicle Exports.

Given the lead times in building capacity and making sourcing decisions, such plans could slow if the yen remains sufficiently weak. At the same time, VW's construction of North American capacity means fewer imports from the EU. And in my visits to suppliers – I will visit 5 firms for the 2014 PACE supplier innovation award – I am hearing of plans to add engineers in Southeast Michigan and Northern Ohio.

Now to be honest this has yet to show up in the automotive sector trade deficit. Yet what I would normally expect to see in the data is that a recovery in the US would lead to a sharp upturn in imports without a corresponding shift in exports. We don't see that, either. I don't expect the US to ever turn into the export powerhouse that Japan once was; global growth means that global vehicles will be made in multiple markets. Tariffs in the BRICs reinforce that tendency. We also need to remember that productivity is up, and that manufacturing employment in the US auto and auto parts sector will therefore increase by less than output. Despite these provisos, it's clear that the US is becoming an automotive export base, and continuing to be an engineering center. It's a nice note on which to end the year.

For background, compare US Treasury Yields and European Bond Rates. When the EU begins growing properly – which as with the US may require several years – then interest rates should rise relative to those in the US and make Euro assets more attractive relative to US dollar assets. I thus expect that over time the Euro will appreciate / the dollar depreciate. However, the timing is sufficiently uncertain that investing on this basis is not likely to pay. If it would, then big money would already be doing so and the Euro would already have appreciated ... whatever the weaknesses of the efficient market hypothesis, there is plenty of evidence that such predictable movements get arbitraged away, leaving markets sufficiently unpredictable as to not offer consistently prfitable strategies.

US$-Mexican PesoUS$-Chinese Yuan
US$-Japanese YenUS$-EU Euro
Auto Sector Imports & Exports, 1965-dateAuto Sector Imports, Exports and Sectoral Trade Balance, 1980-date