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CURRENCY THEMES FOR 2011
As we approach year‐end, it seemed timely to review some of the key themes that should prove important currency drivers in
2011. We expect USD weakness to the overriding theme; accordingly our forecast look for most major currencies to appreciate
against the USD. On the non‐USD crosses, we expect AUD and EUR to outperform; CAD to prove a mid performer and JPY and
GBP to underperform.
Currency wars
This is not a simple theme and one that is complicated by closed
door discussions. It is hard to decipher who fired the first shot,
but the combination of China’s currency policy and the US’
monetary policy have left other nations struggling with the direc‐
tion of their own currencies (mainly under the weight of un‐
wanted currency appreciation). Many of the periphery nations
are left with domestic economies that justify tighter monetary
policy, but wrestling with the currency impact of such a path
combined with already strong currencies on the back of yield
seeking flows. The tactics used by these periphery nations are
defensive more than offensive and include capital controls and
intervention in order to slow the pace of currency appreciation.
We expect this to remain a dominant, potentially the dominant
theme in 2011.
Asian block of currencies will be pressured
The heavy lifting of USD weakness has been undertaken mainly by the non‐Asian currency block (with a few notable exceptions).
Chart 1 summarizes the IMF’s view on the under or over valuation of each region of currencies. According to all three of their
methods, the Asian block is significantly undervalued, while the advanced economies are essentially inline to overvalued and
LatAm is somewhat mixed. We expect the Asian block of currencies will come under increased appreciatory pressure in 2011,
which will see a notable shift in global FX patterns.
Sentiment
Sentiment is a key driver of currencies and swings in this can
have real implications for valuations. As chart 2 highlights, the
market is currently short USD against every primary currency.
Our base case is that the case for USD bears builds further, pres‐
suring the currency lower. However, swings in sentiment will
likely also create some brief periods of retracement; but these
should prove temporary.
Relative growth patterns
As the advanced economies struggle with below trend growth, it
is likely that those that are better positioned on the growth front
will outperform on the currency front as well. This should benefit
AUD and CAD, weigh on the UK and the US. The European
growth pattern is somewhat divergent, with relatively strong growth expected from Germany, but weaker growth from many of
the other EU members. Accordingly, the growth outlook for the EU as a whole should be a fairly neutral driver of EUR.
Monetary policy
Relative interest rates always play an important role in currency markets, but with the widely diverging path that lie ahead, their
importance will be noteworthy in 2011. The currency’s of country’s whose central banks are easing policy and using non‐
GLOBAL FX STRATEGY Monday, November 01, 2010
conventional tools to meet mandates should lag. This includes the USD and GBP. The central banks that are unlikely to turn to asset
buying programs, like the ECB, will likely see currency appreciation. Whereas countries who otherwise would be pursuing tighter
policy should also strengthen but to varying degrees. This includes AUD, CAD and much of the emerging nations.
Fiscal policy
Fiscal policy will take on new importance in 2011, as the market is provided with evidence as to whose austerity measures are
achieving the fine balance of reigning in deficits while still supporting growth. A difficult task indeed. The market’s view is likely to be
supportive of Europe (and EUR) as it does the heavy lifting up front; as well as AUD and CAD as their associated fiscal balances are
more moderate. However, the UK’s strict response could well face criticism, while the US’ lack of a credible plan will certainly weigh
on its currency.
Sovereign risk
Sovereign risk was an important theme in 2010; it has the potential to play a major role in 2011, but our base case is that it plays a
more limited part than it did this year. There is the real potential for one of the weaker EU members’ sovereign position to bubble
into a significant problem. However, the combination of the market’s new found experience with the EU treaties, exposures and
processes as well as progress on the crisis resolution mechanism, should leave the market reaction as more muted.
Risk Aversion
Risk aversion can spike any time, often will little warning, which is why it generates such a violent market response. We expect
bouts of USD supportive risk aversion to be a recurring theme in 2011. However, these should prove temporary. Their impact will be
to slow the downward trend in the USD, but not reverse it.
In summary, our forecast look for most major currencies to appreciate against the USD. On the non‐USD crosses, we would expect
AUD and EUR to outperform; CAD to prove a mid performer and JPY and GBP to underperform leading into December 2011.
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