2010 Review - Part I of II
04/Ιαν/2011 • Currency Updates•
This two part series will provide an overview of the FX landscape for 2011, the key issues for currencies, and our outlook and expectations, with particular attention to events and themes that we believe are being overlooked by the consensus.
In this first part we will recapitulate the main themes that drove FX movements throughout the last year. It is particularly important to do so because none of these issues have resolved themselves yet, and we therefore expect that trading in 2011 will continue to be driven by events and policy decisions around these axes. Our expectations as regards to the FX market in the upcoming year will be summarized in the second part.
First of all, of course, we must refer to the Eurozone crisis. Few would have predicted a year ago that financial markets – and FX markets in particular – would be driven by the blow up of sovereign credit in peripheral Europe, and that the future of the common currency would be called into question. Greece and Ireland have already been bailed out in return for the socialization of all domestic senior bank debt and draconian austerity packages. Portugal seems likely to follow this path, while Spain’s ability to roll over its private and public debt in the markets is very much an open question. The net result is that the euro ended the year well below where it began. It lost about 7% against the dollar, and nearly 10% in trade-weighted terms. This is the more remarkable given the generalized depreciation of the greenback against other currencies and the very strong macroeconomic performance logged in by Core Europe in the second half of the year.
The second driver in 2010 FX markets was the decision by the Federal Reserve to start another round of Large Scale Asset Purchases to supplement the operations carried out in 2009. The decision announced in early November to purchase about USD75 billion worth of medium-term Treasuries every month had been widely signalled by Fed officials in prior weeks. Beyond the immediate effect on markets of these additional purchases, this step highlighted major divide across the Atlantic. US authorities are very concerned about the sustainability of the economic recovery, and are willing to pull out all monetary and (to a lesser extent) fiscal stops to help it along. European officials, by contrast, insist on fiscal and monetary austerity, and have only been reluctantly forced into purchases of peripheral bonds and bailouts by repeated blow ups in those markets. Another significant effect of additional Fed easing in 2010 has been to slow down the pace of monetary tightening in the smaller countries with healthy economies where near-zero rates are increasingly inappropriate, such as Canada, Switzerland, and Scandinavia.
A third factor was the need for and process of global macroeconomic rebalancing. By rebalancing one means, in essence, the need for a lower US trade deficit and a correspondingly lower trade surplus by the world’s saver economies, primarily those of the Pacific Rim. After a significant improvement in the US trade balance during the 2008 crisis and its aftermath, the US returned to form during 2010 and the trade deficit increased again. In fact, US consumption indices are, once again, rising faster than its production indicators, in spite of the depreciation of the trade-weighted US dollar.
Another critical issue that is not getting the attention we feel it deserves is fiscal payback in developed markets. It seems to have been nearly forgotten that the horrifying drop in production and trades from late 2008 and early 2009 was stopped primarily through worldwide fiscal stimuli through 2009 and 2010. This impulse to economic activity is now fading, and is in fact being replaced in many countries (particularly the United Kingdom and peripheral Europe) by draconian public austerity packages. The assumption behind this mindset appears to be that private demand, helped along by continued easy monetary policy, will be enough to pick up the slack. We remain unconvinced.
To repeat, the most notable feature of the global financial landscape remains the absence of resolution in any of these critical issues. The lack of any sense of global coordination (so critical in stopping the downward slide in 2009) adds more uncertainty to the mix, and makes it even less likely that any of these problems will be resolved without a high degree of volatility. We therefore expect 2011 to be a tumultuous year, one in which at least some of the global contradictions described above will be resolved for better or for worse. Our best guesses as to the developments an FX investor can expect in each of these defining themes for 2011 will follow in the second part of this series.