FX and Interest Rate Monthly

January

Politics likely to be more significant than economics and capital flows in 2012

The underperformance of developed economies, with debt encumbered voters and governments, adds to the pressures on their political systems. The euro’s peaks and subsequent troughs have aligned closely with European Council summits for over a year. Repeated failures to come up with a convincing or workable solution have contributed to the credit downgrades and looming recession that will complicate the resolution of the euro debt crisis in 2012. We still expect that a closer fiscal union will be the eventual solution, supported by European Central Bank intervention, but the risks of an uncontrolled break-up are no longer insignificant. And political risks are not confined to Europe – it is now clear that only the November Presidential election can resolve US gridlock.

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February

UPDATED - Lack of euro crisis solution puts pressure on ratings

Standard & Poor’s lowered it credit rating on nine eurozone countries on 13th January, citing a credit crunch for both private and public sectors that is weakening the region’s economy as they simultaneously pay down debt. The problems are compounded by the open and prolonged dispute over how to address them and a misplaced focus on fiscal austerity. Actions announced and taken were deemed inadequate to tackle the financial crisis. This is in line with our long-held view of the structural weakness of the eurozone and risks to the currency. However, with the tradeweighted euro already at a seven-year low amid widespread negative sentiment, short-term weakness looks limited. While a break-up is no longer inconceivable, the euro could rally yet again ahead of the next summit of European leaders on 30 January, given pressure to produce a solution.

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