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December
Euro debt crisis will be exacerbated by looming recession
With even the European Central Bank (ECB) forecasting a mild recession by year end, the only question is how severe it will be. Full-blown contagion from the debt crisis into the financial system is the key risk, and the ability of policy-makers to stop Italian bond yields from spiralling out of control is crucial to avoiding it. Italy’s new government needs to show credible commitment to increasing international competitiveness and moving to a balanced budget. If that doesn’t happen, neither the International Monetary Fund nor the ECB will be willing to provide the scale of funds needed to stabilise Italian government bonds, European banks and the broader euro-zone economy. While the risk of euro break-up remains remote, we would reduce euro exposure for cyclical and structural reasons, until there are clear signs of coordinated intervention.
November
Economic data brightens, but risks still dominate in developed economies
Economic data has recently surpassed depressed expectations, with the global economy steadying after the late summer collapse of confidence. The euro has reversed about half its September losses against the dollar and other currencies have staged similar rallies, as policy-makers have provided reassuring promises of action. However, with risks of political and economic crises still high in the developed world, we do not expect any further dollar correction to be sustained against its major counterparts.
October
The trend of weakness in major currencies will continue in the absence of dramatic policy action
We believe risk assets have yet to bottom, with momentum likely to remain negative in the absence of dramatic policy action to remove the threat of insolvency from the euro-zone periphery and the risk of recession in the US. As such, markets are likely to remain volatile in the months ahead, favouring the currencies of traditional safe-havens and emerging and developed countries with stronger growth and healthier public finances. We expect the longterm trend of weakness in the G4 – the dollar, euro, yen and sterling – to continue.
September
Rates will stay at extreme lows for longer to ease the deleveraging process
We believe zero/near-zero interest rates will remain in place for a multi-year period to ease the deleveraging process for heavily indebted developed economies. The US Federal Reserve (Fed) said it would keep rates on hold until at least mid-2013, while we also forecast further quantitative easing measures from both the Fed and Bank of England. However, while policymakers can slow the process of deleveraging, they cannot stop or reverse it. Consequently, a good outcome over the coming years would be annualised US growth of 2.0%. This would imply little in the way of domestically-produced inflation, though prices of imports will continue to rise on our forecasts of further currency depreciation.
August
Euro-zone measures are insufficient to avoid a further debt crisis.
The comprehensive package designed to halt the euro-zone debt crisis contains the tools to cut the debt service costs of Portugal, Ireland and Greece, but lacks the fire power to deploy those tools convincingly. Growth remains the best way of resolving the crisis, but the latest data is disappointing with purchasing managers’ indices having slowed sharply. While Germany remains robust, other members, including many with the worst debt problems, are experiencing economic contractions. We would thus continue to reduce exposure to the euro for both structural and cyclical reasons.
July
The forecast second-half reacceleration in the US economy, alongside the end of QE2 and gradual tightening of US monetary policy, will squeeze the supply of cheap dollars
Coutts expects the US economy to pull out of its current soft patch in the second half of the year, when we also expect headline inflation pressures to ease. In this context the recent ‘mini-crash’ of commodity prices is clearly good news, boosting economic activity and reducing inflationary pressures. However, a reaccelerating economy will put an end to ultraloose US monetary policy. With the second round of quantitative easing (QE2) finishing in June, US Federal Reserve Chairman Bernanke has publicly dismissed calls for a further round. While that does not rule out QE3 if the economy falters, our growth forecasts suggests that we will instead see the first hike in US interest rates in the first half of 2012. This would be the first rate increase in six years and would come after three years of near-zero interest rates and hundreds of billions in quantitative easing. We expect that this will generate considerable dislocation in foreign exchange markets, as investors and companies adjust to a squeeze on the supply of cheap dollars.
June
Commodities 'mini crash' leads to broadening sell-off, extending to currencies and correcting some anomalies while creating some more
The extraordinary boom-bust of silver highlighted the extent of speculation funded by cheap dollars in commodities and other assets. The correction triggered the liquidation of other positions and a switch back into dollars, correcting its oversold position. As a consequence there has been a broad and indiscriminate sell-off in currencies of commodity exporting economies, such as Australia and Canada, in emerging markets and in other areas where large positions had been built up through cheap dollar funding.
May
Increasing divergence in central banks policy responses implies that FX markets will become more volatile
While the European Central Bank (ECB) has already started tightening monetary policy, and is starting from a much higher base, the US Federal Reserve remains resolutely on hold and is still adding liquidity through quantitative easing (the $600bn Treasury-buying programme is set to end in June). With interest rates also on the rise in emerging economies and developed countries seeing strong, export-led growth, higher yielding assets are being bid up by the flood of cheap dollars. Given inherently volatile ‘hot money’ flows, a bumpy economic recovery and policy uncertainty, exchange rates could be particularly choppy.
April
Currency truce replaces ‘currency wars’ – as the resurgence of growth eases trade tensions
As 2011 gets under way, leading indicators are pointing to a pick up in developed-economy growth and continued expansion in emerging markets. This has produced at least a temporary truce in the ‘currency wars’ of 2010 which flared amid competitive devaluations and measures to deflect appreciation. A more robust growth outlook allows for a more relaxed attitude toward currency movements, as witnessed by the unusually speedy and coordinated response to Japan’s request for support in preventing unwanted appreciation of the yen in the wake of the devastating Tohoku earthquake and tsunami. With higher commodity prices accompanying stronger global growth, there is likely to be increased willingness amongst countries to let currency appreciation dampen imported inflation, setting the stage for further emerging-currency appreciation in coming months.
March
Currency markets remain the lightening rod of global imbalances, with economic fundamentals remaining a key driver of currency rates
The underlying economic imbalances, which are the source of disagreements within the G20, will continue to act as key drivers of FX rates. We therefore favour the currencies of emerging and commodity-exporting economies, which are seeing a continued strong recovery, over those of the G4 (US, euro-zone, Japan and the UK), where activity is impeded by unresolved debt issues. To provide support against short-term volatility arising from the political turmoil in North Africa, we would also look for trade surpluses, strong currency reserves and a preference for raising interest rates and allowing currency appreciation to combat inflation. These characteristics should underpin the currencies of major commodity-exporting developed economies, such as Australia and Canada, as well as the currencies of emerging economies, such as Taiwan, Malaysia and Mexico.
February
US stimulus adds to positive data surprises to lift our expectations for US GDP growth
New US fiscal stimulus plans passed late last year mean that US GDP growth is likely to be around 3.5% in 2011, up from our previous estimate of 2.5% and above the current consensus forecast of 3.2%. Even prior to this good news, economic data had been improving after a disappointing summer. This is clearly positive for the US dollar and we forecast further strength against the other major G4 currencies (euro, sterling and yen) over the next six months.
January
Obama’s new stimulus plans to boost US growth prospects in 2011 and those of the US dollar
Newly passed fiscal stimulus plans mean that US 2011 GDP growth will probably be in the range of 3-4% rather than the 2.5% we were anticipating previously. There are clear signs that the US economic environment is improving, even ignoring the fiscal stimulus. A virtuous circle of improving credit availability, small-business confidence and positive labour-market data is emerging in the US. While the fiscal stimulus package is not likely to trigger a reversal of the Federal Reserve’s announced programme of quantitative easing (QE2) or mean an interest rate hike before 2012, it should be enough to discount a further QE programme. Treasury yields have risen in expectation, with the yield on the five-year benchmark almost doubling from its low of close to 1% to around 2%. This is clearly positive for the US dollar and we forecast further strength against the other major G4 currencies (euro, sterling and yen) over the next six months.
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