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.
Though volatile, major-currency exchange rates have not shifted significantly
Volatility in the major currency pairs over 2011 has obscured limited changes in exchange rates. This combination of higher short-term volatility and few major trends has resulted in meagre returns from these currencies in 2011 from both trading strategies and more economicsdriven approaches. With this state of affairs likely to persist into 2012, modest targets and willingness to take profits or buy on set-backs should continue to be rewarded. Part of the issue is lack of interest-rate differentials, which are set to contract further as slowing growth and inflation drives further policy easing in emerging markets, while developedmarket rates remain at rock-bottom levels.
The US dollar remains the ‘safe haven’, but we see more value elsewhere
Debt deleveraging in developed economies has produced a liquidity squeeze only partly offset by quantitative easing and other unconventional monetary policy measures. In this environment the US dollar is unrivalled as a ‘safe haven’ – it accounts for over half of currency reserves and average daily trading, and is backed by the world’s largest economy and Treasury market. However, while not offering the same protection in a global liquidity squeeze, we see the currencies of some smaller triple-A rated economies as more attractive, particularly the Australian and Canadian dollar and Norwegian krone, given our central economic scenario where commodity demand is underpinned.
Short-term flows or more deep-seated problems – identifying emerging-market opportunities
The looming recession in Europe and global liquidity squeeze has put emerging economies and currencies under pressure. This has extended even to currencies of developed economies linked to Asian and emerging-market growth, such as the Singapore and Australian dollar. However, such short-term underperformance and resulting opportunities must be distinguished from other currencies where fundamental weaknesses have been revealed. Therefore, we would continue to avoid the currencies of countries struggling to control inflation, such as India and, to a lesser extent, Indonesia.
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