All publications were correct at the time of going to publish
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December
We believe the influence of QE2 on FX markets is overstated and prefer the dollar among the majors
The run-up to the re-launch of quantitative easing (QE2) saw the dollar decline to a new low. However the relationship between QE and FX markets is far from direct. While both the dollar and sterling have clearly depreciated ahead of or during QE, this has not been the case for the yen or the Swiss franc. Japanese intervention was modest, at around 1% of GDP, which might explain the lack of impact, but the Swiss franc appreciated by over 10% even as its central bank spent some 25% of GDP on intervention. This suggests QE2 alone is not sufficient to produce currency weakness. We believe that recent signs of strength in the US jobs market, which suggests that recovery is gaining momentum, support our forecast of a stronger dollar compared with the rest of the G4, where recovery is less robust.
November
‘Currency wars’ add significant risks to FX markets
After the coordinated international response to credit crisis and recession, FX markets in 2010 clearly reveal political fragmentation as countries pursue mutually contradictory policies to secure incompatible goals of growth and financial stability. High-profile examples, such as yen intervention, renminbi appreciation and further quantitative easing (QE2) in the US, are just the tip of the ice-berg - in just one week there was policy action, currency intervention or rumours of intervention from 25 central banks.
October
FX markets have seen participants take off risky positions – but a changing outlook suggests a return to the market.
An August correction in the dollar was driven by the closing of June’s record net short speculative positions in the futures market in both the euro and sterling against the US currency. This move left the market broadly flat, with only relatively small positive bets on the ‘safe havens’ of the yen and Swiss franc. This clearly reflects investors’ uncertainty over the economic and market outlook, with low-risk and defensive strategies predominating. However we would not expect this stance to persist as we move towards 2011, as the data either confirms continued growth (our central scenario) or a double-dip return to recession (the key risk). We also anticipate a second round of quantitative easing, starting with the US, and these key turning points are likely to be reflected in renewed volatility in FX markets.
September
Interest rates are forecast to stay low for longer in the G4.
A continuing but weak global economic recovery leads us to expect that interest rates will remain at low levels for an extended period in the G4 economies (the US, euro-zone, Japan and the UK). While we still predict that rates will rise next year (except, of course, in Japan), we see scope for longer-term rates to decline further, despite the yield on the benchmark ten-year German bund already at record lows below 2.5%.
August
European bank stress tests give euro a short-term boost.
The euro has rallied in response to the announcement of the European bank stress tests. These tests are a demonstration of increased political and financial commitment to EU institutions by member states. Hence investor fears of an imminent break-up of the eurozone have been allayed. Our estimates of the potentially punitive costs of leaving the eurozone, with the loss of up to 10% of the departing country’s GDP and an additional 1% for the rest of the euro-zone, suggests that no government is going to opt for the exit while viable alternatives remain. However, our concerns over longer-term structural issues within the euro-zone remain, so we continue to have a negative view on the euro and would recommend using the recent rally to reduce exposure to the currency.
July
We continue to recommend selling the euro...
We see further euro weakness as recent events compound our original concerns on growth and stresses of diverging member economies. Unable to reach political consensus, the eurozone faces significant fiscal austerity that will limit growth and the European Central Bank (ECB) is being forced into quantitative easing as it extends credit and buys member states’ distressed debt. News flow remains negative and there is scope for other central banks to scale back euro allocations in their FX reserves, having bought it at higher prices.
June
European bail-out leaves the FX markets awash with euros.
European policymakers finally got ‘ahead of the curve’ with a €750bn rescue package on 9th May, extending support to any euro-zone member facing difficulty financing its debt. However, the associated fiscal consolidation now planned increases deflationary risks for the region, while the new policy also transfers credit risk from peripheral to core euro-zone nations. After the initial sharp rally in the euro, the prospect of weak growth, low interest rates and an erosion of ECB independence look set to continue weighing on the euro.
May
Global recovery gathers momentum.
Strong and improving purchasing managers index figures, from surveys of major companies on orders, activity and hiring intentions, are pointing to strong growth across the key advanced and emerging economies. Manufacturing confidence is at robust levels and service sector confidence is also improving.
April
Currencies reflect renewed confidence in global economic recovery.
Despite a bitter winter the global economic recovery has continued and relapses, such as Sweden’s dip back into recession in the latter part of last year, have not been sufficient to derail it. The dissipation of investor concerns has been reflected in a rally in currencies with a positive gearing to growth and risk appetite at the expense of those regarded as safe havens.
March
The major themes of risk and recovery have dominated FX and other markets over the past year.
The scale of the market collapse in 2008 and recovery in 2009 were sufficient to overwhelm all other factors. A binary trading environment has prevailed, with the US dollar and the yen on one side and practically everything else on the other side. It mirrored the same division between the safe haven of government bonds on one hand and risk assets, especially equities and commodities, on the other. As some stability returns to both the global markets and global economy, there is scope for other, currency-specific factors to regain greater influence over currency moves.
February
Cheap liquidity continues to flood global currency markets...
Quantitative easing (QE) has pumped liquidity into the global economy to help drive a recovery from the recession. As the Federal Reserve has issued huge quantities of zero yielding US dollars, investors have sought to switch the US currency into higher yielding or higher risk ‘carry trades’ - so ensuring that the US dollar sold off in 2009.
January
The new year is forecast to start as 2009 ended - with a weak US dollar...
Zero-yielding US dollars continue to flood the US economy in order to support the recovery. As a consequence, the US currency remains under pressure as investors switch into higher-yielding or higher-risk currencies as part of the ‘carry trade’.
