2010 was what we called a year of 2 halves for the Dollar. In the first half of the year, the Dollar gained from strength to strength as investors sought a safe haven from the Eurozone debt crisis. At the height of the crisis, Dollar Index went above 88 on risk aversion flows. The second half of 2010 saw the reversal of the Dollar’s fortunes. Markets turned their focus on the Fed’s plan to carry out more quantitative easing and feared the easing measures would bring down the Dollar. In November this year, the Fed announced that it would repurchase $600 billion of long term treasuries for the next 8 months. These purchases would be financed by printing more money and investors started to flee from the Dollar. At the height of the Dollar dumping frenzy, Dollar Index fell to almost 76 levels. It has since rebounded on improving US economic data.
For the outlook in 2011, we think that this could be the year where we will see the steady devaluation of the Dollar. The easy monetary policy by Fed which boosted asset markets in short term, will come back to haunt in the mid-to-long term. Basic economics dictate that excess liquidity chasing a fixed supply of goods and services will bring about inflated prices and weaker purchasing power. While we hold a long-term view that the Dollar will weaken, we continue to see the Dollar being favored in the coming few months as market participants are still preoccupied on sovereign debt issues in other Euro-zone nations like Spain and Portugal. The recent rate cut sprees by rating agencies like S&P, Fitch and Moody’s on Eurozone nations would likely further improve demand for refuge currency like the Dollar. However, US is not free of problems. With the nation’s debt swelling to more than US13trillion (or 93% of GDP) and loose monetary policies, downside pressures on the Dollar might occur once the Eurozone’s problems become less glaring.
If there was any award for the currency that hogged the limelight in 2010, the Euro would have won the award with ease. 2010 saw the bailout of Greece and Ireland as these nations struggled to stay solvent. Euro, the shared currency among 16-nations, suffered as the European Union (EU) and International Monetary Fund (IMF) struggled with solutions to stop the sovereign debt crisis from spreading to other nations. Yield spreads for 10-year Greece, Ireland and Portugal bonds against German bunds reached record levels, implying that investors are demanding a bigger premium to take on the risk of buying Greek, Irish and Portuguese debt. Even healthier nations like France were not spared. The cost to insure French government tripled in 2010, according to data provider CMA.
The outlook for Euro in 2011 may not be as bleak in 2011 as most investors have anticipated. While the PIIGS (Portugal, Italy, Ireland, Greece and Spain) nations continue to be in the media for possible sovereign debt defaults, we are cautiously optimistic that the combined efforts by EU and IMF will eventually receive some level of success and help contain the contagion. The Euro may continue to be weak in the first half of 2011 as investors will scrutinize Spain and Portugal closely for signs of sovereign debt default. Credit rating agencies will likely add fears in the markets by putting some of these troubled nations under downgrade review. However, we think that the funding mechanisms and experience the region have in handling Ireland and Greece bailouts could come in handy should other nations need an eventual bailout. Hence, Euro will probably see a better second half when investors regain confidence that the region’s crisis can be contained.
In the battle between safe haven currencies, 2010 was the year where the Yen prevailed over the US Dollar. The Yen was preferred over the Dollar as the quantitative easing measures embarked by the Fed diminished the Dollar’s attractiveness as a safe haven currency. As such, we saw USDJPY reaching a 15-year low at the 80 levels during late October 2010. However, the surge of strength in the Yen was not viewed favorably by the Japanese government and export-based companies. As the profitability of major blue-chip companies in Japan depended on export demand, the strength in Yen eroded the profits derived from overseas operations. For the first time in 5-year, Bank of Japan (BOJ) intervened in the currency markets by unilaterally selling Yen into the market, in bid to weaken the currency. The impact of the intervention was limited as USDJPY consistently traded below 85 for the rest of the year.
For the outlook in 2011, we may not witness the repeat of Yen strength seen in 2010. USDJPY is positively correlation to US treasury yields. When US treasury yields drops, USDJPY tends to comes under downside pressures. US treasury yields drops when investors are not too optimistic about the global economic health. With the recent tax cuts bill signed by President Obama and the Fed’s QE measures, economic indicators show improvement in US labour, manufacturing and consumption. Yields have come off the lows and we see that the Yen’s strength is diminishing. Furthermore, with FOMC rates and BOJ benchmark rates similar, there is less motivation for carry trades to take place. Consequently, we could see further upsides to USDJPY (or Yen weakening against the Dollar) in 2011.
Aussie had a remarkable year in 2010 as it reached parity against the Dollar. The Australian currency was buoyed by very positive economic growth and healthy labour markets. The Reserve Bank of Australia (RBA) had to hike benchmark rates 4 times this year in bid to stem the red hot economy. Rich in natural resources, Australia is a major exporter of agricultural products, minerals and energy-related commodities. The Aussie, dubbed as a commodity currency, benefited from the meteoric rises in commodity prices this year.
For the outlook in 2011, we remain optimistic on the Aussie. We continue to see the currency benefiting from further commodity price increases. China, the world second largest economy, the main importer of Australian resources, is expected to continue importing large quantities of resources from Australia. Furthermore, analysts are anticipating further rate hikes by RBA in the year of 2011. The anticipated rate hikes would likely attract more foreign capital inflows and boost the currency’s strength further.
This year, we saw the de-pegging of the Yuan against the Dollar. On June 19, 2010, the People’s Bank of China released a statement indicating that they would “proceed further with reform of the Yuan exchange rate regime and increase the Yuan exchange rate flexibility.” Since then, the Yuan had a steady appreciation against the Dollar. China’s GDP for the latest quarter came in red-hot at 9.6%, while inflation was high at 5.1%. In bid to stem inflation, China has raised benchmark rates once and the bank’s reserve requirement ratio (RRR) 5 times.
For the outlook in 2011, we are anticipating continued preference of Yuan over the Dollar in the coming months. The Chinese government is very worried about the inflation in raw materials and food prices. To curb inflation, it can choose between quantitative or monetary tools. While it seems intuitive for Chinese government to allow the Yuan to appreciate freely against other currencies in order to curb import inflation, China is dependent on exports for its economic growth and employment levels. A strong Yuan will affect the affordability of its exports. As such, we are anticipating China to employ rate hikes and RRR hikes instead to shore up excess liquidity. Those actions may attract foreign capital inflows but we think that the Chinese government will employ capital controls to ensure that the appreciation of Yuan will be gradual and manageable. We are estimating China’s GDP to come in at 9% for 2011.
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