Implied forex volatility has declined substantially since last summer. The key components for this unpredictability over the last year have been the movements of various countries’ credit and swap yield spreads, notably those of Spain and Italy. Currently, the market expects little room for divergence in monetary policy amongst the core G10 currencies – with possibly one exception, Japan. The new LDP government seems determined to influence the Bank of Japan (BoJ) to unleash an aggressive policy change throughout 2013. This would certainly pressurize the Yen to trade lower. Who said we were not about to enter a currency war? As an aside of the Asian effect, this should lead investors to continue FX ‘range trading’, and to expect the current low-volume environment to persist.
The market is looking at the EUR to come under renewed pressure in Q1 when we witness the return of Spanish issuance, which should cause some widening of sovereign spreads. Investors can expect these spreads to tighten only if Spain enters an OMT/ESM program. For now, the market is relying on the good nature of the European Central Bank’s commitment to OMT to keep Spanish yields in check. EUR’s expected weakness implies that the central European trio of HUF, CZK and PLN, along with the Scandinavian couplet of NOK and SEK, could be vulnerable in early 2013. However, many expect that with an accommodating central bank, and with the European Union’s largest economy, Germany, gradually finding traction, the EUR should be capable of dragging the aforementioned currencies higher by year-end. Few investors expect the EUR’s 2012 year-end rally to be sustainable. Others believe the EU’s uncertain growth prospects, coupled with a dubious outlook for the region’s systemic stability, will end up hindering the single unit for most of 2013.
Japan’s LDP election victory favored the Yen ‘bears’; they currently hold the market’s most dominant forex positions and are betting on an aggressive BoJ quantitative easing program to be implemented next year. Are these ‘short’ Yen positions going to be disappointed? Any new policy implementation is not expected to be fast or even smooth. In an environment already supported by low, stable U.S. rates, the BoJ may find it difficult to maintain a weaker Yen. The current market positioning is hoping so; otherwise there will be an aggressive unwinding of the “bear” Yen trade. Maybe a sustainable, weaker Yen requires the BoJ to shift its inflation target and buy some foreign bonds? This action certainly would not sit well in international circles!
Trend appreciation looks to be the dominant theme for the Yuan in 2013. Global benchmarks suggest that the world’s second largest economy’s currency remains very much undervalued. Domestic data indicating a rise in global exports and growth in China’s trade surplus returns certainly would back-up this point. A CNY rise should support and favor other Asian regional currency pairs. Countries with strong bilateral trade agreements tend to always benefit. Australia and the AUD is a prime example now that China is that country’s largest trading partner.
The ‘Big’ dollar or the mighty ‘Buck’ is probably looking forward to a mixed 2013. This would be somewhat consistent with the “static outlook” that many analysts expect given the consensus for U.S. monetary policy forecast. That said, because of the Euro zone woes, the dollar could be expected to outshine the beleaguered ‘single currency’ in the medium term. The MXN and the CAD should benefit from any upswing in confidence from its largest trading partner, the USA. However, of the two, the ‘peso’ with its current stronger fundamentals, should trump the ‘loonie’ as Canada deals with an overheating property market. Expected static commodity prices and Canadian benchmark rate differentials do not justify a CAD rallying aggressively above parity versus the greenback.
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