Sunday, December 19, 2010

The market has found it difficult to find peace and direction

An overview …

Overall expectations and risk scenarios

Overall expectations
The next month will be characterised by the battle of whether will be on the development of US economic indicators or news about the debt situation of the European fringe countries. The week of 13-19 December will be particularly decisive for developments in the FX markets for the rest of 2010, since data for US retail sales and industrial production will be released and an FOMC meeting will be held. Furthermore, PMI data and IFO from Germany will be announced. Attention will be paid to the US indicators in particular, since the latest job data were very disappointing. Market participants will seek information as to whether the US job report was a one-off event or an indication that the US is slowing down again. If the coming economic indicators from the US are positive or if the economic indicators from Germany and Europe are negative, there is no doubt in our opinion that focus will shift to Europe again and result in broad euro depreciation.
The centre of attention in 2011 will still be the misery of the European fringe countries. A lid has not been put on the debt crisis yet, and since we expect stronger US indicators, focus is unlikely to shift away from Europe, at least in the first half of 2011.
From a macroeconomic point of view, we assess that global growth will slow slightly in 2011 compared with 2010. We expect growth for 2011 at 3.8% against 4.5% for 2010. In other words, the recovery continues, and actually the US will have recovered the decline in growth caused by the financial crisis already by the end of 2010. Inflation is still slow in many economies, but we do not expect to end up in a situation with dangerous deflation. To put it differently, we expect a slow change towards a normalisation of the global economy, including slightly rising equity prices and interest rates.
Risk scenarios
In 2010 the financial markets have been characterised by substantial volatility. The market has found it difficult to find peace and direction. To some extent, we expect that this will continue into 2011. Themes such as currency war, Korea war, euro collapse or the sustainability of the US debt burden and the negative budgets for that matter are all themes which have become more likely. True, the likelihood is still quite small, but if market focus shifts to just one of these themes, it will lead to substantial movements in the FX market.

The past month in review…

The development in the markets over the past month

The month in review
In November focus shifted to the euro-zone debt crisis again, including the Irish misery in particular. Uncertainty about the sustainability of the Irish budgets and an ailing Irish banking sector, threatening the country’s economy, sent the euro lower against several currencies, but a rescue package to Ireland from the EU/IMF late in the month calmed things down a bit in the financial markets. The Irish circumstances were not the only thing to put pressure on the euro, and market participants are slowly starting to focus on Portugal and Spain. In other words, the turmoil caused by the European debt crisis is still lurking, and the euro therefore lost 3% at index level in November.
The dollar on the other hand benefited from the fact that the question of quantitative easing was finally clarified, and also from a small improvement in the economic indicators. To this should be added that increased tensions between North and South Korea late in the month prompted investors to search to the US dollar as a safe haven. On the whole, the balance between the euro and the dollar moved to the benefit of the dollar in November, and EUR/USD ended at 130.40 compared with 139.50 at the beginning of the month.
Pound sterling gained ground in November – among other things due to positive surprises in the economic indicators, including the PMI index for the service sector. Furthermore, the inflation report from the Bank of England (BoE) did not signal any changes to the monetary policy, which was interpreted in the market to the effect that the BoE will not implement additional monetary-policy easing in spite of sluggish economic prospects and massive fiscalpolicy tightening. Overall, pound sterling gained 3.8% against the euro in November.
The Swiss franc started at 138 in EUR/CHF in November, but the cross rate quickly fell in the wake of the euro depreciation and not least increased risk aversion in the financial markets. In mid-November, the OECD published a report with focus on the prospects of the Swiss economy. The OECD expressed expectations of fairly solid growth and predicted that the Swiss National Bank (SNB) will be forced to gradual hikes of its key rate as of 2011. All in all, the Swiss franc appreciated from 137.10 to 130.55 against the euro.
The yen started the month at a relatively strong cross rate of 80.50 against the dollar, which could bring about intervention. However, intervention has not been used since mid-September, and was not this time either in spite of sharp rhetoric from the Japanese finance ministry. The dollar appreciation which has been seen after the question of quantitative easing was financially clarified in the US has lifted the USD/JPY rate to about 83.60. Although the Japanese yen has depreciated against the dollar, the crisis going on the in the euro zone and the resultant euro depreciation mean, however, that the fall in EUR/JPY was reduced slightly. EUR/JPY declined from 112 to 109 in November.
The Scandinavian currencies were treading water in November – with relatively significant daily changes though. In the light of the sharp focus on sound public finances in the wake of the European debt crisis, there has been a slight trend towards the Swedish krona and the Norwegian krone taking advantage of fair public-budget surpluses and not least low debt in both Norway and Sweden. In periods when risk aversion was not only anchored in the European debt situation but when it was more broadly based, the Swedish krona and the Norwegian krone did, however, bite the dust. Late in the month, the Swedish krona was, however, supported by positive surprises in Q3 GDP. On the whole, the Swedish krona appreciated by 1.6% against the euro in November. The Norwegian krone could not quite follow suit, but it gained 1% after all.

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