2013: Central Banks To Remain Key Drivers Of Forex Markets
With the global financial crisis still far from resolved, central banks are likely to remain in the driving seat in terms of foreign exchange rates as policy makers in the developed world grow increasingly impatient to bring back sustainable economic growth.
Here we go again
If anything 2013 looks set to carry on where 2012 left off. Forex markets are likely to remain news driven with trends sustained or reversed, according to events, which will potentially make life difficult for currency traders with longer-term horizons. With base rates more or less sub-one percent in the large developed economies, the focus remains on who will be most aggressive in terms of unconventional monetary policies such as quantitative easing.
US debt ceiling
Wrangles over the US debt ceiling are likely to continue following an agreement to avoid the fiscal cliff. Investors will hope that a grand bargain over the US debt situation can be reached by political parties. Any sign that debt negotiations are likely to become a recurring feature in US politics will sap investor confidence, the US economy and accentuate risk on / risk off rallies.
US jobs target
Nonetheless, the US economy has been showing tentative signs of recovery with a bottoming out in real estate prices and falling unemployment levels. The other factor is the US Federal Reserve's new focus on lowering US unemployment to no more than 6.5%, it is currently just below 8%. Therefore, a period of sustained job creation would suggest that the Fed will reign in its easy monetary policy, which is likely to be bullish for USD. This focus makes the already very important non-farm payrolls numbers even more prominent.
The words 'currency wars' are likely to be heard again this year with the new Japanese government already applying intense pressure on the Bank of Japan to aggressively increase monetary stimulus efforts, partly to weaken the JPY to help exports. However, JPY is still seen as a safe haven currency and any return to a 'risk on' environment could be supportive for the Japanese currency.
Late last year the Bank of England sounded a warning with GBPUSD moving above 1.6100 that GBP was too strong. However, GBP tends to rise during periods of 'risk off' rallies. The lack of economic dynamism in these two countries could see their central banks indulging in ever more experimental monetary policies egged on by their respective governments. Both also face downgrades in their sovereign debt ratings over the course of this year if their borrowing carries on rising and their economies fail to grow sustainably.
Meanwhile, Eurozone integration is likely to carry on at a brisk, but messy pace, which should be supportive for the EUR. This is backed by the European Central Bank's commitment to do whatever it takes to save the EUR, which has significantly changed sentiment towards the single currency. Later in 2013 signs could emerge that peripheral Eurozone economies are beginning to stabilise following several years of severe economic difficulties.
Italy and Spain are pursuing painful reforms, which could help their competitiveness. Any such signs would be positive for the EUR as it would ease strains within the Eurozone. The big question is whether Spain or even Italy will need to call upon the ECB's Outright Monetary Transactions programme to support their sovereign bond markets. However, big risks remain for the Eurozone and traders will stay focussed on the region's fault lines. National elections and bond auctions will also be watched carefully.
The dragon takes a breather
For commodity driven currencies such as AUD and NZD, a big focus is China's economic growth, which may be about to slow permanently. Thanks to its one child policy, China faces a rapidly ageing population and this is already manifesting itself in terms of labour shortages and soaring salaries of factory workers. With a high level of employment and a fear of igniting inflation, the Chinese authorities may well be satisfied with lower GDP growth rates in future and appear to be trying to refocus economic growth on domestic consumption and away from exports and infrastructure development. Higher Chinese wages should drive demand for agricultural commodities as diets improve and possibly raise energy consumption. The losers are likely to be metals as construction slows.
Slowing Chinese commodity consumption would impact the strength of AUD and NZD and also remove their yield attraction as central banks there would likely cut interest rates to support domestic demand.