One way to understand the currency dynamics of 2013 is to review the intermarket performances of the last four years and grasp the relationships between currencies, equities and commodities.
In assessing a currency’s overall strength, we measure its performance against gold, a common denominator. The “Gold vs. FX” column in “Four-year intermarket performance” shows gold increased the most against the Japanese yen (JPY) in 2012, implying that JPY is the weakest currency.
• 2012 proved the best performing year for equities since 2009 via the cumulative annual returns of major global indexes. Aggressive central bank easing around the world helped establish “backstops” against Eurozone woes and fiscal cliff uncertainty.
• There were some glaring similarities between 2012 and 2009 in the currency space — JPY was the year’s weakest currency followed by the U.S. dollar. Both the Norwegian kroner and New Zealand dollar ranked among the top currencies (against which gold underperformed). Both years involved aggressive central bank stimulus.
• The JPY-Nikkei inverse relationship remained alive and well with the Nikkei posting its biggest annual gain since 2005, and JPY posting its sharpest loss against gold since 2009.
• Commodities fared better in 2012 than 2011, but underperformed in 2010 and 2009. U.S. crude oil was the only “major” commodity to fall against the dollar. Gold’s overall showing against the 11 currencies was weaker than in any of the previous five years.
USD: The U.S. dollar was the year’s second worst performing currency. But the more interesting observation is that of gold and the U.S. dollar. Gold posted single-digit gains vs. all major currencies, with the exception of the JPY, against which it rallied 21%.
Euro: After a poor 2011 and a dismal 2010, the EUR/USD had a major accomplishment in 2012 — posting nine winning months. The last time this happened was in 2002. Draghi’s vow in July to do all it takes to save the euro triggered the crucial stabilization of the currency, to the detriment of eroding periphery yield spreads.
JPY: The Abe government’s vow to reinflate the economy was manifested in historical breakouts of major yen pairs. Several pairs rose above their 200-week moving average for the first time in more than four years.
Later this year, we’re likely to see indications from the Fed about slowing the pace of asset purchases. Some markets may react to this as the near-end of quantitative easing, but with the Fed aiming to reduce unemployment to 6.5%, asset purchases are here to stay. Combined with improved prospects for rating upgrades in Greece and Italy, this will pave the way for +15% gains in global equities in Q1-Q3, keep the U.S. dollar under pressure and further punish the yen.