From the April 2013 issue of Futures Magazine • Subscribe!

The new “new normal” in FX

Dollar days

Most analysts see the dollar as the strongest of the Western currencies, but acknowledge that the end of risk-on/risk-off means the dollar is flying solo. Chappell says the U.S. economy is strong relative to Japan and the Eurozone, but the move toward more normal fundamentals is a two-edged sword for the dollar. “It has to stand on its own two feet — no returning to people rushing [into the dollar] for risk aversion. [But] compared to other G-7 currencies, the U.S. economy is doing better,” he says. 

Wilkinson sees the appeal of the U.S. dollar. “The Fed’s QE policy has helped the economy recover further and faster than a lot of people appreciate,” he says. “And on one hand, you could expect a weaker dollar because of the Fed adding liquidity, it makes more sense for the Fed to stop in its tracks sooner rather than later.”

However, he says an early exit from QE would support the dollar. “I would suggest that the Fed’s activity has created financial market stability and at some point they will be forced to reassess the policy,” Wilkinson says. “[We] probably have reached take-off speed, and the Fed does not need to buy bonds — not to say yields won’t surge.”

More interesting perhaps are the commodity currencies, which have been a mixed bag. 

Chappell says the commodity currencies are a little overvalued. “The dollar will do better than the commodity currencies. We see the Aussie doing worse than the Canadian dollar [because the Canadian] economy will benefit from expected growth in the U.S.”

Wilkinson adds, “I am somewhat surprised that the Aussie and Canadian have both weakened relative to the U.S. dollar. It plays into a bigger picture of contained inflationary pressures around the world. Even as the Chinese economy begins to feel the benefit of a turning point for the Eurozone, it has not stoked any inflationary fears.”

Global demand and inflation are key drivers of commodity-linked currencies, but their value also is based on their stability. Conklin is bullish commodity currencies but does not necessarily see commodities rising. “Broadly, in the short-term they will be correlated with the price of commodities that may be coming down,” he says. “Over the long run, those currencies have far better fundamentals. Their banks are more in control. When you look at the Fed, they are doing monetary experiments. I respect what they have done, but they are forced to conduct monetary experiments.”

Conklin simply points out that the Aussie, Canadian and New Zealand dollars along with the Norwegian Krone have more productive economies. 

All our analysts were more bullish on the BRIC currencies in general and the Brazilian real in particular, which is the consensus pick to have the largest move in 2013. 

The concept of “normal” is a tough one as it relates to markets. The extraordinary events involving the 2008 credit meltdown have led to more government and central bank meddling, but this always has been an issue for markets, particularly forex. But when it gets to a point where traders avoid markets instead of trying to exploit those normal policy initiatives, markets become less liquid and fail to perform their role of risk mitigation. 

There are signs that forex markets have become more robust in the last few quarters but the fact that the U.S. could not come to an agreement before initiating the sequester is a sign governmental dysfunction could roil markets. It is the type of thing that has led to some of the market dysfunction we have seen since 2008. Although there is no guarantee that governments and central banks will “let the markets decide,” it has proven more difficult, if not impossible, to manipulate currency values in this unpredictable world, which is probably a good thing because that fact will keep folks in the market despite the efforts of some. 

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