This post will discuss how revived regional political tensions have provoked the reemergence of the sovereign debt crisis, accelerating the timeline for significant Euro weakness from the 2H’13 into the end of the 1Q’13. We also explain why any calmness in markets will be as a result of the European Central Bank, and nothing more.

As we said in the first post in this series, coming into 2013, peripheral European sovereign yields remained low and relatively compressed to their German equivalents, allowing the Euro to outperform every major currency into February 1. But the journey from $1.2041 versus the U.S. Dollar on July 24 to $1.3710 on February 1 was not an easy one; at many points it appeared like the European Central Bank-induced rally was going to fall apart. This go-around, it may be time.

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With each tumble in the EURUSD in 4Q’12, there was an ensuing rally. But why not; the Federal Reserve had begun its QE3 program and the political situations from Greece to Spain were much calmer than they had been back in July. Yet everyone was very aware that the economics of the region (discussed last post) were remaining quite sour and in most cases, getting worse. Clearly, just as was the case with the rally in the S&P 500, there are other forces in play here driving confidence in the Euro, because a regional growth rate at its weakest point in the past five years is no reason to be bullish.


In order to buy governments time and bring down sovereign borrowing costs, ECB President Mario Draghi fulfilled his late-July pledge to do “whatever it takes” to save the Euro by pledging a liquidity program known as the OMTs, or Outright Monetary Transactions, which would effectively place a ceiling over Italian and Spanish yields for an unlimited amount of time, so long as budget consolidation was taking place.

Initially, similar to the impact that the Federal Reserve’s QE has had on the U.S. Dollar, the expanding ECB balance sheet size in early-2012 led to a sharp depreciation in the value of the Euro. But with bond yields tethered down and no additional liquidity injections required, the ECB was able to reverse the its balance sheet expansion by late-2012, and reduce its size in the beginning of 2013. While this initially led Euro strength over the past several months, sufficient evidence has gathered that the crisis may have been stirred.

The Italian elections that took place at the end of February emphasized how fragile the overall situation is in Europe: voters are becoming angry with their leaders, feeling as if supranational or even international powers are dictating policy. This is fitting, given the governments present in Greece, [especially] Italy, and Spain presently. Pandora’s Box has now been opened: 55% of the Italian electorate voted for the anti-austerity candidates, meaning that the Italian economic picture could worsen dramatically quickly once more, if investors lose faith in the bond market.

Greece and Spain are no “picnics” either. The Greek government remains highly unpopular and will likely head back to elections once German Chancellor Angela Merkel retains her chancellorship in the September German elections, while the Spanish government faces corruption charges and still puts off the necessary budget reforms desired by the core Euro-zone countries. We find there little reason to be bullish on the Euro, given the significant backdrop of European growth and political concerns, and wouldn’t be surprised in the slightest to see the EURUSD trade under 1.3000 for a sustained time (>3 months) in 2013.

This series of eight posts will focus on the major themes affecting currency markets. The eighth and last post in this series will review Chinese growth, performance of base metals, and forecasts for the Australian and New Zealand Dollars for 2013.

This post will discuss the weak economic conditions that have started to proliferate in the Euro-zone once again, marked by declining rates of production, consumption, inflation, and overall growth, all of which are exacerbated by a recently-strong Euro.

There was a period in mid-to-late-2012 when the financial aspect of the Euro-zone sovereign debt crisis appeared to be easing and the ailing economy appeared to be improving. To start, both Italian and Spanish sovereign bond yields compressed rapidly, to much narrower levels relative to their German counterparts. Then, as a sign of confidence in the region, the Euro rallied swiftly, especially against the Japanese Yen and the U.S. Dollar, culminating in a rally into $1.3710 on February 1, from $1.2041 on July 24. Conditions appeared to be improving.

Euro-zone GDP

But, as the saying goes, “don’t judge a book by its cover.” The period of calm that enveloped the Euro-zone over the past half-year warranted a second review, and as 4Q’12 GDP figures have showed, the broader region is now embroiled back in a recession equivalent to the deepest depths of the 2008 to 2009 global financial crisis.

Speaking from the point of having a budget surplus, Germany among other core Euro-zone countries have insisted that leaders in heavily indebted periphery countries embark on acute austerity programs, intended to correct any budget imbalances with a very heavy, swift hand over the next few years. The ramifications have been dramatic: record high unemployment rates in Italy, Greece, and Spain; substantial unpopularity among French, Italian, Greek, and Spanish politicians; social unrest across the continent; and relevant questions over the viability of the European Union as a whole in the long-term.

Now that austerity is creeping into the core of the region and growth begins to slow, we turn our attention to the Purchasing Managers’ Index readings from the major Euro-zone countries, to effectively gauge where growth is heading in the 2H’13. It’s evident here as well that growth rates should continue to contract, and that the crisis is going to get worse before it gets better, if anything.

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With all of the major PMI readings (except for Germany) at or below the growth level of 50.0 (the further away from the 50.0 line, the stronger the condition; above 50.0 is growth, below 50.0 is contraction), businesses are signaling continued weak conditions that are likely to persist for the foreseeable future. Seemingly, over the past two months, the region’s fundamentals have gotten worse, as any recovery on the horizon has been wiped out amid a sharp turn lower in sentiment, led by a very weak French PMI Services reading. When the weak growth situation is considering in context of the burgeoning political problems again, it’s clear that the Euro will struggle this year as markets turn to the European Central Bank for help. The EURUSD could slip below 1.3000 in the 1Q’13, but ultimately should finish the year in the 1.2500 to 1.2750 range.

This series of eight posts will focus on the major themes affecting currency markets. The seventh post in this series will discuss how the political situation in Europe is pushing the monetary union back to the brink.

This post will discuss the recent downgrade of the United Kingdom by Moody’s Investors Service, why the Bank of England may be ill-prepared to act, and why the Government’s refusal to act could keep the British economy, as well as the British Pound, in the gutter for 2013.

As the last week of February arrived, the British Pound found itself in a precarious position: it was the worst performing major currency in 2013. Yes, worse than the Canadian Dollar; yes, even worse than the Japanese Yen. Yes, the Japanese Yen! This is quite astounding, purely because the Bank of Japan and the Japanese government are working double-time to Yen in order to foster inflation, introducing significant stimulus on both the fiscal (new spending programs) and the monetary (doubling the inflation target and introducing an open-ended QE program to begin in January 2014) fronts, while the Bank of England appears to continue to sit on its hands.

Two central banks, moving in slightly different directions, and yet the more aggressively-dovish one doesn’t have the weaker currency. This truly emphasizes how weak the British economy is, and why it is likely that the British Pound remains weak, alongside its economy, for the rest of 2013.

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Growth has been modest at best, with the 4Q’12 GDP print only revised to +0.3% annualized the last week of February, helping the economy elude the difficult economic condition known as stagflation, or a period of economic conditions characterized by low or negative growth, high inflation, and high unemployment. These conditions were exacerbated by Chancellor of the Exchequer George Osborne’s austerity program, a choke on the British economy, which too is heavily dependent on consumption: higher taxes take a chunk out of that 64% of headline GDP figure.

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Ideally, in response to these conditions, the Bank of England would be acting. Instead, it seems unwilling to do so. The most recent policy meeting notes show that outgoing BoE Governor Mervyn King was outvoted trying to increase the central bank’s QE program by £25B. With outgoing Bank of Canada Governor/incoming BoE Governor Mark Carney talking up dovish central bank actions the past several months – going so far as to say that global central banks haven’t let “hit their limits”  – it appears a low rate environment is in store for the British economy, further undercutting the British Pound.

Indeed, these fiscal and monetary forces have provoked Moody’s Investors Service into downgrading the United Kingdom from its pristine ‘Aaa’ rating, to ‘Aa1,’ giving the U.K. a split rating just like the United States. In the near-term (remainder of 1Q’13), there may be few new negative catalysts that might present themselves, preventing the Sterling from getting pounded any further. But for the remainder of the year, as the economy gets worse amid steeper austerity conditions and a BoE that will be struggling to find its new identity, the British Pound could remain one of the weakest major currencies, next to the Japanese Yen. The GBPUSD should move towards 1.4250 by the end of 2013.

This series of eight posts will focus on the major themes affecting currency markets. The sixth post in this series will discuss the diminished economic outlook for the Euro-zone, and why the crisis hasn’t been truly resolved.


This post will discuss the self-induced austerity measures U.S. politicians have manufactured, a major hurdle to the recovery in the world’s largest economy.

The U.S. economy is headed in the right direction thanks to stronger consumer confidence, and now the Federal Reserve is signaling that its policymakers feel that it may be soon to begin the process of draining liquidity from the financial system. But this could not come at a worse time. U.S. politicians remain dramatically partisan and refuse to cooperate on nearly anything; voting among party lines for every major vote in recent memory, seemingly if only to spite one another.


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The best manifestation of this division is best exemplified by the budget negotiations, which have pitted Democrats, in control of the White House and the upper legislative house (the Senate), against the Republicans, in control of the House of Representatives (the lower legislative house). The first such impacts of these cuts were seen in the 4Q’12, when the U.S. economy contracted by -0.1% annually. Why?

The swift -22.0% annualized cut in defense spending, the sharpest pace in a decade, alongside weak inventory growth and the trade deficit (when imports outpace exports), created a -2.7% annualized drag on the U.S. economy. This drag was just enough to offset the strong combined +2.6% annualized growth rate in consumption and private investment (further highlighting how much stronger the U.S. consumer is). This weak growth is noted on the graph above on the far right, where the 4Q’12 GDP figure is circled, with the notation “austerity,” the term meaning “a fiscal policy that entails reduced government spending and higher tax rates, with the purpose of eliminating a budget deficit.” Clearly, a further reduction in government spending – part of that -2.7% drag, best reflected by the steep drop in defense spending – is going to weigh on growth.

As the headlines surrounding the budget sequestration, as it is officially called, continue to flow. In total, $109B in cuts will be made over the course of 2013; however, this results in $85B in cuts on March 1 alone. This will be the beginning of $1.2T (T for trillion) in budget cuts from 2013 through 2021, unless new measures can be agreed upon.

If politicians do not address the budget sequestration right away, then any prolonged period of drain on the economy could negatively affect the U.S. Dollar. While any increased credit risk is likely to roil global markets just as it did in 2011, culminating in Standard & Poor’s downgrading the United States’ then-pristine rating from ‘AAA’ to ‘AA+,’ the weaker economy could alter the Federal Reserve’s exit plans. If it becomes clear that the Fed will have to reverse its recent rhetoric in order to keep liquidity provisions in place, recent gains seen by the U.S. Dollar could be unwound, as the economy suffers. While the U.S. Dollar is strong now and enjoys a potentially bright future, there are certainly concerns lingering; political division in the United States could be the straw that breaks the U.S. economy’s and the U.S. Dollar’s back in the 2H’13.

This series of eight posts will focus on the major themes affecting currency markets. The fifth post in this series will discuss the recently berated British Pound and why the world’s oldest currency looks, well, old.

This post will discuss the broad ramifications of the Federal Reserve’s exit from the markets on the U.S. Dollar, and the process by which it will be accomplished.

While the S&P 500 climbed by +42.15% over the past three years (since the beginning of February 2010), the U.S. Dollar has been quite flat, yet volatility has been quite high. When QE2 took place from November 2010 through June 2011, the Fed’s total balance sheet size surged by $600B. It’s of no coincidence that during the lead up time to the initiation of the program to its culmination that the ICE Dollar Index, a weighted average of the ‘true’ value of the U.S. Dollar relative to a basket of currencies, fell by -16.38%.

More recently, the U.S. Dollar has exhibited signs of strength during periods at which the Federal Reserve stops injecting liquidity or withdraws from the system, but against a backdrop of significant uncertainty around the world, from growth in the United States and Asia, to political in Europe, and violent conflict across the Middle East. There is a case to suggest that the U.S. Dollar would have gained regardless of whether the Federal Reserve was easing at such a torrid pace, but we think it would be even stronger.

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If the Federal Reserve begins to wind-down its QE3 program, it will likely be in a few steps: first, publicly discuss exit plans (happening now); second, slow the pace of asset purchases from its current rate at $85B/month to $0/month over the course of several months (4Q’13); third, keep the balance sheet steady with interest rates near zero percent (ZIRP) (through 1H’14); and fourth, begin to sterilize (sell the assets) the balance sheet (2H’14 through 2H’16). As this process occurs, because market participants usually front-run policy and act on rhetoric rather than actual policy more recently, the U.S. Dollar is expected to continue its upturn despite the continued expansion of the Fed’s total balance sheet, as it’s clear the stronger U.S. consumer is beginning to support a stronger economic recovery.

There’s a big “if” to this whole equation: the U.S. budget sequester. Yes, the pesky, self-induced dose of austerity that U.S. politicians agreed was the best way to fix the nation’s apparent deficit and debt problems. Could the feckless Congress derail the recovery?

This series of eight posts will focus on the major themes affecting currency markets. The fourth post in this series will discuss why political impasse in the United States could be the straw that breaks the economy’s and the U.S. Dollar’s back.

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