To mis-quote Churchill, the dollar in 2012 is likely to be the worst major currency, except for all the others. Reserve managers and funds will still want to diversify away from the US currency in the medium term, but a lack of attractive alternatives and the sheer necessity in holding the currency should help keep the dollar afloat for a while longer, especially as the love affair with alluring BRIC economies is under strain. Timing is, as always, critical and the generally bullish consensus on the currency for 2012 is a concern. Overall, the dollar should start the year on a strong footing and the 1.15 area against the Euro is within reach, but it is likely to hit a peak before mid-year.
From a low point in May, the dollar has regained close to 10% on a trade-weighted basis with the Euro retreating from a high close to 1.50 to below 1.30 as Euro-zone fears increased and the ECB was forced to back-track from disastrous interest rate increases. There has been a shift in expectations surrounding the US economy as the mid-year slide towards recession has been halted. As the fourth quarter progressed the economy gathered momentum with gains for consumer spending and employment. Crucially, there has also been a shift in the Federal Reserve stance and funds have been drawn back to the dollar.
The Fed stood poised over the trigger for further quantitative easing early in the third quarter, but was able to hold back from further action as indicators improved. There should be further momentum at the start of 2012 which will help support the dollar. Yield spreads have moved back in the dollar's favour with 2-year bond spreads over German bunds positive for the first time in a year and the dollar is still undervalued.
It is, however, extremely difficult to build an independent bullish case for the dollar as the US still has to tackle extremely serious structural vulnerabilities. The fiscal position is a disaster as the Federal budget deficit remains out of control and there will be the threat of further credit-rating downgrades, especially as the political cycle is not conducive to cohesive action during 2012. The foundations for an extended period of strong growth are still not there given the individual and government debt levels, although there is at least hope that housing-sector volumes are recovering. The Fed may have held back from additional easing, but policy will certainly remain very accommodative throughout 2012 and there is little doubt that Bernanke will pull the trigger again if the economy threatens to stall.
If the telescope is pulled back to allow a more global view then the dollar's prospects brighten. The Euro-zone will continue to face severe structural problems throughout 2012. Even if the club can be kept together and this remains highly uncertain at best given the desperate Greek situation, there will be strong pressure for the ECB to pump additional money into the system to help avert a collapse in the banking sector.
Emerging markets are looking somewhat tarnished in general with a particular focus on the threat of a sharp slowdown in China while the Indian outlook has darkened. There was an important shift in trends during 2011 as Asian countries in general changed from being net dollar sellers to stop their currencies appreciating to net dollar buyers to prevent losses. Overall, there is likely to be a further net flow of funds into the dollar early in 2012.
This trend is likely to be enhanced by a further spasm of de-leveraging from within the global banking sector. Capital levels remain too low, especially as sovereign-debt has had to be re-classified as having inherent risk. De-leveraging will continue to underpin the US dollar as risk assets are sold off.
No comments:
Post a Comment