Markets around the world rise strongly in the new year, but dollar stages surprising rally against Euro and Sterling

Tom Tong07/Jan/2013Currency Updates

Risk assets in general welcomed the new year with strong rallies. News around the normally quiet Christmas holidays underlined the commitment of economic and monetary authorities worldwide to unprecedented reflationary policies.

In Japan, the new Prime Minister Abe has made clear its intention to implement massive fiscal stimulus even as it pressures the Bank of Japan into a more aggressive inflation target.

In the US, the “fiscal cliff” turned out to be a non-event, as we expected, although another fight looms in late February over the raising of the debt ceiling. Only the Fed surprised the markets on the hawkish side, as the minutes of the December meeting showed relative optimism about the US economy. This latter development brought on a fairly dramatic rally in the US dollar vs. most European currencies, while the greenback lost ground against most emerging market currencies, and finished the week nearly unchanged in trade-weighted terms.

GBP

The UK leaves behind a deeply disappointing 2012. The economy entered a double dip recession and shrunk again for the full year. Strong reflationary efforts on the part of the Bank of England were outweighed by the Treasury’s misguided obsession with austerity. Data for 2013 did not get off to a good start, either.

The services PMI surprised to the downside, dropping from 50.2 to 48.9 and consistent (again) with a contracting sector. We expect that the surprising resilience shown by the labour market will be tested, and are forecasting a slight contraction in UK’s fourth-quarter GDP. Meanwhile, Sterling began 2013 by reverting to its typical behaviour, moving as a low-beta version of the Euro, and rising 0.5% against the common currency while dropping a similar amount against the dollar.

EUR

We had a very quiet start of the year in Europe. One of our favourite indicators, Spanish monthly payrolls, did come out, and showed a job market that is still far from stabilizing. After some statistical adjustments caused by recategorisation of certain workers, we find that on average 40 to 60,000 net jobs are still being destroyed monthly. This evidence that peripheral economies are far from stabilization is consistent with other, more followed indicators, such as GDP (still contracting in all of Europe) and PMI business sentiment indicators, which are still deeply in contractionary territory in every peripheral country.

Clearly, the easing in financial conditions engineered at the sovereign level by the ECB has failed to filter through to the European economies, and therefore think that markets are being way too complacent about the risks of a flare up in the European financial crisis in 2013.

We maintain a very negative view of the Euro, which fell over 1% against the US dollar in spite of the generalized rally in risk assets worldwide.

USD

Positive political and macroeconomic developments last week buoyed the dollar against European currencies. The so-called “fiscal cliff” was defused in an anticlimactic agreement that saw tax rates rise in the higher brackets.

The next milestone in the budgetary soap opera is the “debt ceiling”, by which Congress needs to authorize a further increase in the Federal borrowing limit. We expect this to be yet another non-event, as the Republicans will not have the appetite for another bruising political fight were they will receive most of the blame. The non farm payroll report provided further evidence that the US economy is growing at a moderate yet sustainable pace of 2-3%, and that neither Hurricane Sandy nor the Congressional charade were enough to knock it off course.

The dollar reacted in a positive manner, rising against European currencies in spite of the generalized risk asset rally we saw last week.

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Written by Tom Tong

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