• Home
• /
• World

The euro target of 1.30 gets nearer!

The political, economic and monetary data across Europe suggests the euro is headed even lower than 1.30. The Italian election could mean yet another short term, volatile centre-left coalition with a weak commitment to Mario Monti’s reforms, with Berlusconi and the comedian Grillo the wild cards in a Europe whose politics seems both tragedy and farce. A Bersani/Monti coalition would be benign for the euro. France will miss its three per cent deficit target in 2013 and the Elysee Palace has still not abandoned its dirigiste/punitive taxation mindset. The tensions between the Spanish government of the Partido Popular, embroiled in a political scandal, and Catalonia/Basque regional government, now has spilled over into potential limits on regional debt sales. The Cyprus banking bailout, with its Russian oligarch dimensions, is a toxic issue in Germany.

I had outlined the rationale for a short cable trade in successive columns last summer/autumn, when sterling traded at 1.60-1.62 against the dollar. However, I am stunned at the swift, brutal sell-off in cable to 1.52. It is now obvious that Governor King, Fisher and Miles all expect a rise in the Gilt purchase programme to £400 billion. It is also increasingly evident that the Old Lady of Threadneedle Street is no longer willing to take its own inflation target seriously even as Britain slips into a triple recession. While the FOMC turns hawkish, the BoE is turning dovish Sterling is an ideal funding currency against the Russian rouble, Turkish lira and Brazilian real.

Since the FOMC minutes has focused on the costs of a QE exit, I expect a move higher in the US Dollar Index, from 80 to 82. This means the overvalued Swiss franc is an ideal short against the dollar, possibly down to 0.94-0.96.

It is no coincidence that the Aussie dollar has fallen from its stratospheric heights last summer even though iron ore exports to China/China GDP growth actually rose this winter. The Aussie, above all, is the ultimate carry currency for Japanese investors, who hold $180 billion in Canberra’s bills, notes and bonds. This means that as the carry/volatility ratio declines, the Aussie fell against the dollar even as Japanese investors booked profits on the nine per cent rally in the Aussie/yen. Yet Australia’s yield pickup over emerging markets has seriously declined in the past six months. Toshin (retail) funds sold in Japan show a decline in money flows into Aussie dollar bonds, with flows into the Russian rouble, Brazil real, Indonesian rupiah and the Turkish lira. The RBA is in easy money mode even as gold prices plummet below $1600 and the carry/volatility ratio deteriorates. This means the Aussie dollar can well fall below 0.99 against the greenback.

The Canadian dollar, like the Mexican peso, will continue to struggle as long as Wall Street fears the fiscal cliff/US growth scare. The January FOMC minutes also cast a shadow on gold and crude oil, loonie negative. The Canadian housing sector has also become a concern for the financial markets, as the price action in Dundee Reit suggests. The Canadian dollar can easily fall to its July lows near 1.0260.

The FOMC minutes only increases the bullish case for dollar-yen, though the next catalyst will be Prime Minister Abe’s decision on the next governor/vice-governors at the Bank of Japan. However, risk aversion on Wall Street will limit downside on the yen, though a 97 target sometime next summer does not seem unrealistic. Favourite emerging market currencies to accumulate on risk aversion? South Korean won (1,090), Russian ruble (31) and Mexican peso (12.90).