2010 was a rollercoast year for currencies. The euro dropped versus the US dollar to its lowest level since 2006, due to the European sovereign debt crisis. Canada’s financially stable banking system and commodity rich economy helped the Canadian dollar to rise above parity. The Japanese yen, also rose to a 15 year high against the dollar after the Bank of Japan and new prime minister intervened in the market, to aggressively stimulate the economy. In addition, China’s red hot economic growth, fueled the Chinese yuan’s rise in value. 2010 was also the year that the global currency battle took front and center stage.
2011 US Dollar Outlook & 2010 Review
In general, the US dollar has risen 5% versus the pound [GBP] and 10% versus the euro [EUR] in 2010. The sovereign debt crisis and fear of contagion spreading in the EU nations, have caused both the pound and euro to fall in value. This caused a return to the US dollar as a safe haven, which also coincided with investor demand in US treasuries. The US dollar and treasuries have seen a huge run up in value during May and June 2010. In the last half to the year demand for treasuries weakened, and so did the dollar. The dollar also fell -5% versus the Chinese yuan [CNY], and roughly -10% versus the Canadian dollar [CAD] and Japanese yen [JPY]. This article talks about the other currencies versus the US dollar which has been long used as the world’s reserve currency, so most of the details with the US currency will be mentioned in terms of the other currencies.
In 2011, it would not be unexpected that the USD continue its current trend (decline against the Canadian, Japanese, Chinese currencies, and rise against the pound and euro), but at more subdued levels. The Fed has been determined to continue with quantitative easing as Federal Reserve chair Ben Bernanke has mentioned ($600 billion more). He also indicated that more quantitative easing (money printing) would not be out of the question in mid 2011. The ballooning US federal deficit has reached roughly $13.8 trillion or $13,871,130,353,817.40 USD as of 12/30/2010. Capital needs of both Fannie May and Freddie Mac are still expected to be between $221 billion and $363 billion, through 2013. Both institutions were also seized by the government during the recent financial crisis. Housing prices can still be expected to decline in the US, which will dampen economic recovery, and put further pressure on the dollar.
Despite all the issues that would put downward pressure on the US dollar, the global currency battle (to lower other countries currencies versus the USD) will certainly have a large effect on which direction the US dollar will go (rise or fall). I feel the USD may have also been a bit oversold in 2010, so moderate and slight (more steady) movement in 2011, is expected rather than the larger movements of 2010.
2011 Euro Outlook & 2010 Review
The euro [EUR/€] started the year at 1.4324 USD, but confidence in the euro fell as a result of the sovereign debt problems (particularly with Greece this year). The problems caused the currency to continue its decline significantly, as investors fled back to the US dollar in May. The euro had hit 4 year lows against US dollar in early June. The monthly average in June for the euro versus the US dollar was 1.22085 USD, which was the lowest monthly average of the 2010. By Oct the euro had recovered much of its value (against the dollar), but still ended significantly lower. On December 31st, its value was 1.3362 USD.
In 2011 the euro can be expected to continue to decline moderately overall, as the problems in Europe continue throughout the year. Uncertainty pertaining to bailouts for Spain, Portugal, and other nations experiencing debt problems will continue to weigh on the currency. However, the initial shock of debt problems (as with Greece in 2010) has passed. Stabilization of the euro will be dependent on resolutions made on the issues in the EU. EU finance ministers have held a record 7 summits in 2010, which should also continue into 2011.
2011 Canadian Dollar Outlook & 2010 Review
On January 1 2010, the Canadian [CAD] dollar’s value was 0.9506 USD. The currency continued to rise and temporarily reached par with the US dollar in April, mainly due to the weak US economy and rise in the price of commodities. Canada’s financial system has been quite stable and the major banks have had good quarterly earnings. Furthermore, Canada’s real estate market has shown remarkable stability. In May, the Canadian dollar declined sharply as demand for the US dollar picked up. But the Canadian Loonie continued to rise again and closed above parity in early November and again by the end of the year . On December 31st its value was 1.0042 USD.
In 2011, the Canadian dollar can be expected to continue to trade above parity primarily due to a likely commodity price increases. Canada is a mainly a commodity exporting country (oil, natural gas, metals, lumber), and its currency will be effected by the rising prices. Although the dollar will rise, it is expected that it will not increase by too much more. The BoC has previously (2010) mentioned, that it intends to limit the Loonie’s rise using different monetary policy tools, as a strong Canadian dollar would and has hurt exports. Canada’s trade gap has continued to widen to significant levels, while year end household debt levels rose to 144% of disposable income. Interest rates are also set to rise in 2011, which will put pressure on the Canadian economy and households.
2011 Japanese Yen Outlook & 2010 Review
The value of the Japanese yen [JPY/¥] was was 0.0107 USD on January 1, 2010. After rising in the first two months, the yen fell in April and May versus the dollar. In June, Naoto Kan, the new Japan PM, in his first speech stated that Japan needed financial restructuring to avert a Greece-style crisis. The yen started to rise sharply in reaction, and by mid August the yen struck a 15 year high against the US dollar and a near 9 year peak versus the euro. The US dollar declined to ¥84.14 (the lowest level since November 1995), and the euro had declined to ¥106.70. Investors rushed to the safe haven Japanese currency amid fears of a struggling global economy.
In September, Japan’s Prime Minister and the Bank of Japan (central bank) intervened to sell yen in the market for the first time in six years, and promised to sell more in an attempt to stop the currency’s rise from hurting exporters and threatening a fragile economic recovery in the country. Dealers suggested the amount to be about ¥300-500 billion ($3.6-$6 billion USD). In October, the Bank of Japan cut its overnight rate target to a range between 0 and 0.1% (effectively 0%), from 0.1%, reinstating the zero-interest policy that the BoJ ended in July 2006. It pledged to buy 5 trillion yen ($60 billion USD) worth of assets ranging from government bonds & short-term government securities, to commercial paper & corporate bonds. The BoJ carried out comprehensive monetary easing, to stimulate the economy and attempt to lower the value of the Japanese yen, which was the highest in October. The monthly average of the yen in October at 0.0122269 USD. On December 31st 2010 its value ended the year at 0.0123 USD.
In 2011, we can expect the Japanese yen continue to rise versus the US dollar as Japan continues to take aggressive action to restructure the country’s finances, and stimulate the economy. However, a the rise in 2011 can be expected to be moderate, as the most significant action has already taken place in 2010 when the central bank sold yen in the market for the first time in 6 years and returned to a zero interest policy. Also putting some pressure on the yen is the country’s debt national level.
2011 Chinese Yuan Outlook & 2010 Review
The value of the Chinese yuan [CNY] on January 1st 2010, was 0.1465 USD. The currency experienced a significant rise in mid June, before a larger and sustained rise which started in September. In December, China’s central bank increased the amount of money that lenders must keep on reserve, three times in a single month. The move tightened credit and excess cash in the economy. Furthermore, the central bank raised interest rates twice in the last two months of the year as it stepped up its battle to rein in on high inflation and attempt to cool the economy. The yuan ended the year on 12/31/2010 at 0.1517 USD.
In 2011, it is expected that interest rate increases curb the pace of increase in the yuan. China’s minister has stated that the central bank will use monetary policy tools to control inflation’s pace. Despite monetary policy, and the global currency battle, the conditions are present where we can still expect that the yuan will continue to rise as and its economy continue to grow at a very robust pace.
It is important to note that at some point in time (perhaps not in 2011 though) it would not be unexpected that China’s economy experiences a severe downturn and possible financial crisis. The conditions for such a downturn have been building for some time. Some of the indicators include China’s 64 million vacant homes (enough to house half of America), and even more worrisome are entire cities that are empty. The average Chinese citizen is still very poor, even in Beijing where a square meter of residential property in Beijing costs an average of 26,000 yuan ($3,800 USD), and the average per capita monthly income is merely 2,000 yuan. A recent survey by the Chinese Academy of Social Sciences (CASS) found that 85% of urban families could not afford to purchase an apartment. The property bubble poses the largest threat as it tries to continue boosting domestic consumption. These conditions will continue to accumulate in 2011. Investors must keep a watch on such conditions, especially as the central bank increases interest rates, which will also have a large impact on real estate activity and the ability to maintain payments on credit and mortgages.
The Global Currency Battle
In 2010 we saw the global currency battle become a priority and major issue for world finance ministers and central banks. In early October the international currency battle really heated up as the Euro area policymakers (finance ministers of the 16 nation EU) at the annual EU-Asia summit, pressed China for a faster appreciation of its currency to help re-balance the world economy . The United States and the European Union accused China of keeping the yuan artificially low to boost exports, undermining jobs and competitiveness in the Western economies. Fear of a more intense international currency war sent the US dollar to an eight-month low against the euro (in October) as top world financial officials cautioned that competing devaluations of countries’ currencies could threaten the global economic recovery. Devaluing a nation’s currency enables prices of exports to be more competitive. The Canadian dollar also hit a 5 month high versus the US dollar during that time. Japan’s cabinet also approved another 5.05 trillion yen ($62 billion) in new economic stimulus, in a string of measures to shore up the country’s weak economy amid the strong yen.
By mid October the currency battle deepened further with a series of efforts from many nations to resist capital inflows. Many emerging nations saw inflows of foreign capital, from investors seeking higher returns than the near-zero interest rates offered in the developed world. As a result, their currencies have risen significantly, which threaten exports and undercut the competitiveness of such exporting countries. Many nations started to intervene in foreign exchange markets and invoked policies to curb capital inflows, in order to decrease the effects. Thailand imposed a 15% withholding tax on capital gains and interest income from foreign investment in government debt in a bid to curb the Thai baht, which was at its highest since the 1997 Asian financial crisis. The People’s Bank of China slowed the rise of the Chinese yuan by setting a weaker midpoint reference rate for trading, and insisted that the yuan must rise gradually. Brazil doubled a tax on foreign portfolio inflows into bonds and some other financial instruments to 4%, to reduce upward pressure on the Brazilian real. The Bank of England’s David Miles stated “We do have a policy tool, quantitative easing, which remains a potentially powerful tool and one that we might come to use” as Britain also faced competitive pressures.
The global currency battle has affected many currencies around the world, and has again raised the issue of what the reserve currencies should be. Inflation concerns have also deepened as many nations simply print money and devalue their currency. Devaluing currencies also pose a threat to the global economic recovery, but also cause hard assets and commodity prices to increase. In the last 12 months, gold, oil, silver, copper, coffee, sugar, potash, and countless other commodities have increased significantly in price. It is expected that the currency battle will continue and intensify into 2011. Emerging nations are expected to continue to limit capital inflows, as well as use quantitative easing policies.
This article only touches on a few issues, but it should help investors as a starting point with their own research and analysis. It is important to note that this article is meant to outline conditions which are likely to affect the currencies mentioned. Keep in mind the information in this article is not meant to be a set of predictions. It is meant as a discussion of highly probable scenarios of what we can expect to see happen, based on the information available today. By knowing the likely possibilities, we can plan for them. We can also capitalize on potential opportunities, and will not be caught off guard by possible negative events. Investors should also remain flexible in their view & outlook, and change it as the influencing conditions change.
UPDATE: List of 2010 year-end summaries & 2011 outlooks:
• 12/22/2010: 2010 Year-End Market Summary
• 12/26/2010: 2011 Bond Market Outlook & 2010 Review
• 1/17/2011: 2011 Mergers & Acquisitions Outlook and 2010 Summary
Thanks & Happy Investing! – The Investment Blogger © 2011