A sharp reactionary rebound in risk appetite through much of the past year has produced aggressive rallies in oil, gold and most major currencies against the US Dollar. As 2009 winds down, we examine the major macroeconomic trends that are set to play out across the currency and commodity markets in the months ahead.
If 2008 seemed like the last gasp of life across financial markets, then 2009 was a collective sigh of relief. As central banks dropped interest rates to record lows and governments frantically doled out some $2 trillion dollars in stimulus, the sheer panic that seized investors after the collapse of investment banking giant Lehman Brothers began to recede: the sharp declines in leading economic indicators began to slow, credit markets showed cautious signs of life, and a glimmer of hope began take root across the world’s exchanges. The first quarter proved dismal, but by March a sense that Armageddon had been averted had started to become the consensus view.
What happened next can only be appreciated in light of the carnage of the previous year. Having stared down a near-collapse of the global financial system, overjoyed investors began piling into so-called “risky assets”, setting off sharp rallies in equities, commodities, and high-yielding currencies. Sure, the world economy was far from healthy, but anything that was better than the dark days of late 2008 was good enough. This also brought a sharp decline in the US Dollar, which had previously banked on the sophistication of US financial markets and its unparalleled liquidity and flourished amid the mayhem as a natural safe haven asset. The result was a bipolar marketplace torn between “risk” and “safety” where gains in the Dollar meant declines across nearly every major asset class, and vice versa.
Eight months hence, capital markets have advanced to lofty levels: the MSCI World Stock Index equity benchmark has returned to pre-Lehman levels and are trading at the highest levels relative to earnings since 2002; crude oil is pushing $80/barrel having bottomed near $41 in January; gold is setting record highs above $1100; and high-yielding currencies like the Australian and New Zealand Dollar have retraced close to 80% of the drop that began last year. With the worst now increasingly behind them, however, investors seem to be gaining a sense of sobriety after the intoxicating exhilaration of surviving the credit crunch. The sustainability of the recovery after stimulus is withdrawn and concerns about runaway inflation as a result of ultra-loose monetary policy crop up more and more often, with calls for a retracement of the risk rally starting to mount in earnest. Indeed, October may yet prove to have been a watershed month as the MSCI World Stock Index dropped the most in since February while the VIX index of US stock options volatility that is often seen as a proxy for investors’ risk aversion gained the most in a year. As 2009 comes to a close, we examine the macroeconomic trends that are likely to play out in the year ahead.
Guided by Risk - Euro, Swiss Franc and the ‘Commodity’ Dollars
As the currency of the world’s second-most liquid and developed financial market, the Euro is the natural antithesis to the US Dollar and so will tend to rise and fall on the greenback’s fortunes. It is no wonder then that the EURUSD exchange rate is tightly linked to global equity markets considering the US unit’s standby safe-haven asset status. To that effect, the continuity of the stocks rally is the critical question driving EURUSD trading, with any correction lower likely to carry the pair along for the ride. Further, the Euro’s exchange rate to the Dollar is consistently about 99% inversely correlated with that of the greenback’s value against the Swiss Franc, suggesting that whatever happens with EURUSD is likely to be mirrored in USDCHF.
The so-called “commodity dollars” are also an all-but-pure reflection of the risk versus safety dichotomy. This is particularly the case with the antipodeans, who boast the highest interest rates in the G10 and so are the most attractive buys for yield-seeking “carry” trades. Reasonably, FX carry trades flourish when investors value returns over safety, making the Australian and New Zealand Dollars over 90% correlated with global stock performance (as measured by the MSCI World Stock Index).
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