2013: The Return Of Currency Volatility?

Unable to find a compromise on a lasting solution to the deficit and debt problem, US politicians are resorting to short-term extensions of measures to push back the threat of a potential economic slump. The sequester, due to start at the start of the year, has been delayed to March. Ditto for the debt-ceiling which has been “suspended” until May. Amazingly, markets have cheered each extension as if those were real solutions. Growth expectations (and “risk on” bets) could be pared back if, as we expect, Congress is unable to delay the full sequester come March. The associated safe haven flows could help lift the US dollar.

In light of recent market exuberance which has allowed the euro to defy gravity, we’ve pushed our US$1.23 target for the common currency to the second quarter, expecting investors to rediscover the zone’s weak economic fundamentals.

With the Bank of Canada finally acknowledging the economic stagnation at home and clarifying that rate hikes are “less imminent”, the loonie returned to the weaker side of parity for the first time in weeks as investors pared back bets of rate hikes. We’re now well on our way towards our USDCAD target of 1.04 which we’ve pushed by one quarter to Q2. The loonie’s volatility, which has been declining in recent years, could increase this year helped in part by Canada’s growing external imbalance.


US dollar has potential
The year may have changed but one thing remains steady — the uncertainty generated by the US Congress. US politicians remain as divided and conflicted as ever, unable to find a compromise on a lasting solution to the deficit and debt problem. Instead, they are resorting to short-term extensions of measures to push back the threat of a potential economic slump. The sequester (automatic spending cuts due to start at the start of the year) has been delayed to March. Ditto for the debt-ceiling which has been “suspended” until May. So, America will be able to borrow from markets and meet its obligations e.g. finance government operations and not default on bond holders over the next three months. Amazingly, markets have cheered each extension as if those were real solutions. US equities are near record highs, and the corresponding “risk on” bets, coupled with the Fed’s money printing exercise have hammered the US dollar. But given the short-term nature of those Congressional stop-gap measures, the current market exuberance could be cut short.

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