Currency Impact Report
Currency Impact Report, December 12-16
December 19, 2011
By midweek, the euro had dipped below $1.30, the first time it has sunk to that level since January of this year. The week concluded with more dour news, as Fitch Ratings announced it has targeted France and six other eurozone countries for potential downgrades.
Even U.S. equity markets still seem to be taking their cues from Europe as the 60-day correlation between the S&P 500 Index and the EUR/USD exchange rate hovers around 0.81, after having peaked at 0.91 in November. A correlation of 1.0 would indicate they move exactly in tandem.
Looking forward, Brazil’s central bank is planning on instituting its “dollar fixing” program Monday that aims to provide support for the real. The market seemed to have priced that in to some extent Friday, as the real retraced some of its losses on the week. So it will be interesting to see what, if any, effect the policy will have going forward.
At this point, it’s more appropriate to consider what investors should expect in the coming weeks rather than focusing on day-to-day developments in the eurozone.
Expect to see further credit downgrades this week. Specifically, Austria and France look to be at risk of being downgraded by S&P. Though the markets might be slightly immune to another downgrade, the euro will most certainly suffer further from such an event.
This, in turn, could mean bigger losses for U.S. investors in Europe. On the bright side, the dollar stands to gain the most should the euro tank further, as the U.S. dollar index comprises a 60 percent euro weighting.
Still, the bigger question remains: How far is the U.S. Federal Reserve willing to intervene? Though Bernanke has made it clear the Fed won’t provide more aid to European banks beyond the discount window and swaps, 2008 taught us that anything can happen should things become bad enough.
Doubts about the Chinese economy are beginning to grow. First were concerns over the country’s future growth. Then came the first decline in foreign direct investment in 28 months—then more talk about a policy shift back to stimulation.
These factors, combined with declining cash flows, import tariffs and an explosion in social unrest, are threatening the growth of the entire region, which is so dependent on China’s sustained expansion.
Look no further than India, where a slowing economy is causing both its currency and stock market to fall sharply. The BRIC economy continues to show signs of fatigue, as profit forecasts have been cut to levels not seen since 2009.
While some are calling for a popping of the country’s economic bubble, India’s central bank is concerned enough to have left interest rates unchanged despite overwhelming evidence of inflation. Dollar investors lost more than 5.5 percent in the Indian market last week.
Slowing growth in China is also rippling into Australia, a country that has benefited greatly in recent years from China’s seemingly unending appetite for natural resources.
The country’s market closed down nearly 3 percent last week in U.S. dollar terms, as the nation tries to come to grips with the impact of diminishing Chinese demand for its exports. The Aussie dollar was the region’s worst-performing currency last week.
That’s not to say that Australia was alone in feeling the pain from the dual threat of European insolvency and Chinese weakness.
Korea, Japan and Taiwan all lost more than 2 percent in dollar terms last week, while U.S. investors in Singapore and New Zealand saw losses of more than 1.25 percent.
In short, there was little shelter from the storm in the Asia-Pacific region, as all but one of the region’s markets—Indonesia—finished the week lower.
In Brazil, the central bank restarted a program to sell dollars and repurchase them a month later in an effort to bring the real’s decline under control. Still, their efforts proved challenging as the real has marked a 10.69 percent decline thus far.
In Mexico, central bankers are still unsure of measures to take as they debate whether to raise or lower interest rates. The actions—and inactions—of Latin American central banks are a sign of the times, as many debate how to protect their respective nations in the face of a global economic crisis.
For U.S. investors in these countries, expect to see further decline in the real and the Mexican peso should the European debt crisis intensify, as investors will undoubtedly rush to the dollar as a safe haven.
Teva Pharmaceutical makes up almost 25 percent of the MSCI Israel Capped Investable Market Index Fund (NYSEArca: EIS). Teva shares were buoyed by views it will be able to defend its market share.
Specifically, the Tel Aviv-based firm filed suit against a competitor for allegedly violating a patent on a breast cancer drug. It has also won a legal victory by preventing a competitor from selling pain medication that competes with Teva’s.
The Israeli shekel weakened slightly against the dollar, but the strong performance of local stocks overpowered the FX drag.
Meanwhile in South Africa, U.S. investors were hurt last week by both local returns and the weakening rand. The rate of producer price inflation decreased more than analysts expected, but it remains over 10 percent. Consumer price inflation remains high, too, at around 6 percent. The central bank isn’t likely to lower rates despite weakening demand for South Africa’s exports.
Emerging market economies like South Africa’s are feeling the impact of Europe’s debt woes. Investors moved away from risky assets, and concerns grew that Europe might be heading back into recession. Both factors drove down commodities and commodity producers, such as South African extraction-based firms.
Markets pared back some losses after another week of reduced initial jobless claims and no change in the Consumer Price Index. Despite the bounceback, both U.S. and Canada ended the week down, 2.85 percent and 4.69 percent, respectively.
Capital inflows in October into the U.S and Canada came in below expectation. However, strong inflows are expected into the U.S. in November and December, as a result of a reduction in risk appetite among investors and improvements in the U.S. economy. Such flows don’t bode well for the Canadian dollar.
In the U.S., this week’s Housing Market Index result on Monday and third-quarter GDP on Thursday will be watched to provide affirmation about the strength of the economic recovery. While GDP numbers were previously revised down from 2.5 percent to 2 percent, an upside surprise would provide support to the recent series of improvements among economic indicators.
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