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Global FX
The euro area’s sovereign debt crisis has been dominating trading in financial markets over the past year and the currency market was no exception. The region’s debt problems spread from the peripheral to the larger euro bloc countries such as Spain and Italy. With credit rating agencies threatening to downgrade even the core countries including France and Germany, and the region’s leaders unable to come up with decisive measures to quell the crisis, the euro came under selling pressure. After reaching its 2011 high of 1.4940 against the dollar on May 4, the single currency has been trending lower, to close the year at 1.2560. For the year as a whole, the euro was down 3.2%.
The euro’s woes and concern about global growth also took a toll on other riskier assets such as the commodity-linked currencies. The Australian and Canadian dollar lost 0.3% and 0.4% respectively during the year against their US counterpart. In contrast, safe havens such as the Swiss franc gained ground, and the Swiss central bank had to put a cap on the Swiss franc at 1.20 per euro.
The euro region’s debt crisis is likely to further weigh on the single currency going forward. Rating agency S&P’s is expected to release its verdict on debt ratings for 15 eurozone countries in January, after placing nations including top-rated Germany and France on credit watch negative in early December. Meanwhile, the Fed’s policy stance could also have a potential impact on the dollar’s movement. It has decided to stand pat for the time being, but if the US economy deteriorates, it may well resort to another round of quantitative easing to ensure that the economy does not fall back into recession.
Interest Rates
Global economic uncertainty and the persistent eurozone debt crisis have been forcing major central banks to reverse their monetary policy stance. Those that started tightening policy, including the European Central Bank and Reserve Bank of Australia, had to cut interest rates, while some, such as the US Federal Reserve, had to keep their loose monetary policy for longer.
These trends are likely to persist in the coming months as the euro bloc’s sovereign debt crisis shows no signs of ending. In the advanced economies, both the Fed and the Bank of England would not only keep monetary policy loose, but may even ease further should conditions deteriorate. Possible actions that they may adopt include further purchases of government bonds and other debt securities as they try to lower the costs of longer term borrowing even further.
Similarly, the ECB, under the helm of its new President Mario Draghi, has already shifted to an easing bias. The central bank unexpectedly lowered interest rate by 25 basis points to 1.25% after its regular policy meeting on November 3. This was its first rate cut since June 2009, representing a reversal of its monetary policy stance. The ECB raised interest rates in both April and July this year as inflationary pressures rose on the back of higher food and energy prices. Further interest rate cut could be expected. In addition, the ECB has been purchasing government bonds in the secondary market as yields on Spanish, Italian and even French government bonds have been surging.
Developing countries such as mainland China are likely to shift further to an easing bias. The People’s Bank of China cut banks’ required reserve ratio (RRR) on 30 November for the first time in three years by 0.5 percentage point. More RRR cuts are expected in coming months. Interest rates will also be lowered gradually in the coming year.
US Economy
Recent reports show that the US economy might be on the mend, with consumer sentiment rebounding and labour market conditions stabilizing. Even the housing market showed tentative signs of improving, though house prices continued to decline.
US consumers have become more upbeat. Consumer confidence, as reflected by the Conference Board’s index, rose to an eight-month high of 64.5 in December. The rise largely reflects a better tone in the labour market. The unemployment rate dropped to a 2-1/2 year low in November and applications for first-time jobless benefits are the lowest since April 2008. Despite the improved sentiment, however, consumers continued to hold back and would not spend unless retailers offered large discounts. Personal spending rose 0.1% for a second month in November.
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