Given the problems within the euro area, the dollar looks as if it could post further gains as we head into 2012.
However, talk of further easing from the Fed may weigh on the greenback in the medium term, especially with the political deadlock between Republicans and Democrats in the lead up to next year’s Presidential elections in November.
At the beginning of next year, Italy will have to raise the first tranche of around €330bn in funding for 2012 and with growth in Europe flatlining, and Merkel and Sarkozy insistent on budget sustainability at the expense of growth, it seems likely that the dollar will continue to gain – not because it is doing well, but because there really is no credible alternative. It also remains likely to rise against the pound, especially if, given our proximity to Europe, the situation in Europe continues to deteriorate. Further downgrades will probably weigh, not only on Europe, but also on the UK, as growth stalls and the dollar will probably benefit at the expense of the euro and the pound – simply because there are no other options expect gold.
The damp squib that passed for last week’s Eurozone summit has left traders looking longingly at the safe harbour of the dollar.
We will head into the new year with the euro remaining as vulnerable as before to the whims of bond vigilantes. As a result, euro-dollar will be in for a difficult time, with enthusiasm for the single currency in short supply. Everyone is aware that Italy remains only a few basis points away from the abyss. And Spain could easily follow if the new government disappoints when it announces austerity measures in a few days. The picture for sterling-dollar isn’t much better.
It’s hard to avoid seeing gloom wherever one looks, but with growth in Asia slowing down – as shown by India and South Korea this week – Australian dollar-dollar is also going to be rather out of favour.
All in all, it seems that, barring a new bout of open QE from the Fed, or another tortuous debt ceiling episode in Washington, the likelihood is that the almighty dollar will start 2012 in a much better shape than it did 2011.
America’s improving economic fortunes are providing a stark contrast to the dreadful prospects in both continental Europe and the UK.
Over recent months, US economic releases have consistently surprised on the upside. For instance, the Citigroup US economic surprise index has risen steadily this year to a current reading of 78; up from a low six months ago of -115. In Europe, however, the economic surprise index for the Eurozone is currently at -13. For Fed policy-makers, there is little pressure for additional monetary policy action right now. The labour market is strengthening (albeit slowly), the consumer is spending (cautiously), and both industrial production and capital spending are growing. Bank credit is also expanding at a decent clip, up 10 per cent on an annualised pace in the third quarter, led by strong demand from the corporate side. The latter suggests American businesses are minded to expand and that the recovery is becoming self-sustaining. If the American economy continues to hold up while Europe crumbles, this must be good news for the dollar.
The dollar’s strength, or comparative weakness, is likely to be dictated by two aspects: the prospects for a third phase of quantitative easing by the Federal Reserve and the progression of the sovereign debt crisis in Europe predicating the flight to safe haven asset classes.
For much of the past year, currency flows have largely been dictated by investor appetite for risk, with the dollar benefiting the most from this trend of late. This helped the dollar index to hit a new 11-month high yesterday.
As we head into the year end and 2012, we are likely to see a very similar trend, with many questions still unanswered over Europe’s ability to address the debt crisis and Bernanke leaving QE3 in his armoury, though stubbornly unused, should US growth deteriorate further, as expected.
With the BoE starting QE2 recently and likely to increase asset purchases in February next year – at the same time as Mario Draghi of the ECB signals dovish monetary policy – the prospect is that the dollar will remain much stronger than its euro and sterling counterparts.