No one wants a strong currency these days. Everyone wants more export growth. If they have to stuff their neighbouring countries to get it, then so be it.
Japan is the most obvious case of this, with the prime minister, Shinzo Abe, virtually dictating policy to the Bank of Japan.
But nearly every central bank around the world is now hopelessly compromised by politicians desperate to kickstart growth. The illusion of independence has been tossed aside. The gloves are off.
Experimental monetary policy is being taken to new levels. The more crackpot the ideas, the better.
The big question is: who will win? Which currencies are likely to end the year weaker, and which stronger?
What will happen to the major currencies this year?
Earlier this week, I took a look at why 2013 could end up being the year of the currency war. I made some suggestions as to how to protect your portfolio by spreading your risk across different assets in different parts of the world.
Today I’d like to take a closer look at some individual currencies and make some suggestions about which ones are best-placed to win the race to the bottom, and which are more likely to end the year stronger.
These aren’t trading suggestions. For anyone used to the stock market, foreign exchange is an extremely volatile, active market by comparison. If you’re considering betting on it, sign up for my colleague John C Burford’s free MoneyWeek Trader email – he’ll at least give you an idea of what you’re letting yourself in for.
Instead I’m trying to look at the sorts of factors that might influence some of the biggest currencies this year, what you should be watching out for, and how all that might affect your investments.
The yen: time for a breather, before the next slump
The Japanese yen has been hogging the headlines, so we might as well start there. The yen has plunged against the dollar over the last three months or so. For most of last year it was near its all-time high of around ¥77 to the dollar. Now it’s dropped as low as ¥90.
I wouldn’t be surprised if the yen stops for a breather around here. The Bank of Japan announced a 2% inflation target and promised unlimited quantitative easing (QE) this week. But it was in the half-hearted, foot-dragging, slightly sulky manner typical of the BoJ.
The unlimited QE won’t start until next year, and they plan to buy short-term government bonds. To cut a long story short, this is not as effective as the British form of QE, which buys long-term government bonds.
So does the weak yen story stop here? I don’t think so. Here’s why. The BoJ governor will be replaced in a few months. And this time, Shinzo Abe will replace him with someone rather more like Ben Bernanke – someone determined to ‘do what it takes’. Once that happen, there’s no saying how far the yen could fall.
So I’d stick with Japanese stocks – a weaker yen will be good for them. You could consider buying a yen-hedged Japanese fund (we’ll look at these in greater detail in an upcoming issue of MoneyWeek magazine. But I must admit I’m inclined to just stick with the unhedged funds. That way, if I’m wrong, and this is as far as the yen goes, what you lose on the stock market will be offset by your currency gains.
The Aussie dollar: still heading for a fall
Last year, I was convinced the Australian dollar was heading for collapse. It did plunge sharply below parity in early summer as fears grew over China’s slowdown.
But with markets being back in ‘risk-on’ mode, and China showing signs of a rebound, the Aussie rallied too, and is now barely changed on where it was around this time last year. So what happens now?
I have to say, I’m still bearish. China’s best hope of avoiding a hard landing is to make more effort to rebalance its economy. It needs to direct its efforts to encouraging more consumption and less infrastructure building.
Ultimately that means less commodity usage. And that means less demand for exports from Australia.
Meanwhile, the rest of Australia’s economy is nowhere near as strong as the mining industry. Manufacturers are being hammered by the strong Aussie dollar. Consumers are saving, not spending.
All else being equal, the central bank would probably quite like to cut interest rates to try to help everyone else out. And if every other country starts to ‘fix’ its exchange rate, I don’t think Australia will stand by and watch.
I certainly don’t see the Aussie getting back to its high point, when it bought just over US$1.10 – if it does, the pressure on the Reserve Bank of Australia to intervene would be almost irresistible. And in fact, I think it’ll struggle this year to get back above US$1.065.
That’s not an especially scientific prediction. But we’ve had a pretty euphoric start to 2013, and the Aussie has still struggled to breach the 1.06 level. If it can’t do it now, I’m not sure it will manage it at all.
So do with that suggestion what you will, and I’ll steel myself to cop the flak if I turn out to be wrong.
The euro: how to profit regardless of what it does
I was planning to look at the pound, but my colleague Merryn Somerset Webb has done such an efficient demolition job here that I don’t think I can add much to it. So what about the euro?
I think the euro is the toughest currency to call this year. The euro’s biggest weakness – that it’s a Frankenstein currency – is also its biggest strength. The Federal Reserve can give the dollar as big a kicking as it wants. It’s not as if there’s an obvious substitute currency that most Americans could go off and start using instead.
But if any member country loses faith in the euro, the risk is that it gives them another excuse to drop out and go back to their old currency. So the euro may be the one global currency where the central bank has at least some modicum of interest in guarding its value. Yes, it’s not ideal to have a strong euro – it won’t help the export picture. But let it weaken too much, and it could splinter.
The good news is that European stocks are worth buying either way. They’re cheap enough that the currency can stay at current levels or even strengthen a bit and it won’t be a disaster. But equally, if the euro weakens, it would largely be good news for stocks – particularly if the European Central Bank (ECB) ends up doing QE.
The one caveat is that if the ECB does end up doing QE, it will be in reaction to a fresh eurozone panic. If that happens, you can expect both the euro and European stocks to fall. I suspect that would be a buying opportunity, but we’ll let you know at the time.
We’ll be looking at the outlook for currencies in more detail in next week’s issue of MoneyWeek magazine, out next Friday.
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