Signs of some further flexibility on both sides reveal that negotiations over the US fiscal cliff are progressing, albeit very slowly. Discussions between President Obama and House speaker Boehner yesterday appeared to go relatively well but the chances of a deal by year end remain slim. Against this background US equities posted gains while risk measures improved ignoring the weaker than expected reading for the December Empire manufacturing survey.
There is little else in terms of directional influence today, with highlights including RBA December board minutes, a vote on the Italian 2013 budget, UK inflation data and an interest rate decision in Sweden. The overall tone is likely to continue to be constructive for risk assets.
While I expect GBP to show some resilience over the coming year especially against the EUR, I look for the currency to eventually end the year weaker against the USD. The principal risk to GBP revolves around the UK economy. It seems very likely that the UK economy has contracted in the final quarter of the year. Worryingly, a weaker external environment taken together with the relative resilience of GBP has resulted in a deteriorating trade deficit, which could ultimately inflict pressure on GBP to weaken.
The fact that the UK basic balance (direct investment + portfolio flows + current account) position remains in negative territory also suggests that the underlying support for GBP is weak. Given these soft economic fundamentals it is difficult to see GBP breaking significantly higher over the coming months. Although the relationship is not perfect, my expectation that EUR/USD will drift lower over the course of 2013 will act to drag EUR/GBP lower too, with my forecast at 0.79 by end year.
EUR/SEK has probed higher over recent weeks and look to register further upside. Today’s Riksbank policy meeting will be the next focal point for SEK but with a rate cut largely priced in following recent deterioration in employment data and other signs of slowing growth, the SEK is unlikely to find any support in the near term. Sweden’s industry body and the OECD have highlighted the policy room to lower interest rates, with the OECD also noted the fiscal leeway that Sweden has should economic conditions worsen.
Officials are also targeting the exchange rate given recent comments by Sweden’s finance minister Borg about increasing foreign exchange reserves over the longer term. The implication is that the SEK will suffer as other currencies are bought against it. The weakness in the SEK is consistent with my quantitative models and a break of EUR/SEK 8.80 is looming over the short term.