The FX world has become somewhat more disturbing over 2013. Implied currency volatility has risen relatively sharply over recent months breaking its relationship with the VIX ‘fear gauge’ in large part due to the sharp drop in the JPY. Additionally the trend of improving risk appetite that was conducive to lower FX volatility has come to an end.
The inability of risk appetite to improve further has led to a declining correlation between various assets including currencies. This opens the door to other factors driving FX markets, with investor discrimination based on relative yield and growth differentials expected to take increasing prominence over coming months.
A big mover overnight was the EUR which slid on comments from European Central Bank official Weidmann that Europe’s recovery from the debt crisis may take years he hinting at a rate cut. He was joined by the ECB’s Smaghi who noted that the ECB must find ways to avoid EUR gains. EUR is likely to remain under pressure over the short term, especially on the crosses against the likes of GBP. Eventually I expect its ECB Outright monetary Transactions (OMT) threat led resilience to fade as Europe’s weak growth trajectory weighs on the currency, leading to an eventual move to EUR/USD 1.25 by end 2013.
The CHF and JPY languish at the bottom of our forecast grid in the medium term as would be expected given both their low yield and relatively lack of sensitivity to global growth. Both currencies will face pressure from relatively higher yields elsewhere given the growing attraction of yield and they are set to regain their lustre as funding currencies. In this respect the USD will begin to lose its allure as a funding currency especially as markets become increasingly nervous of a tapering off of Fed asset purchases later in the year.
The price of gold has stabilized over recent days in a USD 1365-1395 per ounce range following its sharp fall, with buyers creeping back in especially from jewelry demand, with strong purchases from India and China reported over recent days. My quantitative model suggests that the recent decline in gold prices is overdone and it may bounce back slightly. Nonetheless, the prospects for gold prices in the months ahead are still downbeat as expected strength in the USD, higher US bond yields, and expectations of a paring back in the Fed’s asset purchases weigh on the commodity.
News that Cyprus proposes selling its gold reserves over coming weeks will also fuel nervousness that other peripheral Eurozone central banks will follow suit. Finally, exchange trade funds (ETF) and speculative demand according to the CFTC IMM data continue to show a decline in investor demand. Consequently I we have revised down our forecasts for gold prices to reach USD 1350 per ounce by end 2013