FX Market Monitor - 1st Quarter 2013
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FX Market Monitor - 1st Quarter 2013



Many fundamental factors, including national economic conditions, monetary and policies, current and capital account flows, to name just a few, impact the returns associated with the world’s ...

Many fundamental factors, including national economic conditions, monetary and policies, current and capital account flows, to name just a few, impact the returns associated with the world’s currencies.



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FX Market Monitor - 1st Quarter 2013 Document Transcript

  • 1. CURRENCIESCurrency Market Monitor1st Quarter2013APRIL 6, 2013John W. Labuszewski Sandra Ro Bluford PutnamManaging Director Executive Director Chief EconomistResearch & Product Development Research & Product Development Research & Product Development312-466-7469 011 (44) 203-379-3789 212-299--2302jlab@cmegroup.com sandra.ro@cmegroup.com bluford.putnam@cmegroup.com
  • 2. An ongoing debate has long persisted in the global These factors including growth and inflationcurrency or FX markets – is FX an “asset class” akin prospects; monetary and fiscal policies; and, currentto stocks and bonds? While practitioners and and capital account balances.academics may debate this point at length, perhapsthe most practical answer is – does it really matter To illustrate, we include a brief discussion of theprovided that investors may draw a return from economic situation prevailing in the United States ascurrency investments? of the conclusion of the most recently completed calendar quarter. Of course, the U.S. dollar (USD)The performance of the currency or FX markets is may be just one side of any currency pair that mayfound in the exchange rates and cross-rates be traded using CME Group FX futures.associated with the world’s myriad currencies. Thetotal return associated with a currency is driven by A brief summary of economic conditions in variousinterest income associated with fixed income nations, organized along similar lines, is included ininstrument investment in the particular currency; as Appendix 1 of our document below. One maywell as pure price performance. compare and contrast these conditions as they exist in the two countries whose currency pairing one mayMany fundamental factors, including national be interested in to draw an appreciation of theeconomic conditions, monetary and policies, current fundamental factors that impact currency markets.and capital account flows, to name just a few,impact the returns associated with the world’s Growth and Employmentcurrencies. Fourth quarter 2012 GDP was most recentlyThis document represents a review of these factors reported at a somewhat disappointing +0.4%. Butas they played out in the most recently completed the Federal Open Market Committee (FOMC)calendar quarter. We include consideration of the attributed this figure, after a rather robust advanceso-called “carry trade” as well as a look at the of +3.1% in the 3rd quarter, to “weather-relatedtheory of “purchasing power parity” as it impacts FX disruptions” with an obvious nod to Superstormmarkets. Sandy “and other transitory factors” such as inventory drawdowns. 1While we cover activity in a broad spectrum ofcurrencies, we focus on the currencies underlying Growth and Employment 6% 11%some of the most liquid of CME Group FX futures. 4% 10% Qtrly Change in GDP Unemployment RateThis includes the U.S. dollar (USD), Euro (EUR), 2%Japanese yen (JPY), British pound (GBP), Swiss 9%franc (CHF), Canadian dollar (CAD), Australian dollar 0% 8%(AUD) and Mexican peso (MXN). -2% 7% -4% -6% 6%In addition, we have special interest in thecurrencies of significant emerging market economies -8% 5%including the Brazilian real (BRL), Russian ruble -10% 4% 05 05 06 06 07 07 08 08 09 09 10 10 11 11 12 12 13(RUB), Indian rupee (INR) and Chinese yuan or Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1renminbi (CNY) – the so-called “BRIC” nations. Real GDP (SA) Unemployment RateFinally, we highlight several CME Group FX Indexes Source: Bureau of Economic Analysis (BEA) & Bureau of Labor Statistics (BLS)including a USD Index, a Carry Trade Index,Commodity Country Index and BRIC Index. The FOMC suggested more recently on March 20thMarket Fundamentals that we are now witnessing a “return to moderateAs a general rule, FX analysts will evaluate thefundamental value of any particular currency by 1reference to a number of national economic factors. Federal Reserve Press Release dated January 30, 2013.1 | Currency Market Monitor 1st Quarter 2013 | April 6, 2013 | © CME GROUP
  • 3. economic growth following a pause late last year.” 2 strengthened further but fiscal policy has becomeThe Fed elaborates that while “[l]abor market somewhat restrictive.” 4conditions have shown signs of improvement inrecent months … the unemployment rate remains Consumer confidence has been buoyed in recentelevated.” 3 Unemployment is winding down, months with the Michigan Index of Consumerreported at 7.6% for March 2013. But it does Sentiment reported at 77.6 in February 2013 and upremain significantly above the Fed’s target of 6-½%. from 75.3 in February 2012. This sentiment is reinforced by a decline in the personal savings rate Employment Statistics to 2.4% in January 2013 from 6.4% in December 11% 67% 2012. Labor Force Participation 10% Unemployment Rate 9% 66% Retail Sector Activity $185 1.50 8% Inventory:Sales Ratio $180 1.45 Retail Sales (Bil $) 65% 7% $175 1.40 6% $170 64% 1.35 5% $165 1.30 4% 63% $160 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 $155 1.25 $150 1.20 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Unemployment Rate Labor Force Partcipation Source: Bureau of Labor Statistics (BLS) Real Retail Sales & Food Services SAThe Fed does concede that it sees “downside risks to Total Business Inventory:Sales Ratiothe economic outlook.” Certainly these risks are Source: U.S. Census Bureauimplied by the ongoing decline in labor forceparticipation, reported at 63.3% for March 2013. Further evidence of retail strength, accounting for perhaps 70% of domestic economic growth, is found Personal Savings & Sentiment in strong retail sales activity. The February 2013 9% 100 retail sales report is the strongest figure on record, 8% 95 topping numbers recorded in late 2007 before the Consumer Confidence Personal Savings Rate 7% 90 full weight of the subprime mortgage crisis was felt. 85 6% 80 Housing Activity 5% 75 2,500 4% 70 3% 2,000 65 000 Units 2% 60 1,500 1% 55 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 1,000 500 Personal Savings Rate Consumer Sentiment Index Source: FRED Database 0 Sep-04 Sep-06 Sep-08 Sep-10 Sep-12 Jan-04 May-05 Jan-06 May-07 Jan-08 May-09 Jan-10 May-11 Jan-12Still, the Fed found solace in the facts that“[h]ousehold spending and business fixedinvestment advanced, and the housing sector has Building Permits Housing Starts Completions Source: Dept. of Housing & Urban Development (HUD)2 Federal Reserve Press Release dated March 20, 2013.3 4 Ibid. Ibid.2 | Currency Market Monitor 1st Quarter 2013 | April 6, 2013 | © CME GROUP
  • 4. March housing activity figures were generally quite late 2007 and early 2008 just prior to the onset ofupbeat with building permits rising to 946 thousand the subprime crisis.units and housing starts up to 917 thousand unitsand the highest levels recorded since 2008. U.S. Corporate Profitability 120% $1,800 S&P/Case-Shiller Housing Indexes 100% Pre-Tax Profits (Billions) 320 $1,600 Annualized Change 80% 280 60% $1,400 40% 240 $1,200 20% 200 0% $1,000 160 -20% $800 -40% 120 -60% $600 Q1 04 Q4 04 Q3 05 Q2 06 Q1 07 Q4 07 Q3 08 Q2 09 Q1 10 Q4 10 Q3 11 Q2 12 80 Sep-01 Sep-06 Sep-11 Jan-00 Nov-00 Jul-02 May-03 Mar-04 Jan-05 Nov-05 Jul-07 May-08 Mar-09 Jan-10 Nov-10 Jul-12 Annual Change Corporate Profits (Bil) Source: Department of Commerce Los Angeles San Diego San Francisco Denver Washington DC Miami Chicago Boston Las Vegas New York Comp-10 Industrial growth was further reflected in strong Source: Standard & Poors corporate profitability. Third quarter 2012 corporateFurther signs of growing momentum may be found profits were recorded at $1.74 trillion. This is anin housing values. The S&P/Case-Shiller Composite advance of 17.9% over the 2nd quarter 2012 figureIndex of 10 U.S. cities was reported for January and the highest observed performance yet to be2013 as 8.4% above the trough recorded in March recorded.2013 but still 29.9% below the all-time peak fromJune 2006. Consumer Price Index (CPI) 6% Industrial Sector Activity 5% Year-on-Year Change 105 82% 4% Industrial Production Index 80% 3% 100 Capacity Utilization 78% 2% 76% 1% 95 74% 0% 90 -1% 72% -2% 70% 85 -3% 68% Dec-06 Sep-08 Jan-04 Aug-04 Mar-05 Oct-05 May-06 Jul-07 Feb-08 Apr-09 Nov-09 Jun-10 Jan-11 Aug-11 Mar-12 Oct-12 80 66% Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 CPI - All Urban Consumers SA CPI ex-Food & Energy SA Source: Bureau of Labor Statistics (BLS) Index of Industrial Production Capacity Utilization Source: St. Louis Federal Reserve FRED Database InflationThis consumer optimism spilled over into the The Fed observed that “[i]nflation has been runningindustrial sector as the Index of Industrial somewhat below the Committee’s longer-runProduction was recorded for February 2013 at its objective, apart from temporary variations thathighest level since April 2008. Similarly, capacity largely reflect fluctuations in energy prices. Longer-utilization rose to 78.3% in February 2013. Still, term inflation expectations have remained stable …these figures fall a bit short of the peaks observed in [t]he Committee also anticipates that inflation over3 | Currency Market Monitor 1st Quarter 2013 | April 6, 2013 | © CME GROUP
  • 5. the medium term will run at or below its 2 percent interest rates, support mortgage markets, and helpobjective.” 5 to make broader financial conditions more accommodative.” 7Indeed, both CPI and CPI ex-food and energy priceswere recorded, on a seasonally adjusted (SA) basis, Fiscal Policyat 2.0% in February 2013 and precisely equal to theFed’s stated objective. The Fed comments that “fiscal policy has become somewhat restrictive.” 8 Certainly this restrictiveMonetary Policy stance is reflected in a decline the Federal deficit for 2012 of $10.1 trillion. While this is a considerableThe Fed suggests that “a highly accommodative figure and far in excess of all previous deficits priorstance of monetary policy will remain appropriate for to the onset of the subprime crisis, it nonethelessa considerable time after the asset purchase represents some improvement over the deficits ofprogram ends and the economic recovery 2009, 2010 and 2011.strengthens … [thus, it is maintaining] … the targetrange for the federal funds rate at 0 to ¼ percent Federal Surplus/Deficit (Billions USD)and currently anticipates that this exceptionally low $400range … will be appropriate at least as long as the $200unemployment rate remains above 6-½ percent, $0inflation between one and two years ahead is -$200projected to be no more than a half percentage -$400point above the Committee’s 2 percent longer-run -$600goal, and longer-term inflation expectations continue -$800to be well anchored.” 6 -$1,000 -$1,200 Benchmark U.S. Rates -$1,400 7% -$1,600 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 6% 5% Source: Office of Management and Budget (OMB) 4% 3% Still, the budget battle in Washington is not over as the gap between the Democratic and Republican 2% fiscal visions are far apart. This battle may reach 1% crisis proportions around May 19th when the next 0% debt limit crisis is projected to come to a head. Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Entitlement spending, income and estate taxes and the size of government remain controversial issues. Target Fed Funds 2-Yr Treasury 5-Yr Treasury 10-Yr Treasury Current & Capital Account Flows 30-Yr Treasury Just as incremental progress is achieved withWhile Fed policy on the very shortest end of the respect to the Federal spending deficit, we also seecurve remains fixed, they nonetheless “decided to some improvement with respect to the U.S. currentcontinue purchasing additional agency mortgage- account or trade deficit. The 4th quarter 2012 deficitbased securities at a pace of $40 billion per month was reported at $100.4 billion. While not altogetherand longer-term Treasury securities at a pace of $45 cheerful, it represents a significant improvement onbillion per month … Taken together, these actions the $133.8 billion deficit from the 1st quarter 2012should maintain downward pressure on longer-term5 7 Ibid. Ibid.6 8 Ibid. Ibid.4 | Currency Market Monitor 1st Quarter 2013 | April 6, 2013 | © CME GROUP
  • 6. and is running at roughly half of the pre-crisis Still, this represents a significant decline from thedeficits which peaked in 2006. $703.7 billion flowing into Treasuries in 2010. Clearly, U.S. Treasuries continue to be regarded as aAnother interesting source of flow of funds data may “safe haven” investment that is highly valued bybe found in the U.S. Treasury Department’s foreign investors, despite generally low yields.Treasury International Capital (or “TIC”) database.This database tracks flows into and out of the U.S. In any event, the weight of these structural U.S.The data is broken into foreign stocks, foreign fiscal and trade deficits appears likely to exertbonds, U.S. stocks, U.S. corporate bonds, U.S. influence on the future course of the USD for manygovernment agencies and U.S. Treasuries. years to come U.S. Current Account Deficit European Sovereign Debt Crisis (Billions USD) $0 In addition to developments specific to the U.S. -$50 economy, the currency markets continue to be colored by a number of fundamental news events -$100 including the ongoing European sovereign debt crisis. The 1st quarter was heavily colored by -$150 developments in Italy, Cyprus and on the unemployment front. -$200 Deadlock surrounding Italy’s elections held on -$250 February 24-25th elevated concerns that it would not 04 04 05 05 06 06 07 07 08 08 09 09 10 10 11 11 12 12 hold firm on economic austerity measures. Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 President Giorgio Napolitano continues attempts to Source: Bureau of Economic Analysis (BEA) facilitate negotiations aimed at forming a new government.Capital flowing out of the U.S. by domestic orforeign investors was rather negligible during the EUR/USD Exchange Rateentirety of 2012. Some $105.2 billion, on a net 1.70basis, flowed into the U.S. equity markets fromoverseas in 2012. But the major story was the 1.60continued inflow of funds into the U.S. Treasurymarkets as overseas investors bought some $391.6 1.50billion of Treasuries, on a net basis, in 2012. 1.40 Net US/Foreign Capital Flows 1.30 (Billions USD) $1,200 1.20 $700 1.10 Sep-08 Dec-09 Jan-07 Jun-07 Nov-07 Apr-08 Feb-09 Jul-09 May-10 Oct-10 Mar-11 Aug-11 Jan-12 Jun-12 Nov-12 $200 -$300 Meanwhile, Cyprus concluded an accord to impose losses on uninsured depositors in the Bank of Cyprus -$800 and Cyprus Popular in return for some €10 billion in bailout funds from the IMF, ECB and EU. These 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 loans carry a 2.5% rate over 22 years. US Treasuries US Govt Agencies US Corporates US Stocks Foreign Bonds Foreign Stocks Source: U.S. Treasury TIC Database Finally, Eurostat reported record 12.0% unemployment in the 17-nation Eurozone bloc by5 | Currency Market Monitor 1st Quarter 2013 | April 6, 2013 | © CME GROUP
  • 7. Feb-13. This rate is up from 10.9% in Feb-12 and ongoing threat of deflation. As such, the BOJincludes some 19.1 million unemployed persons. adopted its own version of quantitative easing (QE)The highest rates were recorded in Greece (26.4%); and has increased its target for inflation to 2%. ThisSpain (26.3%); Portugal (17.5); Ireland (14.2%); has prompted large scale capital outflows fromand, Cyprus (14.0%). The lowest unemployment Japan.rates were recorded in Austria (4.8%); Germany(5.4%); Luxembourg (5.5%); and, the Netherlands USD/JPY Exchange Rate(6.2%). 130 125 120These ongoing uncertainties in the Eurozone 115weighed heavily on the value of the Euro currency 110which declined below $1.30/Euro. 105 100Emerging Economy Performance 95 90Emerging market economies including those in the 85so-called BRIC nations of Brazil, Russia, India and 80China, have played the most prominent role in 75 Jan-07 Apr-08 Sep-08 Feb-09 Dec-09 Oct-10 Aug-11 Jan-12 Jun-07 Nov-07 Jul-09 May-10 Mar-11 Jun-12 Nov-12global economic expansion in recent years.However, this growth has slowed in recent yearsfrom its previous arduous pace. Price Performance BRIC Nation GDP Growth These factors exert an obvious impact upon the 2009 2010 2011 2012 price performance of the U.S. dollar vis-à-vis other Brazil -0.33% +7.53% +2.73% +0.87% world currencies. In order to monitor this price Russia -7.80% +4.03% +4.34% +1.96% India +6.40% +9.80% +7.30% +5.10% impact, CME Group has developed the “CME USD China +9.20% +10.40% +9.30% +7.80% Index” as one in a family of similarly constructed FX Indexes. 9 NOTES 2012 figures based on early indications CME USD Index and subject to further revisions. 1,250 Long Short 16.7% EUR 100% USD 16.7% JPYThese slow-downs have been driven, in some cases, 1,200 16.7% GBP 16.7% CHFby policies aimed at slowing down inflation and the 1,150 16.7% CAD 16.7% CNYpossibility of asset bubbles. Note that the four BRIC 1,100nations experienced (estimated) inflation of 5.4%,5.12%, 9.5% and 2.6%, respectively, in 2012. Still, 1,050growth is generally expected to re-accelerate in the 1,000emerging markets moving forward. 950Policy-Driven JPY Movement 900 Jan-07 Apr-08 Sep-08 Feb-09 Dec-09 Oct-10 Aug-11 Jan-12 Jun-07 Nov-07 Jul-09 May-10 Mar-11 Jun-12 Nov-12One of the more dramatic stories in the FX marketssurrounds the movement in the Japanese yen (JPY).A stellar performer a couple of years ago, the JPYhas reversed downward some 24% since its peak inOctober 2011. 9 The CME USD Index represents a basket of equally weighted positions (as of December 31, 2010) of theThis decline may be attributed to pressure applied USD vs. the Euro (EUR), Japanese yen (JPY), British pound (GBP), Swiss franc (CHF), Canadian dollar (CAD),on the Bank of Japan (BOJ) to adopt a more Australian dollar (AUD) and Chinese yuan (CNY). It isexpansionary monetary policy and to address the (arbitrarily) established at a value of 1,000.00 as of December 31, 2010.6 | Currency Market Monitor 1st Quarter 2013 | April 6, 2013 | © CME GROUP
  • 8. The CME USD Index generally advanced during the during the most recently completed calendar1st quarter 2013 on signs of a consumer-driven quarter. Note the Mexican peso (MXN) led the packeconomic recovery in the U.S. along with increased with a quarterly return of +5.20%; followed by thetensions in Europe and tepid conditions in emerging Icelandic krona (+4.92%); Argentine pesoeconomies. Thus, investors have been moving (+4.65%); and, Indian rupee (+3.65%).funds into USD-denominated investments. Thus,our USD Index remains rallied from 992.19 to The Japanese yen continued its downward skid1,027.16 during the 1st quarter 2012. during the 1st quarter 2013, posting a total return of -7.90%). Other currencies turning in a weakTotal Return performance during the quarter included the South African rand (-7.67%); British pound (-6.39%); and,One of the most popular long-term FX trading the South Korean won (-3.67%).strategies over the past decade is known simply asthe “carry trade.” This practice simply suggeststhat one might exploit “cost of carry” by borrowing Carry Return (Q1 2013)in countries with low nominal interest rates to invest USD-MXN USD-ISKin countries with high nominal interest rates. Thus, USD-ARS USD-INRone might sell the “low-rate” currency and buy the USD-CLP“high-rate” currency. USD-BRL NZD-USD USD-CNY AUD-USD Sell low-rate currency & USD Carry trade USD-TRY buy high-rate currency USD-RUB USD-CAD USD-COPBy so doing, one hopes to capitalize on discrepant USD-TWD EUR-USDinterest rates, and by implication, divergent USD-CHF USD-KRWinvestment opportunities, in the two countries. This GBP-USD USD-ZARstrategy further recognizes that total currency return USD-JPYconsists of 2 components, specifically, exchange rate -8% -6% -4% -2% 0% 2% 4% 6%or price movement plus the accrual of interest. Total Currency Price Movement + = Because the carry trade has become such an Return Interest important and widely followed transaction in the global FX markets, CME Group has developed theThe implicit assumption is that these interest rate CME FX Carry Index.relationships will endure. As such, carry tradersimplicitly discount classical exchange rate theories This novel index is designed to follow theby assuming that the interest rate relationships may performance of a basket of currencies that offerendure over extended periods of time. This relatively high interest rates and have, at least onsuggests that low-yielding currencies that are sold an historical basis, generated favorable total returns.will not advance; and, that high-yielding currencies 10 The CME FX Carry Index closed the 1st quarter atthat are purchased will not decline.Historically, such relationships have been known toendure for extended periods of time, reinforcing 10 The CME FX Carry Index represents a basket of equallyinterest in the carry trade. In particular, vast sums weighted positions (as of December 31, 2010) which isof money totaling in the trillions of U.S. dollars were effectively long a basket including the Australian dollarinvested in the carry trade, specifically by shorting (AUD), Brazilian real (BRL), Mexican peso (MXN), New Zealand dollar (NZD), South African rand (ZAR) andthe Japanese yen (JPY) and investing in other Turkish lira (TRY) vs. short positions in the USD andcurrencies including the Icelandic krona (ISK). EUR. It is (arbitrarily) established at a value of 1,000.00 as of December 31, 2010. The long components of the CME FX Carry Index were selected in light of the highAppendix 2 below depicts the total return associated local interest rates that prevailed in those countrieswith various currencies, relative to the U.S. dollar, during the post-financial crisis era through 2010. The7 | Currency Market Monitor 1st Quarter 2013 | April 6, 2013 | © CME GROUP
  • 9. 934.15 and up 1.3% from its 4th quarter value of Thus, if inflation as measured by an inflation index922.27. increases, the value of the currency should generally CME FX Carry Index decline to maintain price equilibrium. Similarly, if 1,050 inflation declines, the value of the currency should 1,000 advance. 950 The theory of PPP is closely related to another 900 classic theory that addresses exchange rate values 850 Long Short known as the International Fisher Effect (IFE). This 16.7% BRL 50% USD 16.7% AUD 50% EUR theory suggests that the disparity between nominal 800 16.7% ZAR 16.7% NZD interest rates in two countries drive the future path 16.7% TRY 750 16.7% MXN of exchange rates. 700 Sep-08 Dec-09 Aug-11 Jan-07 Jun-07 Nov-07 Apr-08 Feb-09 Jul-09 May-10 Oct-10 Mar-11 Jan-12 Jun-12 Nov-12 Per this theory, one might expect that the value of a currency with a low nominal interest rate might increase into the future. Or that the value of a currency with high nominal rate might decline.Purchasing Power Parity IFE further assumes that real interest rates (i.e., the risk-free interest rate less inflation) should generallyThe theory of purchasing power parity (PPP) dates to be equal across countries. This implies that nominalthe 16th century and the School of Salamanca but interest rates and inflation are positively correlated.was further developed in the early 20th century byeconomist Gustav Cassel. 11 The theory is based If inflation Rates Currency valueupon the assumption that exchange rates are in increases increase should declineequilibrium when purchasing power is equivalent inthe two countries. If inflation Rates Currency value decreases decrease should advanceOn a granular level, PPP is based on the “law of oneprice” or the notion that identical products should be The IFE suggests interest rates and exchangepriced at the same level in different national markets negatively correlated. Similarly, PPP suggestsadjusted for exchange rates. Typically, this law is inflation and exchange rates negatively correlated.qualified by the absence of significant trade barriers As such, the IFE theory is generally consistent withor other artificial constraints on commerce. the PPP theory.But the theory of PPP expands the application of the Putting the classic theory of purchasing power paritylaw of one price from any single good or product to into practice requires a measurement of inflation ingeneralized prices in any particular economy as order to calculate the proportion by which anymeasured by inflation indexes, e.g., Consumer Price particular currency is (theoretically) over- or under-Index (CPI) or Producer Price Index (PPI). The valued relative to the norm. There are three popularimplication of this theory is that inflation rates and methodologies that have been referenced in thisexchange rates should exhibit negative correlation. regard. If inflation Currency value • OECD - The Organization for Economic Co- increases should decline operation and Development (OECD) provides data that is useful in this regard by comparing price If inflation Currency value changes in a representative basket of goods in decreases should advance various countries. • Bloomberg - Bloomberg offers an analytical tool short components of the index were identified because of that is grounded in a very long-term assessment the low interest rates offered.11 See Cassel, Gustav, “Abnormal Deviations in of inflation, as measured by either CPI or PPI in International Exchanges” (December 1918).8 | Currency Market Monitor 1st Quarter 2013 | April 6, 2013 | © CME GROUP
  • 10. various countries extending from January 1982 industrial metals. These price advances have largely through June 2000. been driven by emerging market demand in nations including China and India.• Big Mac - Finally, the Economist’s “Big Mac PPP” methodology compares the price of a (almost) Crude Oil & Gold universally available product with verifiable pricing $160 $2,000 $140 $1,800 in the form of the McDonald’s Big Mac hamburger Crude Oil ($ per Bbl Gold ($ per troy oz) $120 $1,600 in various countries. $1,400 $100 $1,200Actually, all three methodologies may readily be $80 $1,000referenced on Bloomberg quotation devices. $60 $800Appendix 3 below provides data from all three $40 $600methods. Further, we have taken the average of $20 $400the three assessments (where available) for a $0 $200variety of national currencies and rank-ordered the Dec-09 Sep-11 Jan-07 Aug-07 Mar-08 Oct-08 May-09 Jul-10 Feb-11 Apr-12 Nov-12set from most over-valued to most under-valued. Crude Oil GoldNote that the most over-valued currency, per our Source: Bloombergmethodology, remains the Norwegian krone (NOK)at +39.83% relative to the USD. Other highly CME Group has developed the CME FX Commodityvalued currencies include the Swiss franc (CHF) at Country Index to follow the performance of a basket29.84; the Brazilian real (BRL) at +29.66%; the of currencies from nations that rely heavily upon theAustralian dollar (AUD) at +27.27%; and, the exportation of commodities and other raw materials.Swedish krona (SEK) at +23.13%. To the extent that commodities have been in great demand over much of the past decade, theseUnder-valued currencies, per our analysis, include currencies have, on a historical basis, generatedthe South African rand (ZAR) down at -55.60%; the favorable total returns. 12Polish zloty (PLN) at -53.71%; the Hong Kong dollar(HKD) at -49.95%; and, the Hungarian forint (HUF) CME FX Commodity Country Indexat -49.00%. 1,100 1,050One might recommend creating “baskets” of several 1,000currencies to buy and sell on the basis of this 950analysis in order to diversify risks to a certain 900extent. However, it is important to recognize that 850currencies might remain in apparent states of over- Long Short 800 16.7% AUD 100% USDor under-valuation for extended periods of time. In 16.7% BRL 750 16.7% CADfact, the carry trade as discussed above, takes a 16.7% NOKcompletely opposite approach to the classic PPP 700 16.7% NZD 16.7% ZARtheory by buying high-rate currencies and shorting 650 Jan-07 Apr-08 Sep-08 Feb-09 Dec-09 May-10 Oct-10 Mar-11 Aug-11 Jan-12 Jun-07 Nov-07 Jul-09 Jun-12 Nov-12low-rate currencies.Impact of Commodities The 1st quarter 2012 saw modest advances inAs a general rule, the nations whose currencies have energy prices with mixed grain prices but goldremained top performers over the past decade may declined approximately $50 on growing economicbe identified as those whose national income is tiedheavily to commodity production. 12 The CME Commodity Country Index is constructed to beCommodity prices have advanced rather sharply effectively long AUD, BRL, CAD, Norwegian krone (NOK), NZD and ZAR vs. a short position in USD. It isover the past decade as seen in the rise in the value (arbitrarily) established at a value of 1,000.00 as ofof energy, grain, livestock, precious metals and December 31, 2010.9 | Currency Market Monitor 1st Quarter 2013 | April 6, 2013 | © CME GROUP
  • 11. optimism. Thus, the CME FX Commodity Country market movements. Or, to manage the risksIndex declined 2.0% from 953.60 to 934.32 over associated with currency holdings or internationalthe course of the 1st quarter 2012. This decline investments during turbulent times.might be more aptly attributed to USD strength onmodest economic momentum more so than anymovements in commodity values.CME Group has further developed the CME FX BRICIndex to follow the performance of select “emergingmarket” economies and their national currencies,namely the Brazilian real (BRL), Russian ruble(RUB), Indian rupee (INR) and Chinese yuan (CNY),that have created much of the demand forcommodities in the world today. 13The CME FX BRIC Index ended the 1st quarter at921.56 and essentially unchanged from the 4thquarter value of 920.65. CME FX BRIC Index 1,150 Long Short 25% BRL 100% USD 1,100 25% RUB 25% INR 25% CNY 1,050 1,000 950 900 850 800 Sep-08 Dec-09 Jan-07 Jun-07 Nov-07 Apr-08 Feb-09 Jul-09 May-10 Oct-10 Mar-11 Aug-11 Jan-12 Jun-12 Nov-12ConclusionCME Group offers a broad array of currency futuresand option contracts covering a wide range ofcurrency pairings (where one side is the U.S. dollar)and cross-rate pairings (which do not involve theU.S. dollar).These products provide facile and liquid vehicleswith which one may express a view on prospective13 The CME BRIC Index is constructed of equal weightings of long Brazilian real (BRL), Russian ruble (RUB), Indian rupee (INR) and Chinese yuan (CNY) vs. a short position in the USD. Like other CME FX indexes discussed above, the BRIC Index was equally weighted and calibrated to equal an arbitrary 1,000.00 as of December 31, 2010.10 | Currency Market Monitor 1st Quarter 2013 | April 6, 2013 | © CME GROUP
  • 12. Appendix 1: Summary of World Economic Conditions Australia Brazil Canada Economic growth slowed in 2011, and Canada’s is benefiting from the continued jobs Growth, remained sluggishness in 2012. Lower rates expansion in the US economy. Domestically, Inflation China avoided a hard-landing but China risk and fiscal stimulus provided in the past year the oil sector has some challenges. & Fiscal still weighs on the Australian economy. are likely to see their impact in higher real Policy GDP growth rates in 2013. The short-term SELIC rate was brought down Canada’ rate policy is on hold. There are no Short-term interest rates were lowered in in 2012 narrowing the premium over the inflation pressures. The former Governor of 2012 to cushion economic growth without fear Monetary prevailing inflation rate. Further rate the Bank of Canada has been exported to the of inflation pressures accelerating. Further Policy reductions may occur in 2013 if the central UK to run the Bank of England. rate declines in 2013 are unlikely unless bank decides to lean against the wind of significant currency strength emerges. potential currency appreciation. The Australian dollar was once a favorite for Rate differentials with the US are too small to The major factor impacting the Brazilian real in the long-side of the carry trade versus the support the Canadian dollar, even if markets 2013 is likely to revolve around the zero Special Japanese yen. With Japan adopting a shift to risk-on trading. interest rate policies of the US, UK, Europe, Factors “weaken the yen” approach to policy, the and Japan, as currency traders expand their Australian dollar may again receive inflows risk appetites for higher rate currencies. from this source. China European Union India Like China and Brazil, India saw a rapid Economic growth in 2012 decelerated faster The fiscal austerity related to the sovereign Growth, deceleration of economic growth in 2012. than many had projected or hoped. With new debt crisis will continue to be a major drag on Inflation India has taken a number of steps in the leadership and a brighter global outlook for economies within the EU in 2013. Europe & Fiscal direction of policy reform, especially regarding 2013, China’s real GDP growth is likely to faces rising unemployment and the possibility Policy foreign investment, that should work to help stabilize in the 6% to 7% range. of another year of negative real GDP growth. the economy regain its balance in 2013. The monetary authorities have less scope to Expanded bank lending and a push toward lower short-term rates than other emerging ECB rate policy is on hold after the fall-out more rapid development of financial market countries, because of elevated Monetary from the messy bail-out of Cyprus. The ECB institutions is likely. This may include more inflation. Nevertheless, rate cuts are possible Policy will continue to provide bank’s with liquidity as debt issuance by the Government to fund in 2013, especially if the currency takes a turn needed. health care and pollution reforms. toward appreciation and inflation declines a bit. Elections in Germany in September may add India has shown some signs of becoming An end to economic deceleration portends a significant political volatility to the path of the friendlier toward foreign investment. This is Special more balanced supply and demand for the euro. Chancellor Merkel is not popular likely to help the rupee to appreciate along Factors RMB, and this may allow for a faster pace enough to win an outright majority and new with other high-rate currencies in response to toward normalizing the currency in 2013. collation partners may constrain her power to the very low rates from the US, UK, Europe, act. and Japan.11 | Currency Market Monitor 1st Quarter 2013 | April 6, 2013 | © CME GROUP
  • 13. Appendix 1: Summary of World Economic Conditions, cont. Japan Mexico Russia With brighter prospects for economic growth in Elevated crude oil prices are benefitting Russia’s Growth, Japan’s new Prime Minister is totally focused the US economy and with the worst of the economy, but an aging population and a difficult Inflation on expansionary policies to raise both the real fiscal cliff being avoided, Mexico should benefit environment for foreign investment suggest & Fiscal GDP growth rate and to ignite some inflation from increased trade with its partner to the slower economic growth in the years to come. Policy pressures. north. Currency strength in 2012 may have the Russia has accumulated a large quantity of foreign The Bank of Japan has a new leader and his lagged effect of helping to reduce inflation reserves giving the authorities some firepower to Monetary first act has been to expand purchases of pressures in 2013. The central bank may be counter any ruble weakness, if they so choose, Policy Japanese Government Bonds. able to make further modest reductions in during periods of oil market weakness. short-term interest rates. The Bank of Japan’s new commitment to Russia’s energy supply dominance of Europe may Mexico’s currency has emerged as one of the Special quantitative easing is likely to support a be challenged by alternative supplies. The ruble favorites for the long-side of the carry trade, Factors weaker yen. A 2% inflation target by the BoJ may be the casualty. funded by zero-rate short-term US dollars. would suggest a 110-120 yen/dollar rate. Switzerland United Kingdom United States Growth, Switzerland is not immune to the ramifications The UK’s fiscal austerity has constrained US economic growth in 2013 faces some increased Inflation of the long-term debt problems facing the economic growth. As we start to look toward fiscal austerity. We see just enough economic & Fiscal European Union. Economic growth will be future elections, even well down the road, growth to keep the unemployment rate on a Policy constrained for another year. fiscal policy may get a little less restrictive. declining path. The Federal Reserve may end its asset purchase As the EU debt crisis has morphed into a long- programs in 2013 or early 2014. Even with a The Bank of England, now led by a Canadian, Monetary term problem, the Swiss have little flexibility declining unemployment rate, the Fed is unlikely is likely keep rates very low and focus its Policy and are likely continue to keep a lid on the to consider abandoning its zero federal funds rate efforts on financial supervision. Swiss franc relative to the euro. policy until it sees some inflation pressure, and there is none. The post-2008 financial crisis has led to Tensions between the UK and the European increased regulation of financial institutions all Union are only likely to intensify. Any push by The US dollar is not a strong currency. The US over the world. On net, this increased Special the EU to impose financial transaction taxes dollar is exhibiting strength against the pound, regulation poses additional challenges for the Factors will only worsen tensions. UK politics may euro, and yen because they are all even weaker traditional model of Swiss secrecy and the lead to a non-binding referendum on EU currencies with even bigger long-run problems. overall role of Switzerland in the world’s membership around 2015. financial system.12 | Currency Market Monitor 1st Quarter 2013 | April 6, 2013 | © CME GROUP
  • 14. Appendix 2: Select Currency Performance (1st Quarter 2013) 1st Quarter 2013 2013 Year-to-Date Spot Quote Quote 3-Mth Rates Currency Ticker Total Spot Interest Total Spot Interest (3/29/13) Convention (3/29/13) Return1 Return2 Return3 Return1 Return2 Return3 Argentine Peso USD-ARS 5.1231 USD per 1 ARS 18.25% 4.65% -4.02% 8.95% 4.65% -4.02% 8.95% Australian Dollar AUD-USD 1.0419 AUD per 1 USD 2.95% 1.00% 0.23% 0.69% 1.00% 0.23% 0.69% Brazilian Real USD-BRL 2.0200 USD per 1 BRL 2.69% 1.47% 1.12% 2.69% 1.47% 1.12% British Pound GBP-USD 1.5198 GBP per 1 USD 0.47% -6.39% -6.50% 0.04% -6.39% -6.50% 0.04% Canadian Dollar USD-CAD 1.0174 USD per 1 CAD 1.11% -2.22% -2.49% 0.20% -2.22% -2.49% 0.20% Chilean Peso USD-CLP 472.15 USD per 1 CLP 2.82% 1.49% 1.23% 2.82% 1.49% 1.23% China Renminbi USD-CNY 6.2102 USD per 1 CNY 3.55% 1.42% 0.33% 1.02% 1.42% 0.33% 1.02% Colombian Peso USD-COP 1,825.00 USD per 1 COP -2.35% -3.18% 0.79% -2.35% -3.18% 0.79% Euro EUR-USD 1.2819 EUR per 1 USD 0.11% -2.80% -2.83% -0.04% -2.80% -2.83% -0.04% Icelandic Krona USD-ISK 128.07 USD per 1 ISK 5.90% 4.92% 3.53% 1.26% 4.92% 3.53% 1.26% Indian Rupee USD-INR 54.2800 USD per 1 INR 8.25% 3.56% 1.32% 2.14% 3.56% 1.32% 2.14% Japanese Yen USD-JPY 94.2202 USD per 100 JPY 0.09% -7.90% -7.93% -0.04% -7.90% -7.93% -0.04% Mexico Peso USD-MXN 12.3312 USD per 1 MXN 4.34% 5.20% 4.23% 0.85% 5.20% 4.23% 0.85% New Zealand Dollar NZD-USD 0.8371 NZD per 1 USD 2.65% 1.71% 1.01% 0.62% 1.71% 1.01% 0.62% Russian Ruble USD-RUB 31.0564 USD per 1 RUB 7.40% -0.03% -1.71% 1.64% -0.03% -1.71% 1.64% South Africa Rand USD-ZAR 9.2362 USD per 1 ZAR 5.07% -7.67% -8.26% 0.57% -7.67% -8.26% 0.57% South Korean Won USD-KRW 1,111.35 USD per 1 KRW 2.54% -3.67% -4.22% 0.51% -3.67% -4.22% 0.51% Swiss Franc USD-CHF 0.9492 USD per 1 CHF 0.00% -3.57% -3.56% -0.08% -3.57% -3.56% -0.08% Taiwanese Dollar USD-TWD 29.033 USD per 1 TWN 0.85% -2.45% -2.66% 0.14% -2.45% -2.66% 0.14% Turkish Lira USD-TRY 1.8103 USD per 1 TRY 6.38% 0.07% -1.47% 0.01% 0.07% -1.47% 0.01% United States Dollar USD 1.0000 USD 0.28% 0.07% 0.00% 0.07% 0.07% 0.00% 0.07% Notes (1) Return from price movement and interest (2) Return from currency price movement vs. USD as “base currency” (3) Return from interest at prevailing 3-month rates or implied NDF rate Source: Bloomberg13 | Currency Market Monitor 1st Quarter 2013 | April 6, 2013 | © CME GROUP
  • 15. Appendix 3: Purchasing Power Parity (“PPP”) Analysis (as of 3/29/13) % Over/Under Valued Bloomberg Bloomberg Currency Ticker Average OECD Big Mac (CPI) (PPI) Norwegian Krone NOK 39.83% 36.86% 11.59% 71.03% Swiss Franc CHF 29.84% 33.52% 20.31% 6.46% 59.06% Brazilian Real BRL 29.66% 29.66% Australian Dollar AUD 27.27% 37.09% 33.24% 27.42% 11.34% Swedish Krona SEK 23.13% 26.50% -4.72% -2.78% 73.52% New Zealand Dollar NZD 21.89% 21.88% 30.47% 36.35% -1.14% Danish Krone DKK 17.57% 26.25% 14.17% 15.26% 14.61% Canadian Dollar CAD 14.02% 16.91% 14.76% 4.11% 20.31% Icelandic Krona ISK 13.23% 13.23% Euro EUR 8.94% 3.50% 13.14% 11.24% 7.88% Colombian Peso COP 7.88% 7.88% British Pound GBP 0.59% 3.52% 8.10% -2.01% -7.26% Chilean Peso CLP -4.86% -4.86% Japanese Yen JPY -5.87% 10.28% -7.06% -3.54% -23.16% Argentina Peso ARS -15.58% -15.58% Singapore Dollar SGD -17.50% -17.50% Czech Koruna CZK -18.52% -18.52% Turkish Lira TRY -29.54% -66.38% 7.30% South Korean Won KRW -30.95% -36.56% -25.33% Thai Baht THB -31.47% -31.47% Phillipines Peso PHP -33.51% -33.51% Indonesian Rupiah IDR -34.98% -34.98% Mexican Peso MXN -39.88% -47.90% -31.85% Chinese Renminbi CNY -41.02% -41.02% Malaysian Ringgit MYR -41.87% -41.87% Russian Ruble RUB -45.90% -45.90% Hungarian Forint HUF -49.00% -79.55% -18.44% Hong Kong Dollar HKD -49.95% -49.95% Polish Zloty PLN -53.71% -71.83% -35.58% South African Rand ZAR -55.60% -55.60% Notes Please note that data regarding all countries is not generally available. Source: Bloomberg14 | Currency Market Monitor 1st Quarter 2013 | April 6, 2013 | © CME GROUP
  • 16. Copyright 2013 CME Group All Rights Reserved. Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only apercentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders should only use funds that theycan afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade. All examples inthis brochure are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience.”Swaps trading is not suitable for all investors, involves the risk of loss and should only be undertaken by investors who are ECPs within the meaning of section 1(a)18 of the CommodityExchange Act. Swaps are a leveraged investment, and because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited fora swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one tradebecause they cannot expect to profit on every trade.CME Group is a trademark of CME Group Inc. The Globe logo, E-mini, Globex, CME and Chicago Mercantile Exchange are trademarks of Chicago Mercantile Exchange Inc. Chicago Board ofTrade is a trademark of the Board of Trade of the City of Chicago, Inc. NYMEX is a trademark of the New York Mercantile Exchange, Inc.The information within this document has been compiled by CME Group for general purposes only and has not taken into account the specific situations of any recipients of the information.CME Group assumes no responsibility for any errors or omissions. Additionally, all examples contained herein are hypothetical situations, used for explanation purposes only, and should notbe considered investment advice or the results of actual market experience. All matters pertaining to rules and specifications herein are made subject to and are superseded by official CME,NYMEX and CBOT rules. Current CME/CBOT/NYMEX rules should be consulted in all cases before taking any action.15 | Currency Market Monitor 1st Quarter 2013 | April 6, 2013 | © CME GROUP