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Currency Market Monitor: India, Chile Carry the Quarter in Carry Trades


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U.S. Dollar Retains Soft Tone Amid Sluggish Economy
The Indian rupee and Chilean peso led gains among global currencies in carry trade performance during the third quarter, posting returns in excess of 7% against the U.S. dollar, CME Group analysts said in a report. Other strong performers included the Russian ruble, which returned 5.7% against the dollar, and the Mexican peso, up 4.9%, during the quarter, according to the latest Currency Market Monitor, which was written by CME directors John Labuszewski and Sandra Ro and Chief Economist Blu Putnam. The South African rand was the only currency among 20 studied to lose value against the dollar, reflecting a sluggish U.S. economy and a renewed "risk on" attitude as Europe's financial crisis appeared to stabilize. Carry trades involve borrowing in nations with low interest rates to invest in higher-rate countries. CME Group analysts also identified the Norwegian krone as the most overvalued currency relative to the dollar, followed by the Swiss franc and the Australian dollar. Highly under-valued currencies included the Polish zloty, the Hong Kong dollar and the Mexican peso.

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Currency Market Monitor: India, Chile Carry the Quarter in Carry Trades

  1. 1. CURRENCIESCurrency Market Monitor3rd Quarter2012OCTOBER 18, 2012John 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
  2. 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 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 you 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. Second quarter 2012 domestic GDP was mostThis document represents a review of these factors recently reported at a rather anemic +1.3% andas they played out in the most recently completed quite a bit lower than preliminary reports of +1.8%calendar quarter. We include consideration of the growth. This further represents substantial declineso-called “carry trade” as well as a look at the from 1st quarter growth reported at +2.0%.theory of “purchasing power parity” as it impacts FXmarkets. Growth and Employment 6% 11% 4% 10% Qtrly Change in GDP Unemployment RateWhile we cover activity in a broad spectrum of 2% 9%currencies, we focus on the currencies underlying 0%some of the most liquid of CME Group FX futures. 8% -2%This includes the U.S. dollar (USD), Euro (EUR), 7% -4%Japanese yen (JPY), British pound (GBP), Swiss 6% -6%franc (CHF), Canadian dollar (CAD), Australian dollar -8% 5%(AUD) and Mexican peso (MXN). -10% 4% Q1 04 Q4 04 Q3 05 Q2 06 Q1 07 Q4 07 Q3 08 Q2 09 Q1 10 Q4 10 Q3 11 Q2 12In addition, we have special interest in thecurrencies of significant emerging market economies Seasonally Adj Real GDP Unemployment Rateincluding the Brazilian real (BRL), Russian ruble Source: Bureau of Economic Analysis (BEA)(RUB), Indian rupee (INR) and Chinese yuan or & Bureau of Labor Statistics (BLS)renminbi (CNY) – the so-called “BRIC” nations. The unemployment rate, which has been trendingFinally, we highlight several CME Group FX Indexes down in recent months, was reported at 7.8% byincluding a USD Index, a Carry Trade Index, September 2012. As cheery as that number mayCommodity Country Index and BRIC Index. appear, it may be quite misleading as it does not reflect the declining proportion of the population thatMarket Fundamentals is actually employed.As a general rule, FX analysts will evaluate the Thus, the “Labor Force Participation Rate” hasfundamental value of any particular currency by become of increasing interest over the past fewreference to a number of national economic factors.1 | Currency Market Monitor 3rd Quarter 2012 | October 18, 2012 | © CME GROUP
  3. 3. years. Note that while the unemployment rate has is open-ended with no pre-determined total packagedeclined from its peak of 10.0% in October 2009, size. Further, the Fed is continuing its “Operationthe Labor Force Participation rate has steadily Twist” originally announced in September 2011. Butdeclined to 63.6% by September 2012. this time, the policy is aimed squarely at the mortgage markets. Employment Statistics 11% 67% While housing market activity remains at levels of 10% 67% roughly 1/3rd of peak activity observed in late 2005, Labor Force Participation Unemployment Rate 66% there are actually some signs of life in the market. 9% Building permits were reported above 800 thousand 66% 8% units in July and August for the first time since 65% August 2008. Home values, while still well below 7% 65% pre-crisis peaks, have been recovering a bit in most 6% markets across the nation. Certainly this renewed 64% 5% 64% activity may be attributed in some part to continued record low mortgage rates. 4% 63% Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Housing Activity 2,500 Unemployment Rate Labor Force Partcipation Source: Bureau of Labor Statistics (BLS) 2,000 000 Units 1,500As such, this statistic is hovering near the lowestrate recorded since September 1981 and reflects 1,000large numbers of long-term unemployed simply 500dropping out of the workforce entirely. We mightconclude that the decline in the unemployment rate 0since late 2009 is largely attributable to frustrated Sep-03 May-04 Sep-05 May-06 Sep-07 May-08 Sep-09 May-10 Sep-11 May-12 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11workers and not to any true economic recovery. Building Permits Housing Starts CompletionsMonetary Policy Source: Dept. of Housing & Urban Development (HUD)As a result, the Fed announced on September 13,2012 that it would “increase policy accommodation The Fed further decided “to keep the target rangeby purchasing additional agency mortgage-backed for the federal funds rate at 0 to ¼ percent andsecurities at a pace of $40 billion per month … [it] currently anticipates that exceptionally low levels foralso will continue through the end of year its the federal funds rate are likely to be warranted atprogram to extend the average maturity of its least through mid-2015.” 2holdings of securities … These actions, whichtogether will increase the Committee’s holdings of Inflationlonger-term securities by about $85 billion eachmonth … should put downward pressure on longer- This latest Fed policy announcement was criticizedterm interest rates … [and] … support mortgage by some as inflationary in the long-term despite themarkets.” 1 Fed’s observation that “longer-term inflation expectations have remained stable.” 3 In fact,Thus, the Fed is initiating another round of August reports show the Consumer Price Index (CPI)quantitative easing (“QE3”), focusing on the anemic advancing +1.70% on a year-on-year basis with CPIhousing sector. Unlike previous QE programs, QE31 2 Federal Reserve Press Release dated September 13, Ibid. 3 2012. Ibid.2 | Currency Market Monitor 3rd Quarter 2012 | October 18, 2012 | © CME GROUP
  4. 4. ex-food and energy at +1.90% - and well within the Current & Capital AccountsFed’s mandate. In addition to the troublesome fiscal deficit, the U.S. Consumer Price Index (CPI) further faces a significant trade deficit as reflected in 6% the current account balance. While the trade deficit 5% diminished in the immediate wake of the subprime Year-on-Year Change 4% crisis, it is growing once again although it has not 3% yet breached pre-crisis levels. Still, the deficit 2% strains upwards to 4.0% of GDP in 2011 and the 1% 0% highest amongst all G10 nations. -1% -2% U.S. Current Account Deficit (Billions USD) -3% $0 Mar-05 May-06 Sep-08 Apr-09 Mar-12 Nov-09 Aug-04 Jun-10 Aug-11 Jan-04 Oct-05 Dec-06 Jul-07 Feb-08 Jan-11 -$50 CPI - All Urban Consumers SA CPI ex-Food & Energy -$100 Source: Bureau of Labor Statistics (BLS) -$150Fiscal Policy -$200The Federal spending deficit appears to have -$250stabilized after increasing into the neighborhood of 04 04 05 05 06 06 07 07 08 08 09 09 10 10 11 11 12$1.2-$1.4 trillion beginning in 2009. The 2012 can Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1be expected to fall within the same general range. Source: Bureau of Economic Analysis (BEA)Future deficits will be a function of both economicand political considerations. Some slight improvements in these figures seem to be developing as the trade deficit “decreased to Federal Surplus/Deficit (Billions USD) $117.4 billion in the 2nd quarter from $133.6 billion $400 in the first quarter. The decrease in the current $200 account deficit was accounted for by a decrease in $0 the deficit on goods and an increase in the surplus -$200 on income.” 4 -$400 -$600 In addition to monitoring current account activity, -$800 we may likewise study capital account flows. The -$1,000 U.S. Treasury Department’s Treasury International -$1,200 Capital (or “TIC”) database represents a ready -$1,400 source of information. This database tracks flows -$1,600 into and out of the U.S. The data is broken into 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 foreign stocks, foreign bonds, U.S. stocks, U.S. corporate bonds, U.S. government agencies and U.S. Treasuries.Bush administration tax cuts currently are scheduledto expire with automatic spending cuts being Foreign investors liquidated some $573.6 billion inimposed at year-end, leading to the so-called “fiscal U.S. equities during 2011 while investing somecliff.” But the composition of the Senate and House $380.6 billion in U.S. Treasuries. By the outflowmay shift as a result of the November 2012 electionsand with it, the fate of these tax and spendingmeasures and the federal deficit. 4 Bureau of Economic Analysis (BEA) News Release: International Transactions: Second Quarter 2012 (September 18, 2012).3 | Currency Market Monitor 3rd Quarter 2012 | October 18, 2012 | © CME GROUP
  5. 5. was stemmed during the period January through These events lent strength to the Euro and to equityJuly 2012 as foreign investors put some $23.1 billion markets around the globe. Still pending, however,into domestic equities on a net basis. But this figure are decisions on a possible bailout package for Spainpaled relative to the $297.7 billion net foreign and the disposition of the 240 billion EUR Greekinvestment in U.S. Treasuries during the same bailout package. These issues likely will not beperiod. determined until a summit of European leaders scheduled for late October. Net US/Foreign Capital Flows (Billions USD) Euro/US Dollar Exchange Rate $1,200 1.50 $1,000 $800 1.45 $600 $400 1.40 $200 1.35 $0 -$200 1.30 -$400 -$600 1.25 -$800 1.20 2003 2004 2005 2006 2007 2008 2009 2010 2011 H1 12 Mar-11 May-11 Sep-11 Mar-12 May-12 Sep-12 Jan-11 Nov-11 Jan-12 Jul-11 Jul-12 US Treasuries US Govt Agencies US Corporates US Stocks Foreign Bonds Foreign Stocks Source: U.S. Treasury TIC Database Price PerformanceEuropean Sovereign Debt Crisis These factors exert an obvious impact upon the price performance of the U.S. dollar vis-à-vis otherIn addition to developments specific to the U.S. world currencies. In order to monitor this priceeconomy, the currency markets were colored during impact, CME Group has developed the “CME USDthe 3rd quarter 2012 by a number of fundamental Index” as one in a family of similarly constructed FXnews events including the ongoing European Indexes. 5sovereign debt crisis. While European sovereigndebt woes remain far from resolved, the markets The CME USD Index rallied during the 2nd quarter asnonetheless took considerable comfort from the investors sought refuge from the EuropeanEuropean Central Bank (ECB) offer of September 6th sovereign debt crisis in U.S. dollar denominatedto buy the debt of troubled Eurozone nations. investments. But from a longer-term perspective, the Index remains near 1,000 or its (arbitrarilyTaking a cue perhaps from the Fed’s quantitative established) value as of December 31, 2010 andeasing (QE) programs, ECB President Mario Draghi near the bottom of the range established from 2007unveiled an open-ended plan to buy securities going through the conclusion of the 1st quarter 2011. Thisout up to 3 years in maturity. This offer is USD weakness may largely be attributed to theconditioned upon the receipt of a formal application weight of the dual U.S. fiscal and trade deficits asfor such aid along with adoption of fiscal austerity discussed above.measures.The situation in Europe was further calmed by aruling by Germany’s constitutional court onSeptember 12th that endorsed a 500 billion EUR 5 The CME USD Index represents a basket of equallybailout fund known as the European Stability weighted positions (as of December 31, 2010) of theMechanism (ESM). The ESM would require Eurozone USD vs. the Euro (EUR), Japanese yen (JPY), Britishstates to contribute 32 billion Euros in two tranches pound (GBP), Swiss franc (CHF), Canadian dollar (CAD), Australian dollar (AUD) and Chinese yuan (CNY). It isby the conclusion of October. (arbitrarily) established at a value of 1,000.00 as of December 31, 2010.4 | Currency Market Monitor 3rd Quarter 2012 | October 18, 2012 | © CME GROUP
  6. 6. CME USD Index invested in the carry trade, specifically by shorting 1,250 Long Short 16.7% EUR 100% USD the Japanese yen (JPY) and investing in other 1,200 16.7% JPY 16.7% GBP currencies including the Icelandic krona (ISK). 16.7% CHF 1,150 16.7% CAD 16.7% CNY Carry Return (Q3 2012) 1,100 USD-INR USD-CLP USD-RUB 1,050 USD-MXN NZD-USD 1,000 USD-ARS USD-KRW USD-CAD 950 GBP-USD USD-TRY 900 USD-JPY AUD-USD Jun-07 Apr-08 Sep-08 May-10 Mar-11 Aug-11 Jun-12 Jan-07 Nov-07 Feb-09 Jul-09 Dec-09 Oct-10 Jan-12 USD-TWD USD-ISK EUR-USD USD-CNY USD-CHF USD-BRLTotal Return USD-COP USD USD-ZAROne of the most popular long-term FX trading -2% 0% 2% 4% 6% 8%strategies over the past decade is known simply asthe “carry trade.” This practice simply suggeststhat one might exploit “cost of carry” by borrowing Appendix 2 below depicts the total return associatedin countries with low nominal interest rates to invest with various currencies, relative to the U.S. dollar,in countries with high nominal interest rates. Thus, during the most recently completed calendarone might sell the “low-rate” currency and buy the quarter. Note the Indian rupee (INR) leads the pack“high-rate” currency. with a quarterly return of +7.61%. The INR is followed by the Chilean peso (CLP) at 7.04%; the Sell low-rate currency & Russian ruble (RUB) at +5.73%; and, the Mexican Carry trade buy high-rate currency peso (MXN) at +4.91%.By so doing, one hopes to capitalize on discrepant Of the various currencies tracked in Appendix 2, onlyinterest rates, and by implication, divergent a single currency, the South African rand (ZAR),investment opportunities, in the two countries. This declined vs. the U.S. dollar (USD) with a return of -strategy further recognizes that total currency return 0.56% during the 3rd quarter.consists of 2 components, specifically, exchange rateor price movement plus the accrual of interest. Thus, the U.S. dollar was generally weak as a result of general domestic economic weakness coupled Total Currency Price Movement + with a renewed “risk-on” attitude as European woes = Return Interest are addressed, at least for the moment.The implicit assumption is that these interest rate In any event, and because the carry trade hasrelationships will endure. As such, carry traders become such an important and widely followedimplicitly discount classical exchange rate theories transaction in the global FX markets, CME Group hasby assuming that the interest rate relationships may developed the CME FX Carry Index. This novel indexendure over extended periods of time. I.e., that is designed to follow the performance of a basket oflow-yielding currencies that are sold will not currencies that offer relatively high interest ratesadvance; and, that high-yielding currencies that are and have, at least on an historical basis, generatedpurchased will not decline. favorable total returns. 6Historically, such relationships have been known toendure for extended periods of time, reinforcing 6 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 dollar (AUD), Brazilian real (BRL), Mexican peso (MXN), New5 | Currency Market Monitor 3rd Quarter 2012 | October 18, 2012 | © CME GROUP
  7. 7. CME FX Carry Index If inflation Currency value 1,050 increases should decline 1,000 If inflation Currency value 950 decreases should advance 900 850 Thus, if inflation as measured by an inflation index Long Short 16.7% BRL 50% USD increases, the value of the currency should generally 800 16.7% AUD 50% EUR 16.7% ZAR decline to maintain price equilibrium. Similarly, if 16.7% NZD 750 16.7% TRY inflation declines, the value of the currency should 16.7% MXN 700 advance. Jun-07 Jun-12 Apr-08 Sep-08 May-10 Mar-11 Aug-11 Jan-07 Nov-07 Feb-09 Jul-09 Dec-09 Oct-10 Jan-12 The theory of PPP is closely related to another classic theory that addresses exchange rate values known as the International Fisher Effect (IFE). This theory suggests that the disparity between nominalPurchasing Power Parity interest rates in two countries drive the future path of exchange rates.The theory of purchasing power parity (PPP) dates tothe 16th century and the School of Salamanca but Per this theory, one might expect that the value of awas further developed in the early 20th century by currency with a low nominal interest rate mighteconomist Gustav Cassel. 7 The theory is based increase into the future. Or that the value of aupon the assumption that exchange rates are in currency with high nominal rate might decline.equilibrium when purchasing power is equivalent in IFE further assumes that real interest rates (i.e., thethe two countries. risk-free interest rate less inflation) should generally be equal across countries. This implies that nominalOn a granular level, PPP is based on the “law of one interest rates and inflation are positively correlated.price” or the notion that identical products should bepriced at the same level in different national markets If inflation Rates Currency valueadjusted for exchange rates. Typically, this law is increases increase should declinequalified by the absence of significant trade barriersor other artificial constraints on commerce. If inflation Rates Currency value decreases decrease should advanceBut the theory of PPP expands the application of thelaw of one price from any single good or product to The IFE suggests interest rates and exchangegeneralized prices in any particular economy as negatively correlated. Similarly, PPP suggestsmeasured by inflation indexes, e.g., Consumer Price inflation and exchange rates negatively correlated.Index (CPI) or Producer Price Index (PPI). The As such, the IFE theory is generally consistent withimplication of this theory is that inflation rates and the PPP rates should exhibit negative correlation. Putting the classic theory of purchasing power parity into practice requires a measurement of inflation in order to calculate the proportion by which any particular currency is (theoretically) over- or under- Zealand dollar (NZD), South African rand (ZAR) and valued relative to the norm. There are three popular Turkish lira (TRY) vs. short positions in the USD and EUR. It is (arbitrarily) established at a value of 1,000.00 methodologies that have been referenced in this as of December 31, 2010. The long components of the regard. CME FX Carry Index were selected in light of the high local interest rates that prevailed in those countries during the post-financial crisis era through 2010. The • OECD - The Organization for Economic Co- short components of the index were identified because of operation and Development (OECD) provides data the low interest rates offered.7 See Cassel, Gustav, “Abnormal Deviations in that is useful in this regard by comparing price International Exchanges” (December 1918).6 | Currency Market Monitor 3rd Quarter 2012 | October 18, 2012 | © CME GROUP
  8. 8. changes in a representative basket of goods in Impact of Commodities various countries. As a general rule, the nations whose currencies have• Bloomberg - Bloomberg offers an analytical tool remained top performers over the past decade may that is grounded in a very long-term assessment be identified as those whose national income is tied of inflation, as measured by either CPI or PPI in heavily to commodity production. various countries extending from January 1982 through June 2000. Commodity prices have advanced rather sharply over the past decade as seen in the rise in the value• Big Mac - Finally, the Economist’s “Big Mac PPP” of energy, grain, livestock, precious metals and methodology compares the price of a (almost) industrial metals. These price advances have largely universally available product with verifiable pricing been driven by emerging market demand in nations in the form of the McDonald’s Big Mac hamburger including China and India. in various countries. CME Group has developed the CME FX CommodityActually, all three methodologies may readily be Country Index to follow the performance of a basketreferenced on Bloomberg quotation devices. of currencies from nations that rely heavily upon theAppendix 3 below provides data from all three exportation of commodities and other raw materials.methods. Further, we have taken the average of To the extent that commodities have been in greatthe three assessments (where available) for a demand over much of the past decade, thesevariety of national currencies and rank-ordered the currencies have, on a historical basis, generatedset from most over-valued to most under-valued. favorable total returns. 8Note that the most over-valued currency, per our CME FX Commodity Country Index 1,100methodology, is identified as the Norwegian krone 1,050(NOK) at 40.27% relative to the USD. Other highlyvalued currencies including the Swiss franc (CHF) at 1,00030.21%; the Australian dollar (AUD) at 26.96%; the 950Swedish krona (SEK) at 22.35%; and, the New 900Zealand dollar (NZD) at 21.15%. The magnitude of 850 Long Shortthese overvaluations have advanced a bit during the 800 16.7% AUD 100% USD 16.7% BRL3rd quarter due to relative weakness of the USD and 750 16.7% CAD 16.7% NOKa more aggressive “risk-on” attitude as European 700 16.7% NZDwoes abate. 650 16.7% ZAR Apr-08 May-10 Mar-11 Aug-11 Jan-07 Oct-10 Feb-09 Jan-12 Jun-07 Sep-08 Jun-12 Nov-07 Jul-09 Dec-09Highly under-valued currencies include the Polishzloty (PLN) at -53.25%; the Hong Kong dollar (HKD)at -50.80%; the Mexican peso (MXN) at -46.15%;and, the South African rand (ZAR) at -45.99%. But the 3rd quarter 2012 saw some advanced in the value of crude oil. Thus, the CME FX CommodityOne might recommend creating “baskets” of several Country Index had generally advanced during thecurrencies to buy and sell on the basis of this most recent calendar quarter.analysis in order to diversify risks to a certainextent. However, it is important to recognize that CME Group has further developed the CME FX BRICcurrencies might remain in apparent states of over- Index to follow the performance of select “emergingor under-valuation for extended periods of time. Infact, the carry trade as discussed above, takes acompletely opposite approach to the classic PPPtheory by buying high-rate currencies and shorting 8 The CME Commodity Country Index is constructed to below-rate currencies. effectively long AUD, BRL, CAD, Norwegian krone (NOK), NZD and ZAR vs. a short position in USD. It is (arbitrarily) established at a value of 1,000.00 as of December 31, 2010.7 | Currency Market Monitor 3rd Quarter 2012 | October 18, 2012 | © CME GROUP
  9. 9. market” 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. 9The CME FX BRIC Index had advanced during the 3rdquarter on general U.S. dollar weakness asdiscussed above. Still, the BRIC Index is trackingnear the bottom of its long-term range. CME FX BRIC Index 1,150 1,100 1,050 1,000 950 900 Long Short 25% BRL 100% USD 25% RUB 850 25% INR 25% CNY 800 Apr-08 Sep-08 May-10 Mar-11 Aug-11 Nov-07 Jun-07 Jun-12 Jan-07 Feb-09 Jul-09 Dec-09 Oct-10 Jan-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 prospectivemarket movements. Or, to manage the risksassociated with currency holdings or internationalinvestments during turbulent times.9 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, 2010.8 | Currency Market Monitor 3rd Quarter 2012 | October 18, 2012 | © CME GROUP
  10. 10. Appendix 1: Summary of World Economic Conditions Australia Brazil Canada Canada’s ties to the US mean that it benefits Growth, China’s growth continues to decelerate and Economic growth slowed in 2011, and further from the relatively good performance of the Inflation Australia is feeling the impact. Both economic sluggishness is expected through 2012 with an US economy compared to the stagnation in & Fiscal growth and inflation are slowing in 2012. exceptionally weak automobile sector. Europe and rapidly decelerating growth in Policy China. The short-term SELIC rate is being brought While the Bank of Canada welcomed the down, as allowed by declining inflation appreciation of the currency through parity Short-term interest rates have been lowered in Monetary pressure. Further rate reductions may also with the US dollar, the resulting dis-inflation 2012 to cushion economic growth without fear Policy take a little of the pressure off the Brazilian impact means Canada may need to consider of inflation pressures accelerating. real, especially in comparison to the Mexican cutting short-term rates in 2013. peso. The Brazilian government has shifted toward The Canadian dollar may get an extra dollop of The Australian dollar was once a favorite for more stimulatory monetary and fiscal policies. volatility from the US Presidential election in Special the long-side of the carry trade versus the The ability to re-ignite growth, however, is so far as there is any impact on expectations Factors Japanese yen. China growth risk makes this a limited by the slowdown in China (Brazil’s for pipeline construction to better move less desirable trade. largest trading partner) and the economic Canada’s tar sands crude oil to market. uncertainty in Europe. China European Union India Even with the ECB Committed to saving the Like China and Brazil, India is seeing a rapid Growth, Economic growth is decelerating faster than euro, the fiscal austerity related to the deceleration of economic growth in 2012 Inflation many had projected. We expect continued sovereign debt crisis will continue to be a toward the 3% real GDP territory. & Fiscal weak and disappointing economic data through major drag on economies within the EU, and a Policy 2012 and into the first half of 2013. source of much bickering. Expect no real GDP growth in 2013. The ECB is likely to keep short-term rates very The country continues to struggle with Bank lending has expanded in 2012 to cushion low and provide vast quantities of liquidity as elevated inflation rates, and thus, the the long transition process from infrastructure Monetary part of its save the euro program. Along with monetary authorities have little scope to lower building to a consumer-driven economy. Policy the US Dollar, global investors may see the short-term rates. As economic growth slows, Nevertheless, the economy continues to euro as a favorite to borrow for the short-side though, rates may be cut anyway. decelerate. of the FX carry trade. Slower economic growth portends a more The German Constitutional Court approved in India is considerably more insular than other balanced supply and demand for the RMB, and September 2012 Germany’s participation in dynamic growth countries, has many Special this may allow for a faster pace toward the EU Financial Stability Compact, but while restrictions on the rupee, which are not likely Factors normalizing the currency in 2013 as the new the details are negotiated there is likely to be to be relaxed anytime soon, so foreign leadership takes control of the country. more uncertainty for markets than clarity. investment is restrained.9 | Currency Market Monitor 3rd Quarter 2012 | October 18, 2012 | © CME GROUP
  11. 11. Appendix 1: Summary of World Economic Conditions, cont. Japan Mexico Russia Japan’s economy is to be hit in 2013 from the Elevated crude oil prices are benefitting Growth, rise in the national sales tax. While this step With even modest growth in the US economy, Russia’s economy, but an aging population and Inflation appears necessary for getting control of the Mexico should benefit from increased trade a difficult environment for foreign investment & Fiscal fiscal deficits, it comes with a heavy price of with its partner to the north. suggests slower economic growth in the years Policy political uncertainty. to come. The Bank of Japan’s zero-rate policy is not Russia has accumulated a large quantity of likely to change for years to come. Moreover, As inflation pressures ease, the central bank foreign reserves giving the authorities some Monetary there is an increasing likelihood of a more may be able to make modest reductions in firepower to counter any ruble weakness, if Policy active currency intervention policy to weaken short-term interest rates. they so choose, during periods of oil market the yen. weakness. Mexico’s currency is likely to emerge as a Russia’s energy supply dominance of Europe Japan’s outstanding government debt load favorite for the long-side of the carry trade, may be challenged over the next 5-10 years if tops the world tables in debt per person. Only Special funded by short US dollars. If this turns out to the natural gas fracking and supply revolution the long-term zero-rate policy keeps the debt Factors be the case, the central bank may move to spreads to continental Europe. overhang from becoming a serious challenge lower interest rates even if not justified by for markets. inflation. Switzerland United Kingdom United States The UK has cranked down hard on fiscal US economic growth in 2013 will be decided by Switzerland is not immune to the ramifications Growth, austerity to get its budget house in order, but the US Congress. If Congress drives the of the debt problems facing the European Inflation the consequences have been felt by the country off the fiscal cliff (20% chance) than a Union. Economic growth will be constrained & Fiscal economy. 2013 looks like a modestly better new recession will commence. More likely, the for another year, although last year’s move to Policy year, with the possibility of modestly positive fiscal cliff can be avoided, but we have to wait cap the rise of the Swiss franc was helpful. growth. and see. The US economy is growing at 2% in real GDP The Bank of England seems committed to As the EU debt crisis has morphed into a long- terms despite a recession in Europe, rapid keeping rates very low while the Government Monetary term problem, the Swiss have little flexibility growth deceleration in China, and the looming operates a tight fiscal policy. A change in the Policy and are likely continue to keep a lid on the fiscal cliff at home. Even so, the Fed has leadership of the central bank is not likely to Swiss franc relative to the euro. embarked on more emergency QE measures, make any policy difference. although little impact on job creation is likely. The big political “if” in the US in this election The UK’s lack of participation in the European The post-2008 financial crisis has led to year is the make-up of the 2013 US Senate Union bail-out funds has added to tensions increased regulation of financial institutions all and House of Representatives. With the Bush Special with the continent. Any push by the EU to over the world. On net, this increased tax cuts expiring and automatic spending cuts Factors impose financial transaction taxes or heavy- regulation poses additional challenges for the being imposed in 2013, the fiscal policy handed EU-wide bank regulations will only traditional model of Swiss secrecy. challenges will demand compromises that so worsen tensions. far have been elusive.10 | Currency Market Monitor 3rd Quarter 2012 | October 18, 2012 | © CME GROUP