FX Market Monitor - 1st Quarter 2013

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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

  1. 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. 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. 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. 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. 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. 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. 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

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