Dollar Wins by Default ... Again: Currency Markets Are Seeing a Shifting Outlook as Nations Take on Austerity Programs and Geopolitical Challenges Drive Up Energy Prices While Central Banks Try to Maintain an Even Keel

Article excerpt

[ILLUSTRATION OMITTED]

While some progress on European sovereign debt problems may have slowed or halted the decline of the euro for now, uncertainty on a fundamental level predominates in currency markets, leaving traders and technical factors in control and possibly less volatility in the outlook.

The dollar recently has seen some signs of strengthening while the yen has resumed weakening as central banks in the United States and Japan have taken different tacks on quantitative easing and currency traders and analysts are looking for more of those trends in the coming year.

Among factors affecting currency prices are recent crude oil price spikes as well as hard assets, which weigh particularly on the "commodity currencies," such as the Canadian and Australian dollars.

Mark Frey, vice president of corporate payment and risk solutions for Cambridge Mercantile Group, says that following the Greek bailout deal many currency market participants believed the rebounding euro would challenge the $1.35 mark, but when that failed in the wake of the European Central Bank's long term refinancing operation, thinking on the euro changed.

"The market is going to be able to focus a little bit more on the euro fundamentals," he says. "The euro fundamentals at this time are obviously not that robust. We've got some significant concerns from an employment point, from a GDP contraction standpoint. As the various austerity measures get pushed through across Western Europe, it's going to have a more negative impact on the overall euro and the economy."

This is likely to lead to more economic contraction in Europe with the euro again heading downward. "It's no secret that 2012 is going to be a difficult year for the Eurozone with austerity measures going into place," says Greg Michalowski, vice president and chief currency analyst with FXDD. He notes that continued problems with the smaller European countries like Greece, Spain and Portugal are weighing on growth prospects of the Eurozone and that currency markets have that idea priced in.

"You can see it in some of the volatility in the euro. Last year the average daily range for the euro was about 157 pips and that fell to 121 pips in February," Michalowski says (see "Euro takes a chill pill," right). "The volatility has come down and that is a reflection of this idea that we know what's ahead."

At least for now, prospects of a breakup of the Eurozone are seen by most observers as having been put on hold. "In the short-term the euro will continue, but I can't say what will happen in the long-term," says Thomas Molloy, chief dealer at FX Solutions. "It's possible that eventually at least one of the nations in Europe will not necessarily have been kicked out but will have chosen to leave (see "Jamie Thorsen: Enjoying the action of forex," page 16)."

He and others say that increasingly stronger nations in Europe are more likely candidates to leave the monetary union. "The big risk to the euro is that Germany exits, and if Germany exits, it basically falls apart," Frey says. "Whereas you could lose Greece, and while that would be messy and it wouldn't be that convenient for anyone concerned, the euro could still survive. But at some point down the road in the very long run, if Germany were to exit, that marks the end of the euro for sure."

Kathy Lien, director of currency research at Global Futures & Forex Ltd., also expects the euro to continue but adds, "Unfortunately I do not believe that a second bailout of Greece will be the end of the Eurozone's troubles," she says. "Greece was never the main problem--it is contagion. As a result, expect more volatility in currencies this year."

Differing outlooks also are seen for the U.S. dollar in light of European developments and recent Congressional testimony by Federal Reserve Chairman Ben Bernanke. "The dollar is much lower than it was three months ago and also the prospects of easing have soured sentiment toward the dollar index," says Andrew Wilkinson, chief economic strategist for Miller Tabak & Co. …