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Analyst Interview: David Song on Debt Crisis and Fundamental Themes For 2012

Analyst Interview: David Song on Debt Crisis and Fundamental Themes For 2012

David Song, Strategist

Hot off the press this week we have the Eurozone and Greece reaching an agreement on a second bail-out. Going forward this is obviously better news for the Eurozone as a union but what impact do you feel it will have on the currency?

The agreement has helped to dampen the risk for contagion, but the implementation of the unprecedented measures will certainly influence the currency market as the sovereign debt crisis clouds the fundamental outlook for the euro-area. As the region slips back into recession, the tough austerity measures certainly raises the risk of seeing a major economic downturn in 2012 and the European Central Bank may take further steps to shore up the ailing economy as growth and inflation falter. At the same time, renewed threats of a Greek default instills a bearish outlook for the single currency as Fitch pledges to lower Greece’s credit rating to ‘Restricted Default’ and the ongoing turmoil in the euro-area may continue to sap risk-taking behavior as European policy makers struggle to restore investor confidence.

Outside of the Greek bail-out, what other indicators or themes are you watching for in terms of having an overall forex market impact and dictating trend direction?

Beyond the sovereign debt crisis, I am keeping a close eye on China as policy makers scramble to avert a ‘hard landing.’ Indeed, the People’s Bank of China took further steps to shore up the economy by lowering the reserve requirement ratio (RRR) for commercial banks and it seems as though the central bank will carry out more easing in 2012 in order to shore up the banking sector. It seems as though the Chinese government is turning a blind eye to the stickiness in price growth amid the slowing recovery, but the efforts may fail to produce a ‘soft landing’ for the economy as the region faces a liquidity squeeze.

The US economy added more jobs than predicted this month and jobless claims recently have trended lower and just fell to a four-year low last week. A general rosier outlook is emerging for the US economy and the job market. In your trading analysis, are you buying into this picture of a healthier US economy and how is this effecting your trading decisions? (If not, what do you think is going to put a dampener on this rosier outlook?)

As the more robust recovery in the U.S. economy limits the Fed’s scope to push through another large-scale asset purchase program, I expect to see the central bank soften its dovish tone for monetary policy in 2012. With the stickiness in underlying price growth, Fed officials may see scope to conclude the easing cycle this year and the central bank may lay the ground works to start normalizing monetary policy as the recovery gets on a more sustainable path. With this in mind, I expect the correlation between risk and the USD to decouple later on this year and the greenback should show a greater reaction to the developments coming out of the world’s largest economy as speculation for QE3 diminish.

The NZD/USD has been on a roll basically since the end of December and has been trading at its highest level since early September. Can you comment on this pair and what you feel has been the driver behind the recent ascent? Also, do you feel we will see higher levels still?

Interest rate expectations have certainly helped to prop up the NZD/USD as the Reserve Bank of New Zealand strikes an improved outlook for the region. As the RBNZ expects the rebuilding efforts from the Christchurch earthquake to foster a stronger recovery, the central bank is widely expected to lift the benchmark interest rate from the record-low and we may see a series of rate hikes in the second-half of the year as economic activity picks up. In turn, speculation for higher borrowing costs should prop up the NZD/USD throughout the first-half of the year, but currency traders may become bearish against the New Zealand dollar should the central bank further delay the normalization of monetary policy.

We have seen major upward movement in the USD/JPY in the past few weeks after trading in a relatively tight range for a long while and, in fact, the Yen has been very weak against the other major currencies. Can you explain why you feel the Yen has been weak and where do you see this currency over the short to medium term?

The USD/JPY broke out of its narrow range after the Bank of Japan expanded its asset purchase program by JPY 10 trillion, but the widening spread between U.S. and Japanese government bonds foreshadows a bullish outlook for the pair as it raises the appeal of reserve currency. The renewed efforts by the BoJ to stem the risk for contagion suggests that the central bank will further increase its asset purchase program amid the slowdown in the global economy and the pair should continue to retrace the sharp selloff from the previous year as it breaks out of the multi-year downward trend. In turn, we expect the USD/JPY to work back towards the 2011 highs around 85.50, but the bullish momentum underlining the dollar-yen may produce a test of 90.00 over the medium-term as the fundamental outlook for the world’s largest economy improves.

Oil prices are trading above $100 per barrel now and there is much speculation that prices will be heading higher as tension in the MiddleEast with Iran continues to flare up. If oil prices do continue higher, what currencies do you see as benefitting the most or losing the most from this circumstance?

Indeed, tension in the Middle East pushed oil above $100 per barrel and the geopolitical risks surrounding the world economy is likely to keep crude prices elevated over the near-term amid fears of a supply-side shock. The Canadian dollar tends to benefit from higher oil prices amid the historical correlation between the two asset classes, but the recent strength in crude is likely to taper off later this year as the fundamental outlook for the world economy deteriorates. As the slowdown in global growth becomes an increased concern, expectations for lower demands are likely to bear down on commodity prices and we expect to see crude prices fall back towards $80 per barrel going into the second-half of the year.

--- Answers provided by David Song, Currency Analyst for for an interview with

To contact David, e-mail Follow me on Twitter at @DavidJSong

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