LONDON: The euro may surprise in the final days of 2012, with a rise to $ 1.3400 possible, as US and Japanese monetary policies make the dollar and yen less attractive investments.
With very low benchmark interest rates in the euro zone, Japan and the US, investors restricted to the major developed economies become less concerned about return on capital and more about protecting the value of their capital.
Nuances of monetary policy become more significant.
The US benchmark federal funds rate range remains at zero to 0.25 percent, but last week’s Federal Open Market Committee meeting unveiled a new stance.
The Fed now sees such an “exceptionally low” range as appropriate while the US unemployment rate remains above 6.5 percent, compared with its current 7.7 percent and while inflation remains within certain bounds.
Those bounds are namely that “inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored,” the FOMC said.
The elevation of jobless rate targeting to such a prominent position may lead some investors to conclude that the Fed might be softer on inflation, perhaps resulting in some downward pressure on the dollar.
“I see material upside risks to inflation in 2014 and beyond, given the current trajectory for monetary policy,” Richmond Fed President Jeffrey Lacker said this week.
While Lacker is a confirmed inflation hawk, who has dissented at every Fed policy-setting meeting this year, his view may now resonate with some investors.
In Japan, Prime Minister-elect Shinzo Abe met Bank of Japan Governor Masaaki Shirakawa recently and urged the BOJ to adopt a 2 percent inflation target, which would entail a substantive easing of monetary policy that could hit the yen.
Abe won Sunday’s election campaigning for hyper-easy monetary policy and big fiscal spending to beat deflation, a recipe for yen depreciation.
If the BOJ is pushed to adopt such policies, investors may well shy away from yen-denominated assets.
That leaves the euro.
The European Central Bank notably left its benchmark rate unchanged on Dec. 6 emphasizing, as per its mandate, that inflation expectations remain firmly anchored.
No hint there that the ECB will be more tolerant of inflation, a fact that might prove attractive to euro investors.
Indeed, the ECB continues to keep its benchmark interest rate at its record low 0.75 percent even though its new forecasts suggest the euro area economy will contract next year.
There is also an argument that euro zone policymakers might tolerate some euro appreciation as evidence that the currency bloc’s reputation is being rehabilitated among investors.
Asian central banks, some of whom have been intervening to stem the rise of their own currencies against the dollar, may have to diversify out of some of those greenbacks in order to keep the overall complexion of their reserves in balance.
It may well be that such flows also end up heading into the euro.
With markets thinning out as the year winds down, that might be enough for a push to $ 1.34.
— Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own.
