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J.P. Morgan sees gradual change in currency outlook.

Sara Yates, Global Currency Strategist at J.P. Morgan Private Bank, provides outlook for the currency market in Q1 2013, and looks across the macro, developed FX markets and the case for China in the year ahead.

"2013 promises to be another year of loose monetary policy, but unlike 2012 there will be fewer downside risks. Growth in the US and China looks set to improve while the tail risk from the euro area has been substantially reduced by the creation of the OMT (Outright Monetary Transaction). This environment means three things for currencies: investors will continue to look for yield; they will be more comfortable in moving along the risk spectrum; and a currency's fundamentals will matter more," said Yates.

"We expect "risk-on" currencies to be the top performers in 2013, especially in H2.

EURUSD and GBPUSD are likely to face opposing headwinds: improving global sentiment will act as support, while weak growth in the UK and euro area is likely to drags on performance. We look for both to move largely sideways, with the EUR slightly outperforming GBP," she continued.

"Monetary policy is expected to remain extremely accommodative throughout 2013. The Fed has committed to keeping rates between 0-0.25 per cent until unemployment falls below 6.5 per cent and/or inflation rises above 2.5 per cent. Neither outcome seems likely this year.Alongside standard monetary policy measures, central banks continue to use inventive policy measures to support global growth. The most common is quantitative easing whereby central banks expand the money supply by buying longer dated government bonds. These measures have helped drive the longer end of the yield towards historic lows.

"Unlike 2012, we expect fewer downside risks in 2013. Recent economic data suggests that China has achieved a soft landing and that conditions will gradually firm in 2013. Conditions in the other engine of growth, the US, also look set to slowly improve in 2013. Perhaps even more important is the reduced tail risk from the euro area following Draghi's commitment to do "whatever it takes" and the creation of the OMT (Outright Monetary Transactions)."

Moves in EURUSD or GBPUSD are largely governed by changes in four key drivers: general risk appetite, interest rate differentials, country specific risk and oil prices:

"Risk appetite- Improved risk appetite is a positive for EURUSD and GBPUSD. But as neither have a strong relationship with risk, they will not benefit from firmer sentiment as much as "risk-on" currencies such as the SEK and MXN.

"Interest rate differentials - All three central banks are likely to keep monetary policy loose for sometime. This suggests little impetus from this driver for EURUSD or GBPUSD.

Oil - We are constructive on oil and are looking for a move to $120 per barrel by the end of 2013. This will be a modest positive for EURUSD and GBPUSD.

"Specific risk - As euro area progress continues we expect the risk premium on all European currencies to fall v USD. Within Europe, the EUR is likely to be the largest beneficiary of a fall in the European risk premium and GBP the biggest loser as intra European safe haven flows unwind. The UK's weak fundamentals mean the risks are skewed towards the UK losing its cherished A sovereign credit rating. This would add a further weight on GBP v EUR.

"2013 promises to be a year of loose monetary policy and less systemic risk. And as market confidence grows, we expect investors to feel more comfortable in taking on a larger amount of risk in their search for yield. In other words, we look for "risk-on" currencies to outperform.

"But investors need to pick carefully. Less systemic risk means correlations are falling and that a currency's fundamentals will matter more. We expect cheap, "risk-on" currencies, with a positive real yield, good fundamentals, and a central bank not adverse to appreciation to see the strongest performance as global prospects firm."

2012 CPI Financial. All rights reserved.

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Publication:CPI Financial
Geographic Code:9CHIN
Date:Jan 14, 2013
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