David Simmonds: Japan leads "race not to be top"

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The Bank of Japan is likely to adopt more quantitative easing (QE) next year to weaken the yen and strengthen its stock market.

David Simmonds,
Head of Currency
and Emerging Markets
at RBS

We expect more QE in pursuit of the country’s elusive 2 per cent inflation target and Japanese institutions to invest more in global assets.

The race to the bottom has become the race not to be top.

The trick for central banks is to guide markets sufficiently to ensure they’re not expected to tighten earlier than their competitors. The Bank of Japan wins this race away from the top, enjoying policy flexibility and a strong mandate to boost growth and inflation.

We expect it to come back to the QE monetary easing table next year.

The policy task is to try and keep inflation expectations up, driving down real interest rates and weakening the yen while strengthening their stock market.

The Bank of England (BoE) may lose this ‘race from the top’. It is likely to find itself as the most neutral among the major central banks next year – so relatively speaking it may ultimately sound the most hawkish.

Turning to the emerging markets, as yield curves in major economies steepen, investors should be wary of those with external deficits that must compete for scarcer surplus savings from another area. This makes emerging markets that have been growing credit and leveraging more vulnerable as they now attempt a controlled slowdown.

One of two things may happen as these economies compete for someone else’s scarcer, costlier surplus savings. Either real interest rates go up to compete more aggressively and/or the value of those currencies may fall.

Turkey faces key elections in March and August and higher real rates there would be tricky. The central bank has a mandate to support economic growth but inflation is well above the official 5 per cent target. The currency may take more of the strain because real interest rates are falling when they really need to be rising.

A couple of our other 2014 top themes and trades for 2014 are based on the RBS Currency Ranker, which assesses global currencies across 17 criteria and assigns a ranking to each. Criteria include valuation, balance of payments and fiscal sustainability.

The ranker suggests investors should buy euros and Polish zloty and sell North American Free Trade Agreement currencies like Canadian dollars and Mexican pesos.

The depreciation of the Mexican peso is in line with falling productivity, deteriorating basic balances and faltering government reforms that threaten sustained recovery. Canada, meanwhile, is challenged by persistently low inflation and slow export recovery.

The euro, by comparison, has been bolstered by a robust balance of payments surplus. More ECB easing is a risk but not until later in the year.

Another top trade involves selling Australian dollars for US dollars. The Australian dollar looks the most expensive G10 currency in the long term as Australia’s terms of trade start to decline and as the multi-year commodity investment boom ends.

Australia is heavily exposed to China’s restructuring from fixed investment towards consumption-led growth. Unemployment is rising, wages are falling and Australia needs a lower exchange rate to reinvigorate its nonresources sector.

Other key developments I expect in 2014 are:

  • The US Federal Reserve and the European Central Bank are likely to remain dovish and maintain low interest rates
  • Market volatility is likely to remain subdued across all asset classes
  • European periphery spreads can initially tighten further because of suppressed volatility, but eurozone countries that lack policy flexibility may ultimately face a deflationary debt trap
A selection of David Simmonds’ top FX themes for 2014
  • ‘Race to the bottom’ becomes ‘race not to be top’ – long GBP/JPY
  • Long Europe, short NAFTA
  • Let the long-term FX drivers drive – short AUD /USD
  • Crunch time for EM deficit runners: Long USD/TRY


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