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2010: CURRENCIES

12/22/2009

The avalanche of ETFs and their impact on the capital markets has become a hotly debated topic. My take is that like everything else in life, some are good, and some aren't so good. However, I am rather certain that the introduction of currency ETFs is a positive for investors.

Exposure to the highly volatile currency markets has been difficult to achieve in previous years. ETFs provide a solution. Given the massive efforts on the part of central banks to navigate the credit crisis, currencies have become an asset that investors need in their portfolios.

The "great reflation trade" powered the capital markets for most of 2009. U.S.$ depreciation benefited exporters and provided pricing power to the Natural Resource/Commodity producers. Most importantly, it allowed the Fed/Treasury to monetize our massive debt via currency depreciation in AN ORDERLY FASHION - counter to the prevailing media buzz during the year that a $ RIOT was imminent.

US DOLLAR JAN 2, 2009 - DEC 22, 2009


Source: Bloomberg

So what happens next to the Dollar? A rather accurate seasonal pattern affects the dollar. Historically, September, October, and November are the three weakest dollar months. January and February are the two strongest dollar months. The seasonal effect dates back to 1969! A good year for New York Jets fans. The dollar is rallying, heading into year's end. I view this rally as an anticipation of the historical January/February strength, not a major bottom for the Dollar. What is absent to suggest a major dollar bottom is that the U.S. current account balance is still in deficit - a transition to a surplus would support a major dollar bottom. In addition, the dollar has not fallen to deeply undervalued levels. To that point, let's pullback our view of the dollar's recent price action. In November of this year, a trough in the 2009 dollar move was established, but still well above the 2008 trading range from March to August.

Source: Bloomberg

For 2010, the path of the U.S. dollar should be highly correlated to the level of strength in the U.S. economy. Stronger than expected economic growth, dramatic labor market improvement, and spectacular corporate earnings would support the dollar. However, that is quite a bit to ask for an economy that is coming back from the brink of Armageddon. Yes, the secular dollar downtrend may be in the late innings, but remember that we have to play all nine before the game is over. A major dollar bottom is a theme I will be watching intently in 2010.

Should the dollar begin to strengthen, the anti-dollar currency, the euro, will decline.

The yen will re-assume its role as the global "funding currency."

The commodity currencies in Canada and Australia may lose some upward momentum; however, I would not expect a reversal in their longer term secular bull trends.

Finally, my sleeper currency for 2010 is the British pound. Across the pond, the pound may just be positioned for outperformance in either a "dollar up" or "dollar down" world.

Could this be the year the dollar makes a third major bottom, as it did in 1978 and 1992? Stay tuned.

Let's take a look at the year to date performance of global currency markets through December 22:

  • The Indianapolis Colts of 2009 for global currencies looks like the Eastern African nation of Seychelles. Its rupee is +47% year to date.
  • The Brazilian real has returned 29% so far year to date and the Chilean peso has returned 25%.
  • My favorite commodity play in early 2009 was the Australian dollar; it did not disappoint - up 25% year to date.
  • The Central African nation of Congo (formerly known as Zaire), has seen its franc down 28% year to date.
  • Eastern Europe remains a global trouble spot as the heavily indebted nations of Belarus, Tajikistan, and Kazakhstan had currency depreciation of at least 15%.
  • By the way, for all the dollar riot chatter, as of December 22, the USD is only down 4% year to date.

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.