Currencies React to the reality of no Fiscal Cliff Deal

Going over the Fiscal Cliff in a Barrel. US Fiscal Cliff: Deadlock and Dithering. The Fiscal Cliff Time Bomb is Ticking. Fiscal Cliff Politics As Usual, Who Has A Better Poker Face? Fiscal Cliff Dive. These are a few of the headlines I have seen recently. At this point, it seems journalists’ main objective isn’t necessarily to report the progress (or lack thereof) of Fiscal Cliff negotiations, but rather to come up with the catchiest one-line zinger for the headline. Thank you Bernanke for originally coming up with the term “Fiscal Cliff”. Zzzzzz. Makes me wonder what news and financial pundits talked about before the Cliff. Although Obama and top members of Congress are meeting today, I would be surprised (shocked actually) if any deal was crafted. So much for that misguided optimism a few weeks ago. The markets have been jittery in these waning days. Stocks fell again today, putting the S&P 500 on track for a fifth straight decline. It has dropped 1.3 percent so far this week. The broad index was on pace for its worst weekly performance since mid-November. To offer a little brightness going into the New Year, I would remind everyone that the fiscal cliff is an artificial creation of Congress and President Obama. It exists because the Republican led House, Democrat led Senate and President Obama could not reach a deal to reduce the deficit in 2011. Instead of making cuts or raising taxes, they postponed everything until the end of this year, hoping that high stakes would force a deal. We know now that didn’t work. However, come 2013, I wouldn’t be surprised to see a bit of a rally even after the higher taxes and spending cuts go into effect, just because the uncertainty of the Fiscal Cliff will be gone. I would also expect that Congress and the President will continue to hammer away at crafting a deal and one will get done to blunt the severe affects of the Cliff. Clearly, both sides had to know that taxes were going up in 2013 and spending needed to come down. Now they just need to come to terms as to how much. Hopefully that will happen sooner rather than later to avert the recessionary effects of the Fiscal Cliff and enable the US to maintain its credit rating.

In currency markets, the Euro lost a cent overnight before bouncing back 50 cents. The drop was due to the realization that it doesn’t appear that a Fiscal Cliff deal was going to materialize. Even though it seems ironic that greenback would rise in that situation, US assets are still the primary place investors go to when they are looking for safety in an uncertain world. The EUR/USD pair is currently sitting around 1.3220. It has been a volatile year for the Euro, despite the fact that it is currently sitting at roughly the same level it was year ago (it appreciated 2.5%). As you recall, it sunk all the way to around 1.2000 in June. The turning point likely came on July 26, when European Central Bank President Mario Draghi said the central bank would do "whatever it takes" to save the euro. Before then, borrowing costs for the euro-zone's troubled economies, including Spain and Italy, soared to levels many economists and politicians considered unsustainable. The surge, combined with political instability in Greece, had caused Wall Street strategists to entertain the possibility that the currency union could dissolve.

It seems that attention is slowly shifting away from the constant focus on the Euro. Investors now have trained their gaze on developments in Japan. The Liberal Democratic Party and its leader, Shinzo Abe, recently won the election there on December 16th. Abe campaigned on the promise that the Bank of Japan should be doing more to spur the economy there. The currency has gone from roughly 83.50 getting to 86.50 on Thursday since that time. It’s currently just above 86. Analysts at Morgan Stanley, RBS and Deutsche Bank predict the currency could weaken to around 90 yen to the dollar in 2013, its lowest level since June 2010, as the BOJ implements more aggressive monetary easing. This is good news for Japanese exporters.

The Aussie Dollar has also seen its value fall over the past couple of weeks. The Aussie currency is sensitive to risk appetites and the uncertainty caused by the Fiscal Cliff has caused its value to wane. It has lost almost 2 cents to come down from 1.0540 a couple weeks ago to around 1.0368 today. Expect more downward pressure if the way forward on US politics remains murky.

This will be the last installment of the Bridge Bank FX Commentary for 2012. I hope 2012 was a good one for you. And if it wasn’t, you only have to endure it a couple more days. I also wanted to thank all the Bridge Bank clients reading this for your business this year. Have a Happy New Year and a prosperous and healthy 2013!

For additional information please call (408) 556-8377.

Regards,

Brian Simonson
Senior Vice President - FX Trading

Bridge Bank, N.A.
55 Almaden Boulevard
San Jose, CA 95113
T. 408.556.8377
F. 408.275.0362
Email

Disclosure

Bridge Bank cannot accept liability for any inaccuracies that occur. No statement is to be considered as a recommendation or solicitation to buy or sell securities or other instruments or to provide investment, tax, or legal advice. Readers should be aware that the information provided is not intended to replace professional advice in relation to any topic discussed.

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