By Don Alexander, MBA
Associate, RSD Solutions Inc.
Currency markets are showing increased signs of investor caution as various measures of risk aversion are rising. This more cautious investor stance is based on concerns about the sustainability of US and global growth, inflation surprises in emerging markets (China), and general unease about debt levels and new asset bubbles. Already, global Purchasing Managers Indices suggest that global growth concerns have extended across most countries.
The rise of risk aversion and investor uncertainty could persist for an extended period. The traditional response of investors was to move into more liquid currencies based on the view that central banks would ease policy to keep the recovery intact. However, it is possible in this new environment that central banks may become more cautious about providing support. This can be found in recent policy statements of central banks: the Fed has shown no signs of implementing QE3, the ECB still plan to raise rate at a slower pace, Canada and Australia continue to show a slight tightening bias and inflation remains a focus in China.
The soft patch is driven by policymakers emphasizing post crisis adjustments and attempt to reduce the debt overhang. As a result, G-20 central banks will be less reluctant to support a growth slowdown and investors focus on government debt. The central bank of China and some emerging markets will continue to tighten monetary policy due to inflation fears reducing global liquidity. In an environment of upside inflation risk and central bank caution, this could leave some of the commodity and liquidity-driven currencies more vulnerable.
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