The Herald - Fundamentals
31 October 2009
A colleague recently bought some Euros ahead of her holiday, and was shocked at the exchange rate she was quoted. Sterling is moving back towards the 1-1 lows against the euro seen at the end of 2008. Economists may talk in grandiose terms about the necessity of currency movements helping an economy rebalance; the harsh reality has come home to many households of what this really means, how expensive an overseas holiday can become when their spending power does not go very far!
Sterling's shift against the euro and other major currencies -approaching 10% since the summer - is just one example of an important investment theme- currencies are becoming volatile again. Why is this happening and what are the implications for investors? It is necessary to step back and examine how different countries perform as they emerge from the great recession of 2008-09. The first stage of the economic recovery is over. In many respects that was the easy part - throw money at the problem and create some growth! We expect the next stage of the recovery will be much more complex. Many economies need time to adjust after the shocks of recent months. Policy makers face very difficult decisions about how and when to withdraw the exceptional stimulus. International capital flows will become more discerning.
We place countries into three broad groups. Most of the press focuses on the very largest, the US, Europe and Japan, only slowly recovering from recession. They face many headwinds, such as significant pressures on household incomes from unemployment approaching 10%. Nor will these pressures disappear quickly; the scheduled rise in VAT in the UK in January will be the forerunner of several years of tax increases and spending cuts.
Investors should not overlook two other important groups. The first comprises some smaller economies, which either did not enter recession, such as Australia, only experienced a brief slowdown, such as Brazil, or show signs of recovering relatively quickly, such as India or South Korea. Some of these countries already face the prospect of higher interest rates - the Reserve Bank of Australia has hinted that it could raise interest rates by year end, to prevent a house price bubble! How different from the environment here in the UK or the US. Lastly, there is China and some of its key trading partners. The Chinese authorities were very conscious of the need to bolster economic activity, and therefore keep unemployment under control, in the 60th anniversary year of the foundation of the People's Republic. Indeed, on some estimates China will overtake Japan as the world's second largest economy in 2010. Investor flows into emerging markets in general, and China in particular, have been a noticeable feature this year.
To sum up, we expect markets to remain volatile. Investors will respond to different environments and different policy decisions in different countries at different times. Currency analysis becomes more important. For example, some countries may try to engineer stronger economic growth via cheaper currencies - the UK is one example. Other countries face the problem of how to cope with strong capital inflows and whether to intervene to try and prevent them becoming too strong. Japan and Korea today are examples, while professional investors are debating when China might break its fixed exchange rate against the US dollar. Whether you are a holiday maker, a company taking part in overseas trade, or an investor interested in global markets, then watching currency movements, to enhance or protect yourself, is a sensible course of action in the coming year.
Andrew Milligan, Head of Global Strategy, Standard Life Investments
This article was first published in The Herald on Saturday 31st October 2009.
