Currency wars and eurozone woes set to impact on markets in 2011

News - Funds

Written by Ray Clancy

Monday, 06 December 2010 09:36

The effect of the continuation of eurozone woes and currency trade wars on financial markets are the biggest risks for investors in 2011, it is claimed

Economic and debt concerns across the eurozone and the simmering animosity between the US and China are set to worsen and dominate markets in 2011, according to the UK’s oldest investment trust.

‘After a fairly robust 2009, markets in 2010 were unsettled by events which resulted in Greece and Ireland having to receive financial assistance from Europe. Whilst the International Monetary Fund and European Union have attempted to address the sovereign debt issues that have arisen so far, the underlying issues around solvency have not yet been resolved,’ said Jeremy Tigue, manager of the Foreign & Colonial Investment Trust at a briefing in London.

‘For this reason, I believe the problems will simply move from one country to the next, starting with Portugal and then probably Spain and Italy. Whether this is next year or in 2012, in my view it seems inevitable,’ he added.

Tigue warns that the euro itself is at risk of falling apart if the EU attempts to struggle on and persist with the rescue of the smaller European countries on a reactive basis, rather than proactively.

‘It can’t carry on as it is. If they don't work to address these issues in 2011, before they reach crisis point, we may end up with a core EU probably comprising Germany, Austria, the Netherlands, Belgium, Luxemburg and Denmark or possibly a situation where Germany feels they have no alternative but to leave the Euro altogether. Both of these outcomes are currently unthinkable in terms of political consequences, not to mention the impact on the European and UK markets,’ he explained.

Twelve months ago Tigue reflected that he had predicted a major currency dislocation between China and the US in 2010. He anticipates that this situation will likely continue into 2011 and worsen.

‘What we saw at the end of 2009 is a situation where China pegged their currency to the US dollar and kept the exchange rate low, effectively exporting deflation to the rest of the world. The US has since responded with a second round of quantitative easing; China believes that the US is perhaps acting unfairly through its monetary policy by effectively devaluing its currency. The US in turn believes that China's stance is unfairly boosting its export industry,’ explained Tigue.

Tigue believes that one party will have to give way to the other; either way, when the shift eventually comes, Tigue anticipates the repercussions will cause a great deal of turmoil across the globe.

Also following on from the US Federal Reserve’s decision to introduce a second round of quantitative easing, the markets have so far responded unfavourably. The routing of the Democrats in the US mid-term elections and increasingly tense political backdrop arising from that means, in Tigue’s view, it is more likely the FED will adopt a ‘wait and see’ attitude and avoid introducing more QE if they can, to avoid becoming a political football between the Democrats and Republicans.

Tigue believes that 2011 will undoubtedly see emerging markets continue to grow faster than in the West and there is further evidence of the shift in economic and political power from the developed to emerging nations from the G7 to the G20.

He had previously anticipated a ‘blow-up' in emerging markets for 2010, largely due to the conflict between China and the US. Whilst the anticipated shock did not materialise in any major form, Tigue still believes the emerging markets success story is in danger of becoming a potential ‘bubble’ either in 2011 or soon after.

‘Global growth is currently being driven almost entirely by growth in emerging markets, as their governments and banks are in stronger financial positions than in the developed economies. Emerging market growth is likely to be one of the dominant features of economies and markets for at least the next decade. Nevertheless, at some stage, emerging markets will become too popular with investors. Investors are once again extrapolating the past into the future, as they always do, and assume that strong performance in emerging markets over the last decade will continue for the next decade,’ he said.