2012 is finally drawing to close and we want to take this opportunity to wish all of our readers a happy, healthy and prosperous New Year.
While we can talk at lengths about how the negotiations in Washington are ongoing, with less than 24 hours before the Fiscal Cliff deadline, at best, we can only expect a slimmed down deal that involves nothing more than extensions on jobless benefits and tax cuts for households earning less than $250,000. What is more likely at this point however is no deal at all which means the U.S. economy will fall off the cliff temporarily. It won’t be the end of the world but it may nonetheless shock the financial markets.
So instead, we want to take this opportunity to share our top forex trading ideas for 2013. For most Forex traders, the most interesting currency pairs are the majors. However the trend of these pairs are generally determined by the market’s appetite for risk and U.S. dollars and not relative fundamentals. For example, the outlook for the Eurozone could continue to improve in the New Year but if the U.S. Fiscal Cliff causes massive turmoil in the markets, the EUR/USD could fall. Therefore we believe that the clearer and perhaps cleaner forex trading opportunities for 2013 are in the crosses.
TRADE IDEA #1 – LONG EUR/GBP
For the first time in years, it finally feels like Europe’s sovereign debt crisis could be in the rearview mirror. European bond yields have held steady over the past few months and German stocks climbed to their highest level in nearly 5 years. The European Central Bank’s OMT program effectively reduced stress in the region even though no one has asked the ECB to activate the program. While economic growth is expected to remain slow in the coming year, we believe that the decline in sovereign risk will encourage investors to return to Eurozone assets. During the first half of 2012, many investors dumped their investments in the Eurozone and parked those funds in the British pound. If you recall, at the time many people were calling the GBP, the “new safe haven currency.” This demand drove EUR/GBP to its lowest level since 2008. Now that the risks are receding, the money is beginning to flow back into euro and we believe that this trend will continue in 2013, making long EUR/GBP one of our favorite trades of the year.
The reduction in Eurozone sovereign stress should also draw the limelight away from the mainland Europe and onto the U.K. In early December, Standard & Poor’s put the U.K.’s sovereign debt rating on negative watch and we believe there is a very good chance either S&P or Moody’s will strip the U.K. of its AAA rating in 2013. Both U.K. economic growth and fiscal finances have fallen short of the government’s forecasts while the stickiness of inflation will limit the support from the Bank of England. As a result, we strongly believe that the challenges facing the U.K. economy will become more apparent in 2013, making sterling less attractive compared to the euro.
Technically, we are already beginning to see a turn in EUR/GBP. The currency pair has broken above its 50-week SMA at 0.8100, which means the next resistance is not until 0.8265, the 38.2% Fibonacci retracement of the 2011 to 2012 bear wave. We believe EUR/GBP could rise as high as 0.8425 (50% Fib) and maybe even test 0.8580, the 61.8% Fibonacci retracement.
TRADE IDEA #2 – LONG AUD/NZD
The Australian and New Zealand dollars are 2 highly correlated currencies but during the first half of December, the New Zealand dollar broke out and soared, leaving the Australian dollar behind. Yet what rose fastest also fell the sharpest in the second half of the month because investors realized that the kiwi hardly deserved its lofty valuations. In the coming year, we believe the outlook for the AUD is more promising than the NZD, which should lead to further gains in AUD/NZD.
One of the biggest “calls” by economists in 2013 is for slower growth in China but we have seen Asia’s largest economy outperform grim economic forecasts time after time and we believe the risk next year is for stronger and not weaker Chinese growth. If we are right, then Australia’s economy stands to benefit the most because of its reliance on China. New Zealand on the other hand sends only 15% of their exports to China and should therefore benefit less from any upside surprises in Chinese growth. Recent disappointments in New Zealand data, a massive current account deficit and the prospect of aggressive fiscal tightening by New Zealand’s government over the next 2 years also makes the outlook for New Zealand less attractive. The RBA is expected to cut rates one more time in early 2013, which could be negative for the AUD but even at 2.75%, Australia would still have a higher yield than New Zealand. This final dose of stimulus would also provide a nice cushion for Australia’s economy for the rest of the year. So while both the Australian and New Zealand dollars are extremely overvalued on a purchasing power parity basis, Australia’s fundamentals are and should continue to be stronger than New Zealand’s in 2013.
Technically, there is a mini head and shoulders pattern that is attempting to form in AUD/NZD. For our call to be right, we would need to see AUD/NZD break above resistance at 1.27. Alternatively if AUD/NZD slips down to 1.25, it could represent an attractive value point. If AUD/NZD breaks above 1.27, a rally to 1.30 would be likely.
TRADE IDEA #3 – LONG USD/JPY
In the forex market, the most popular call for 2013 is to short the Japanese Yen buy the popularity of this trade call is the very reason why we are weary about how high USD/JPY can rise. Since LDP leader and current Prime Minister Abe started to talk about pressuring the Bank of Japan to increase its inflation target, USD/JPY has been on a tear. Since mid November, USD/JPY appreciated as much as 700 pips or nearly 9%. There are fundamentally sound reasons for the Yen’s weakness. The Japanese economy is extremely weak, the country is running a trade deficit and the threat of slow growth in the coming year will make any recovery difficult. As a result, even without Abe’s pressure on the BoJ to increase asset purchases aggressively, the central bank will need to ease monetary policy further in the coming year.
In January, the BoJ is expected to acquiesce and raise its inflation target. USD/JPY could extend higher in the lead up to the January 20th announcement as long as it doesn’t fall victim to risk aversion from the U.S. government’s failure to reach a Fiscal Cliff deal. Most targets for USD/JPY range from 87 to 90. The trade is getting crowded however so it may be better to buy on a pullback than to chase it higher.
Technically, the uptrend in USD/JPY is strong. As seen in the weekly chart below, a break above the 200-week SMA opens the door for a move to 90 because there is no technical resistance until that level.
BONUS TRADE! LONG USD/KRW
Instead of chasing USD/JPY higher, a more attractive trade would be to short the Korean Won (KRW) or go long USD/KRW. Economists have grown extremely worried about the outlook for Korea’s economy in recent months because the currency appreciated nearly 8% since the beginning of the year. As an export dependent economy, a stronger currency poses a major threat to the economy. Japan is a leading competitor of South Korea in the market for high tech manufactured goods and the strength of the Won has already hurt the attractiveness of Korean goods but the real problem will be the weakness of the Yen.
Before the Yen was rising alongside the won but now it is trending lower. If the Japanese Yen continues to slide, Japan’s products will become even cheaper on a relative basis and on top of that Japan is also Korea’s second most important trade partner (behind China). This means a weakening Yen will also hurt Japan’s demand for Korean goods, creating a double blow for Korea. As a result, we expect USD/KRW to bottom in the near future and turn higher in the coming year.
Technically, USD/KRW is in a very strong downtrend with support at its 3 year low of 1049. Like USD/JPY, rather than arbitrarily picking a top or bottom, it may be better to wait for the currency pair to turn higher first (break above 1080 for example) before going long for a move up to 1120 or higher.