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Currency markets • Dagmara Fijalkowski, MBA, CFA The latter would mean an accelerated path to a Eurobond market, in which peripheral countries could benefit from the financial guarantees of stronger countries, Germany being the key among them. Only when fiscal union becomes a real prospect does it make sense to talk about a Eurozone-wide government-debt-to-GDP ratio and current account. Aside from these two long-term sources of support (unconditional buying commitment by the ECB and/or German acquiescence to a fast-tracked Eurobond market), other band-aid solutions can be considered. Among them: additional extraordinary liquidity measures similar to the ECB’s Long- Term Refinancing Operation (LTRO); EMU-wide deposit insurance; and the creation of a ‘bad bank’ in Spain to hold non-performing real estate loans. Paradoxically, the other source of shortterm support for the euro may be that investors are already so pessimistic about the currency. Although consensus forecasts call for only minor depreciation, every positioning survey we monitor shows a persistent euronegative bias (Exhibit 10). With many investors having lower risk budgets, tolerance for losses is very limited, and any relief and/or headline-driven rallies force them to cover their short positions, fueling temporary support. But with the euro now less attractive as a reserve currency, long-term investors will use these rallies as opportunities to reduce their holdings. In the longer term, investors’ bearish stance is justified by most valuation frameworks, including purchasing power parity, which suggests the euro is on the expensive side of the ledger. EXHIBIT 9. % 85 75 65 55 45 35 25 15 5 -5 Central Bank Reserve Allocations USD EUR GBP JPY CHF Others EUR peaked in 2009 at 33.9% 2006 2007 2008 2009 2010 2011 Source: IMF COFER, Barclays Research EXHIBIT 10. Positioning However, a 14% PPP overvaluation does not give the high level of confidence offered by overvaluations in excess of 20%. Based on technical analysis, the bearish channel suggests further downside with the initial objective in the 1.20 region, but a more severe drop is possible over the next 12-18 months. Euro rallies should be contained in the low 1.30s for now, which would provide a good opportunity to sell. IMM TFX State Street Deutsche USD Very Long Long Very Long Very Long CAD Very Long Neutral Neutral Very Long EUR Very Short Short Short Very Short JPY Very Short Short Very Short Long GBP Very Long Very Short Very Long Neutral AUD Very Short Long Short Very Short CHF Very Short Short Short Very Short NOK N/A Long Very Short Neutral SEK N/A Very Long Very Long Long MXN Short N/A Very Short Short Source: RBC GAM SAMPLE Putting together this list of positives and negatives from long- and shortterm perspectives, we believe that short-term rallies should not obscure the long-term negatives. Given current valuations, the negatives should push the single currency down over our forecast horizon. A weaker currency remains an important component of a resolution to the European crisis, assuming that Germany can tolerate slightly higher inflation. We are calling for the euro to fall to 1.20 in 12 months. While our forecast is much 46 I The global investment outlook RBC INVESTMENT Strategy coMMITTEE Summer 2012
Currency markets • Dagmara Fijalkowski, MBA, CFA lower than the consensus, we don’t consider it overly aggressive. The Canadian dollar As for the Canadian dollar, our discussion must start with PPP valuations, since our currency is again flirting with the line in the sand (Exhibit 11). Historically, the upside potential of buying the loonie at these levels is not attractive, and the currency’s forays beyond this 20% threshold have typically lasted months rather than years. Much of the good story on the Canadian dollar is already priced in. Keeping that in mind, we note that shorter-term valuations are more in line with current price levels, although there is a significant divergence of views in the market. Our own shortterm model, which is based on different monetary policies, commodity prices and differences in growth proxies, justifies exchange rates within 2% of parity (Exhibit 12). From a short-term valuation perspective, the Canadian dollar remains first and foremost a proxy for growth and, unless we expect growth to accelerate in 2012, the upside is limited. The same goes for the downside. It appears that in the absence of growth surprises or other unexpected macroeconomic developments, the Canadian dollar will remain comfortably around parity. Even after the Bank of Canada’s shift to a more hawkish tone in April significantly raised expectations of interest rate hikes, the loonie barely budged. The positive effect of monetary policy was overwhelmed by general risk aversion surrounding the Greek elections in May. Our view is that the change in the BOC’s stance would EXHIBIT 11. 1.70 1.60 1.50 1.40 1.30 1.20 1.10 1.00 0.90 1973 1976 1979 1982 1986 1989 1992 1995 1999 2002 2005 2008 2012 EXHIBIT 12. 1.06 1.02 0.98 0.94 0.90 USDCAD Short-Term Valuation Model S&P 500, WTI Oil and 2-Year Interest Rate Differential Actual Model Estimate Actual Value: 1.03 Estimated Value: 1.01 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Source: RBC GAM, Bloomberg EXHIBIT 13. 8% 6% 4% 2% 0% -2% -4% -6% USDCAD vs. Purchasing Power Parity PPP Average USDCAD 20% Bands Source: RBC GAM, Bloomberg SAMPLE Canada External Balances Current Account Balance (% of GDP) Foreign Direct Investment Balance (% of GDP) Portfolio Flows (% of GDP) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: Haver Analytics The global investment outlook RBC INVESTMENT Strategy coMMITTEE Summer 2012 I 47
Page 1 and 2: The Global Investment Outlook RBC I
Page 3 and 4: Contents Executive Summary 2 The Gl
Page 5 and 6: Executive summary • Sarah Riopell
Page 7 and 8: Recommended Asset Mix Asset mix - t
Page 9 and 10: Recommended Asset Mix Balanced Asse
Page 11 and 12: Capital markets performance • Mil
Page 13 and 14: Global Investment Outlook Eric Lasc
Page 15 and 16: Global Investment Outlook • Eric
Page 37 and 38: Global Fixed income markets • Soo
Page 45 and 46: Currency Markets Dagmara Fijalkowsk
Page 47: Currency markets • Dagmara Fijalk
Page 51 and 52: Currency markets • Dagmara Fijalk
Page 57 and 58: Regional outlook - U.S. • Ray Maw
Page 59 and 60: Regional outlook - CANADA • Stuar
Page 61 and 62: Regional outlook - Europe • Domin
Page 63 and 64: Regional outlook - Asia • Yoji Ta
Page 65 and 66: Regional outlook - emerging markets
Page 67 and 68: Eric Lascelles Chief Economist RBC
Page 69 and 70: This report has been provided by RB

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