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Most of the world's major economies have emerged (cautiously) from the biggest recession in decades, but growth remains fragile.
In such an environment, most of the major economies of the world would rather avoid, if at all possible, having their currencies appreciate, and the efforts of several countries, including the United States, Japan and United Kingdom, at quantitative easing, seem designed at least in part to bring about a lower exchange rate.

However, clearly not every country can have a weaker currency. In the past year or so, if you wanted to own a floating currency where the central bank was not actively debasing its value, your list of options was pretty short: Canada, New Zealand and Australia, and if you didn't want any of those, there was always gold.

Forecasting exchange rates over the short term is fraught with danger; a mug's game some would say. With that caveat in place, let's have a go.

In 2011, there's a decent chance that many of the trends and themes that have dominated currency markets over the past year or more will reverse.

The tone of the economic data coming from the US has improved markedly of late. Fears of a renewed recession have abated.

True, the US housing market remains depressed and over time the government still needs to de-lever. However, household incomes are rising, the private sector is hiring, and key business surveys are at levels consistent with reasonable economic growth.

This is not to say the US is firing on all cylinders - it is not, but over the year ahead it is likely to become clear that of the major economies the US is performing reasonably well, and the broad downtrend in the US dollar over recent years is likely to reverse.

Japanese growth is likely to remain subdued and the economy remains mired in deflation. In Europe, the problems on the European periphery are truly massive, and there is little sign of a decent resolution emerging any time soon. Among the majors, the US economy is the best of a mediocre bunch.

Over the past couple of years there have been plenty of reasons to love the Australian dollar: the soaring terms of trade, widening interest rate differentials as the Reserve Bank of Australia raised interest rates earlier and faster than virtually everybody else, healthy public finances, and a strong economy.

However, the currency is now significantly overvalued on traditional measures such as purchasing power parity. For those sectors not exposed to the resources boom, such as inbound tourism, education and manufacturing, the level of the currency is becoming problematic.

The reasons to love the Australian dollar are now well known to all and sundry. It wouldn't take much to go wrong here (or right for the rest of the world) for the currency to fall significantly. Enjoy the overseas shopping while you can, but it probably won't last.

One of the things that could go wrong for Australia would be a sharpish slowdown in Chinese growth or a significant change in the composition of that growth.

Given the deft management of their economy the Chinese authorities have demonstrated in recent years (one of the benefits of in many ways still being a command economy) such a slowdown is unlikely, but it can't be entirely ruled out.

The Chinese authorities have continued to resist international pressure to allow their currency to appreciate at a faster rate, fearing an adverse impact on their export growth. While they are most unlikely to agree to such pressure, the year ahead is likely to see further modest increases in the value of the renminbi.

MLC & NAB Wealth investment strategist Brian Parker

 

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