KUALA LUMPUR: Uncertainty across the financial markets, instability in the eurozone and persistent high unemployment in the US — these are the issues that are going to weigh down the global economy this year.

Since growth is expected to falter, the outlook for regional Asian currencies is bleak. “Regional currencies will not outperform. Weakness [in economic growth] should continue although it may pick up towards the end of this year,” says Manokaran Mottain, senior economist at AmResearch Sdn Bhd.

When Asian currencies fall, the US dollar is expected to trend up. Although many expected the greenback to fall last year due to the US’ trillion-dollar budget deficit, it managed to recover in the second half.

On Aug 27, 2011, the ringgit traded at RM2.93 to the dollar but when the eurozone sovereign debt crisis took a turn for the worse, the US regained its status and attraction as a safe haven. The greenback hit a high of RM3.20 (RM/US$) last October and held steady through to the end of the year.

The currency’s appreciation was largely unexpected and many observers say “Operation Twist”, implemented by the Federal Reserve last September, gave it an additional boost. Under Operation Twist, the Federal Reserve sells medium-term bonds that are trading at low yields and buys long-term bonds. The upcoming presidential election in the US is another factor that supports the dollar as funds will be repatriated to fund the event.

The allure of the US as a safe haven will continue to support the greenback this year as investors avoid volatility and risks perceived in Asian economies and the trouble in the eurozone. Suresh Ramanathan, senior vice-president, regional rates and forex strategy, at CIMB Group Treasury, says the strength of the dollar is largely due to instability of the eurozone.

“European banks are selling their leveraged finance and structured finance operations in Asia. Capital outflows [from this region] have increased. A lot of money is going out and will probably hit a peak in 1Q2012 when a weak country in the eurozone actually defaults on its debts,” says Suresh.

In the first quarter, Suresh sees heightened volatility among currencies, with Asian ones falling and the greenback appreciating. “It will be a difficult time at the start of the year. If commodity prices fall, it will not bode well for resource-producing countries [and their currencies]. Commodity prices could fall between 10% and 20% this year. The greenback may well be the only currency to perform this year,” he says.

But extreme depreciation in the global economy and currencies is also unlikely. Nizam Idris, head of forex strategy at Macquarie Bank Ltd, says: “We’re not that pessimistic. To say it will likely be a bad period for Asian currencies in the near term is too presumptuous. We expect the eurozone to muddle through and eventually find a solution. We will see a shallow recession there for three quarters [a relatively short period] and foresee a decent 2.4% growth for the US. China and India are also expected to experience soft landings. This is not necessarily a bad environment.”

A vulnerable but supported ringgit

Although the ringgit appreciated against the US dollar last year, Nizam expects the exchange rate between both currencies to stabilise this year. “Based on our base case, the ringgit will not fare badly. We see uncertainty in the first half of the year and the RM/US$ at rather elevated levels, approximately RM3.20 in 1Q2012.

The ringgit will probably weaken before improving to RM3.00 by the end of the year. This translates into 7% volatility, which is now considered usual. Malaysia’s commodities will support its currency and [its course] should remain unchanged,” says Nizam.

The only thing that might push the ringgit down are unexpected results in the 13th general election, widely expected to be held this year. Manokaran’s forecast for the ringgit is RM3.10 by the end of the year, and says the local currency will be affected by falling softening global demand for exports.

To take advantage of currencies, Suresh says, there will be pockets of opportunities for investors to arbitrage. “Retail investors should identify those pockets. You wouldn’t get significant bottoms, but there will be pockets [when prices fall]. Do not hold for too long as cycles in currency markets are shorter – ideally it should be less than a month.”

End of the euro?

Problems in the eurozone show little sign of abating and the euro is the most vulnerable currency this year. Macquarie Bank Ltd’s outlook on currencies (as at last Dec 5), was that the euro would “be the worst-performing currency over the coming six months as its economy undergoes the necessary structural adjustments to keep the union alive”.

Will the eurozone survive 2012? Some analysts say a break-up is imminent while others are more optimistic. Suresh is among those who say a break-up in the eurozone is imminent and expects it to happen by the first quarter of the year. “Greece and Portugal have huge debts that mature in the first quarter of this year. These countries don’t seem able to pay. Greece is likely to be the first to leave the union, followed by Portugal,” he says.

Other experts like Manokaran and the Macquarie analyst do not believe that the union, formed in 1956, will allow a break-up of its existing members. “The euro area is ultimately a political union designed to bring long-lasting peace to Europe, more than it is an economic union. We think that this makes a break-up of the euro on the back of economic fault lines more unlikely,” notes Macquarie in its report.

If a break-up does indeed happen, will the euro crash? Suresh does not think so as Asian banks have been holding the euro steady so far and will likely to continue to do so.

“During the 2006/2007 rally in the markets when the US dollar was plunging, a lot of Asian central banks had diversified their reserves out of dollars into euro. Hence, they are not able to allow a significant plunge of the euro as it will affect their reserves,” says Suresh.

Despite its proximity to the crisis, the British pound will unlikely suffer the same effects as the euro.

“I am neither bullish nor pessimistic about the currency, but think it may fare marginally better than the euro. The question is whether the UK will benefit from the eurozone crisis. It’s uncertain for the UK but what is very clear from the Bank of England is that it is not implementing a tightening monetary policy as it is concerned about growth slowing down. These are recipes for keeping the pound weaker from a structured basis but there will be pockets for this currency to strengthen if the crisis in the eurozone worsens and funds flow out of continental Europe,” says Suresh.