We may all think we are headed into the sunny uplands of growth and prosperity, but this year could see more volatility than we bargained for.

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One area of concern is governments’ monetary policies and the impact they have on foreign exchange rates. Low energy costs, low inflation and cheap imports on the back of slowing emerging market growth and the strong dollar have made us feel as if things are finally going our way. Not to pour cold water on a number of encouraging trends, but that strong dollar is already causing problems and those problems will get worse.

Source: Daily FX

Source: Daily FX

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Some countries in Europe already have negative interest rates, Denmark and Switzerland’s are at -0.5% and -0.75% respectively, charging clients for the pleasure of holding their money, in an effort to stave of safe-haven status vs the euro.

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Royal Bank of Scotland Research is not predicting base rates in euro-land or Japan to rise from 0.1% in 2015 or 2016, and in the UK they are predicted to only rise from 0.5 to 1.0% next year. That is a reflection of an almost deflationary environment and such weak growth that the risks to inflation are non-existent.

Source: RBS Bank

Source: RBS Bank

Chinese rates are predicted to fall from 6% last year to 5.6% this year and 5.3% in 2016. Likewise, India, which could fall to 7% this year from 7.8% last year, will likely only rise to 7.3% in 2016.

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After taking a 4-week break in February, the US dollar has restarted its ascent, skyrocketing again in March. The index is recently hit a new multi-year high.

Dollar Index since 2013

US dollar index since 2013. Source: MetalMiner

Meanwhile, the Euro has fallen to its lowest level in more than a decade. Continued friction between Greece and its EU and IMF creditors and sluggish economies are all impacting the Euro.

Euro index since 2013

Euro index since 2013. Source: MetalMiner

We know that spikes and falls in currencies can have huge impacts on commodity prices and, therefore, in the price you pay for your metals. As the dollar strengthens again, it might not be long until commodities take another hit.

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In particular, the rising dollar will keep downward pressure on crude oil. Oil prices have stabilized since their big drop and the beginning of the year, however, the rising dollar might be pointing to further declines in oil prices. Read more

We have briefly covered Greece’s decision to vote in the far left “anti-austerity” Syriza party in posts this week, mentioning the short-term impact it has had on copper and gold prices.

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In truth, though, the outcome of the election had been largely priced into both commodity prices and foreign exchange rates, so although the euro weakened on the news it has not crashed. Switzerland’s removal of the Franc’s peg to the euro had more impact and the European Central Bank’s annnouncement of a quantitative easing program was equally disruptive. But Syriza’s election and formation of the government with the help of the far-right Independent Greeks party will certainly start a period of considerable volatility in European markets as negotiations are conducted in the glare of publicity, and no doubt behind closed doors, about Greece’s future in the European single currency.

The new Greek government has started positioning itself ahead of negotiations with Greece’s creditors and some would argue they have nothing to lose. There are many voices urging Greece to simply default on everything, leave the Euro and launch a new devalued Drachma but that is clearly the nuclear option and will be held as an unspoken threat during negotiations.

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This is part two of an examination of the political and economic ramifications of the election of Greece’s far-left Syriza party. Read part one if you missed it.

Any failure to meet austerity commitments to the European Central Bank, International Monetary Fund and European Commission next month by Greece will see the next tranche of loans not being paid by the troika of at the end of February. As liquidity from the ECB to Greece’s banks dries up, a banking crisis will ensue.

Not surprisingly, private money is already heading for the door, some €8 billion of deposits have been pulled since November when the election was called. So, who will blink first? Syriza or the troika?

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It is clear voters in Germany, Finland and the Netherlands, do not want their taxes used to underwrite a blank check for countries that get into financial trouble.

“Ultimately, this is a clash of democracies, rather than a clash of ideas,” Mats Persson, director of Open Europe, a research organization in London is quoted by the New York Times as saying. “Voters in Germany and Greece want very different things.”

More than that, he adds this understatement: “Germans and Greeks have fundamentally different views on how to run an economy.” Don’t they just. But you can see the Germans’ point of view. Of all the bailout money provided to Greece, Germany has been the largest contributor.  Their contribution is all in the form of loans that have not yet fallen due.

If Greece defaults, the German taxpayer will largely foot the bill. Nor does the European Union want to set a precedent by allowing Greece to renegotiate its position and end the austerity drive but maintain the bailout funding. The risk of contagion, not for an exit but for a renegotiation, is high. In Spain Podemos, a party similar or at least highly sympathetic to Syriza, leads the opinion polls and national elections are due next year. Germany really can’t afford for a major relaxation of rules for repayment or the drive to collect more taxes and balance the books. As they see it, if they let Greece off the hook Spain could be next, then Italy and you can bet France would be right behind.

So, we are set for a clash of ideologies, and at the moment neither side has given the slightest hint they intend to back down. Inevitably that is going to cause considerable foreign exchange, stock market and, by association, commodity volatility, particularly in Europe. Banks across the region will be seen to be at risk, some of whom have been major players in commodity financing. If they cut their risk profile to shore up their positions they may well start with commodity financing. Syriza has won an important victory, but a new chapter of European instability is only just beginning.

The new year in metals has already been marked by steep dives in commodity prices, and major changes in the status quo, so why should week three be any different?

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But this week’s story wasn’t about falling commodity prices or the price of oil and how it’s dragging its commodity brethren down. It was, instead, the week of central banking reaction and currency coming back to the fore. Sit back for MetalMiner‘s money market manipulation maelstrom.

Kneel Before the US Dollar!

Lead Forecasting Analyst Raul De Frutos wrote about how the dollar is going nowhere but up and the dollar index just hit an amazing 11-year high this week. Commodities, in turn, hit their lowest levels since 2009, but that’s old news by now. The bigger takeaway was that foreign currencies are now depreciating heavily against the strong dollar.

US Dollar Index since 2000

US Dollar Index since 2000. Source: MetalMiner.

How governments react to their falling currencies could cause major shifts in commodity prices. So, how ARE those governments and central banks responding?

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The Swiss franc rose 20% against the euro on Thursday, after the Swiss Central Bank announced its decision to remove the exchange rate cap against the euro. A massive rally boosting the franc occurred within seconds and liquidity dried up since, obviously, no one was going to buy euros after the announcement.  This left investors and big trading firms naked as they couldn’t sell their positions until the franc was already way up. They couldn’t do anything but lose a ton of money.

Swiss Franc to Euro since 2010

Swiss Franc to Euro since 2010. Source: MetalMiner.

This kind of regulatory change causes huge market disruptions and the move was as volatile as can be. Now, this 20% move might seem like a lot, especially after a 3-year period of slight movement, but could the franc go higher?

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Investors see the Swiss franc as a safe-haven and in 2011 it appreciated greatly against the euro. Then, the franc experienced a quiet period as the cap was introduced in September 2011. But now, as the cap is being removed, the trend is back up again as the franc marks a new all-time high against the euro. Sure, it’s a big jump, but in this period of weakness in Europe and emerging economies, we could see safe-havening inflows pushing the Swiss franc even higher .

Swiss Franc to Dollar since 2010

Swiss franc to US dollar since 2010. Source: MetalMiner.

The franc also appreciated steeply against the US dollar, marking a 3-year high (see above). Despite the strong performance of the dollar during the past few months, it seems like it will have a new competitor.

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Europe is once again in the news as a cause of fear in the financial markets. This time it’s not due to Greece or any of the Club Med countries but more due to the EU economy and the Euro as a whole.

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The value of the euro fell to its lowest level in years this week, hitting $1.19 a 15% fall from May and the lowest level since 2005, In response European stocks fell sharply amid uneasiness about whether the region is on the verge of a new economic and financial crisis.

Source NY Times

Source: NY Times.

Stock markets were already under pressure from falling oil stocks as Brent crude hit a 5-year low, interpreted by many as a sign that global demand has collapsed resulting in a glut of oil driving prices down. The markets are betting on the European Central Bank (ECB) introducing sovereign and corporate debt purchases at their next meeting on January 22, a form of “Quantitative Easing.”

Indeed, in the New York Times Jean Pisani-Ferry, an economist who serves as a policy adviser to the French government, is quoted as saying the markets have already priced in the introduction of QE and if the ECB fail to act, the consequences could be dire.

“Disappointing those expectations would bring an abrupt and damaging unwinding of positions: Long-term interest rates would rise, stock markets would sink, and the exchange rate would appreciate,” he wrote.

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You can’t accuse the Germans of mincing their words, or certainly not one German economist interviewed by the Telegraph newspaper and reported in full last week. Hans-Werner Sinn, the president of Germany’s Ifo Institute for Economic Research is reported as saying the Euro-zone is doomed to a decade or more of economic stagnation and civil unrest that could destroy the single currency if countries such as France do not implement vital reforms.

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Mr. Sinn does not reserve his criticism for France but some of his words ring a bell with a view long-held in the US that the social heart of Europe is living in cloud cuckoo land when it comes to their competitive position relative to the rest of the world.

Source Telegraph Newspaper

Source Telegraph Newspaper

He went on to say French industry has been dying for decades now. The share of manufacturing in GDP is only 9%, less than half that of Germany. The people who were set free from manufacturing, or their children, have by and large been absorbed by the government sector, which has now a quarter of the workforce, twice that of Germany.

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Read the first part of this post here

Would the US, Britain, or Japan change policy at the request of foreign powers because the foreign powers were, relatively, not doing as well? I don’t think so, especially if that meant lower support for exporters and industry, stoking inflation, and boosting internal consumption when the economy already has the lowest unemployment rate in Europe.

The villain here is not Germany, but the Euro. Arguably, if Germany left the Euro, one could see some immediate corrective swings occurring. Germany’s new currency would rise dramatically against the “new” Euro, and the remaining Euro countries would benefit from a massive devaluation in their currency, boosting competitiveness.

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Unfortunately, there would be no one to fund the hundreds of billions of dodgy loans and outright debt the area is saddled with. Because what is oft overlooked is the fact that Germany has been the largest contributor to the European Stability Fund and the European Central Bank. German guarantees supporting the existing bailout fund amount to €211 billion ($285 billion). The ESM will require a capital contribution from Germany. If the ESM lends its full commitment of €500 billion ($675 billion) and the recipients default, Germany’s liability could be as high as €280 billion ($378 billion).

As the FT points out, the size of these exposures is huge in relation to Germany’s GDP of around €2.5 trillion, and German household assets estimated at €4.7 trillion. Nor is Germany without its own problems. It has substantial levels of its own debt (over 80% of GDP), an ageing population, and deteriorating dependency ratios, to compound its problems.

Don’t forget to read October 2013 MMI analysis before November’s full report comes out next week!

No wonder Germany suggested taking over the running of the Greek economy early in 2012. They wanted to be sure a major default didn’t start a domino effect that would end at Germany’s doorstep.

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