USD in 2013: Will Risk Aversion Prevail?

Now that the U.S. economy is showing signs of life, there are some analysts who believe that 2013 could finally be the year that Uncle Sam gets back on its legs!

But just like a baby learning how to walk, there will be times where the U.S. economy will stumble and get some boo boos. Like my old boxing coach used to say, “You gotta fight through the pain, Gump!”

Here are three issues that we should all keep an eye on this year as they could prove to make-or-break the U.S. economy in 2013.

Housing and Labor Market Growth

Two areas that have started to show glimmers of hope recently have been the housing market and the labor market.

As I’ve pointed out in the past, housing starts and new home sales trended higher in 2012. Meanwhile, surveys conducted by the National Association of Home Builders (NAHB) showed improved sentiment for the housing industry.

As for the job market, non-farm payrolls have been posting jobs growth figures of over 100,000 for the past four months now. Part-time employment and the number of discouraged workers have also dropped from their peaks, indicating that jobs are opening up in the market.

While this is certainly good news, I can’t help but feel a little bit cautious.

For one, the construction industry no longer appears to be as big a contributor to the U.S. GDP as it used to. Residential investment and new home construction used to contribute 6.3% and 3.5% of GDP back in 2005; in 2012, these figures have dropped to just 2.4% and 0.9% respectively.

I’ve also noticed that the NFP report tends to be artificially inflated during the last quarter of the year, as companies hire more people ahead of the Christmas holidays. Chances are that this cannot be sustained, and we could see hiring take some hits during the early part of the year.

QE Round 5: Is it possible?

Back in September, the Fed lit up the markets to the tune of an additional 500 billion USD worth of bond purchases. Apparently, QE1 and QE2 weren’t enough to juice up the economy.

Later on in mid-December, the FOMC decided that QE3 wasn’t enough either and decided to add another round of bond purchases! Starting this January, the Fed will be buying bonds to the tune of an additional 45 billion USD each month!

In the past, some economists have warned us to prep ourselves for not only QE4, but for QE5 and maybe QE6 as well! While I won’t go as far as saying that more liquidity measures are as sure as a Kevin Durant jump shot, I would say that there’s a good chance that we could see the Fed continue to add to its bond portfolio.

Keep in mind that Barack Obama is still in charge and chances are that he’s gonna stick with Ben Bernanke as the Chairman of the Federal Reserve. Bernanke has been pretty cautious about the state of the U.S. economy, so if we do see any signs of weakness in the U.S. economy, don’t be surprised if we see Bernanke hint at the possibility of QE4.

Surviving the Fiscal Cliff

Unless you’ve been living under a rock, you should know that investors are worried about the “Fiscal Cliff.” The “cliff” here refers to the simultaneous implementation of the automatic federal spending cuts and the expiration of the Bush-era tax cuts by 2013.

What’s worrying market geeks is that the fiscal cliff could make a significant dent on U.S. economic growth, enough to drag it into a recession.In fact, a study conducted by the Congressional Budget Office in May already estimates that the fiscal cliff could cost the economy a whopping $600 billion in the first nine months and a ridiculous $800 billion if nothing is done throughout 2013. Yikes!

In order to avoid the fiscal cliff, the government must find other ways to reduce the deficit. Based on history though, it’s more likely that the politicians will end up kicking the can down the road and raise the debt ceiling rather than make any significant progress in dealing with debt.

So how could all these issues affect the dollar’s performance in 2013? Well, I have a feeling that aside from U.S. fundamentals, the Greenback will also be influenced by risk appetite.

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If the labor figures don’t sustain their recent trends or if politicians don’t come up with a way to avoid the fiscal cliff, then investors could become uneasy about the state of the financial markets, which could drive traders back to the safety of the Greenback.
On the other hand, if we see a shift to fundamentals, then the Fed’s strategy of continous bond purchasing could drive the dollar lower. We may even see the USDX drop below the major support level around 79.25!

If the euro zone debt woes and the possibility of slowing economic growth in China continue to dominate the newswires, then investors will most likely flock to low-yielding currencies like the dollar and the yen.

I’m no Pipstradamus, of course. It’s hard enough to predict the weather next week, let alone the dollar’s direction for a whole year. But for now, you can use the list above to consider the possibilities on where the dollar is headed next year.