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For the most part, we think that the majors themes discussed in our 2010 reviews will continue to press the markets in 2011.

Eurozone: Break it or make it?

The eurozone will go through major adjustments to fix the now uncontrollable bank and sovereign debt levels, along with the divergence in growth and fiscal responsibility that the debt crisis of 2010 has brought to light. Greece and Ireland have gotten their bailouts, but will the handouts stop there? Portugal is perceived to be next on the list of countries weak enough to warrant a bailout, followed by Spain. If they do, it could be lights out for the euro, especially if the stronger eurozone countries, like Germany, become unwilling to front the bill or maybe even leave the eurozone.

While I don’t see any members breaking away, another bailout is possible along with another euro drop. If there’s one thing I learned from all this debt drama, it’s that history tends to repeat itself. Remember how the Greek debt drama played out? After news of Greece’s worsening finances hit the airwaves, a bailout was swift to come and the euro was allowed to live and trade another day. We could see the same price action in 2011 with EUR/USD dropping to 1.20 and finding a bottom there once again. Besides weakening against the Greenback, we like shorting the euro against the Swiss Franc if things go south in the eurozone. The downsloping trend has been strong and could continue throughout the year.

Will QE2 Help or Hurt the US?

The other major theme transferring from 2010 to 2011 is the effect of QE2 and whether or not it it will help the US improve its outlook. The expected short-term affects of introducing another $600B into the system seems to have already been priced into the markets as we saw equities, commodities, and high-yielding currencies rise against a falling Dollar. Besides the markets, the effects of new stimulus remains to be seen, but we are starting to get bits of data here and there showing some signs of life (we got better-than-expected US manufacturing, pending home sales, and intial claims data this past week).

Couple this new stimulus with the massive reserves of over $1T on US corporate balance sheets, and the potential for a sharp bounce back in the US economy is there. Will US companies start hiring in 2011? If so, will they start spending like gangbusters on homes and consumers like before the financial meltdown?

The final question to ask concerning QE2 is the inflation effect. Will the cost of goods rise in the US with all this new money in the system? Again, it’s too early to tell after only a month, but it could be that QE2 might have already had an indirect effect on producer and consumer prices through commodities like oil and agriculture. I’m sure you’ve seen this the last time you filled up your gas tank or went out for a fancy dinner. If inflation does rear it’s ugly head, it could be a problem for growth. Let’s knock on wood and hope it doesn’t.

Overall, we think that Dollar weakness will continue at least during the QE2 process (through the first half of 2011) and we like to go long the Australian Dollar and Canadian Dollar because of the strong commodity components to their economies and positive interest rate differentials. The Swiss Franc has also been on a tear and after breaking the 2008 financial crisis lows and 2010 lows, we think this trend could continue and test the next major handle in USD/CHF: .9000.

Ok, that’s it, but don’t go yet! I asked the FX-Men for their “Top 5 Ridiculous and Highly Unlikely predictions for 2011.” We had fun with this so we hope you enjoy!

  1. Having already created the perfect gadget to amaze the world for years (yes, we’re Apple fanboys and fangirls), Steve Jobs quits Apple to search for new challenges and decides to run for the office of President of the United States. When asked at his first press conference how he plans to balance the budget, end the war in Afghanistan, and find jobs for every American out there, he simply responds, “Easy. There’s an app for that.”
  2. Activision takes a huge risk with their next installment of their massively successful “Call of Duty” video game series by releasing “Call of Duty: Prehistoric Warfare.” You play a Neanderthal warrior taking action against a rival tribe with sticks and stones as your weapons of choice. You’ll also be able to call in special airstrikes (pterodactyls dropping boulders) and triceratop stampedes. As with all of their previous hits, work productivity will decrease the day of its release.
  3. Facebook releases its IPO with spectacular fanfare but in an oddball fashion. Shunning hedge fund and institutional investors, Facebook decides to only give their loyal users access to their stock with two conditions. 1. They must agree to sign up and actively participate in Farmville (each user will get stock for “farm coins”) and 2. They must become Facebook friends with Mark Zuckerberg. Facebook stock opens at $1 and trades at that level for the rest of the year due to “lack of liquidity.”
  4. Pajama Jeans” becomes the must-have fashion product for women ages 15 – 65, and a billion dollar business in 2011. This will be in thanks to Kim Kardashian, who rocks a pair of “pajama jeans” hard during a cameo role in the upcoming sequel, “Sex in the City 3.” Oddly enough, the movie becomes THE big hit of 2011, especially with men ages 15 – 65.
  5. After over 50 years of tension and bloodshed, North Korea and South Korea abruptly ends their war and finally signs a peace treaty. The reason for doing so was kept in secret, but thanks to WikiLeaks, the amazing truth was uncovered. What united the people once again wasn’t a great act of compromise, but a shared love and passion for one thing–the movie “Men in Black.” Yeah, we don’t get it either, but leave it to Will Smith to save the day once again.

That’s it folks! Good luck and good trading in 2011!