By: Dean Popplewell, chief currency strategist and Alfonso Esparza, senior currency strategist, OANDA:

As the foreign exchange community winds down a typically eventful year, investors are already looking ahead to 2013.  In 2012, central banks exerted control over their balance sheets which led to limited volatility and decreased opportunities. The global economy is expected to strengthen somewhat as the effects of last year’s global liquidity injections finally move from the “financial arena” to the real economy. Most analysts expect even the modest upticks in economic growth intersecting with still-accommodative monetary policies to provide support for other asset classes like global equities.

But how many more “questionable assets” can policymakers absorb on their balance sheets? Last year this provided sustained downward pressure on volatility and led to tighter trading ranges. In 2013, expect investors to seek out more risk to sustain high returns, which will lead to change in the self-investment process. The market should expect future investing to reflect the intensity of credit and political risk in high-yielding assets. The US output gap and labor market will again come under intense scrutiny. Can policymakers initiate the fiscal tightening required to make budgets work in the medium term without undermining the ongoing present activity?

With traditional asset classes continuing to disappoint investors, there is an opportunity for forex spot trading to grow as a viable investment alternative. Trust in forex brokers depends on regulatory oversight as it gives clients the confidence to deposit their funds. Regulators around the world are moving towards implementing policies in the forex markets that validate the asset class and open the doors to the new global investor.  

High & low volatility

As more market participants become risk averse we could see a continuation of the lower volumes of the past two years. Safe havens are becoming ever scarcer which could make it harder for the economies of the U.S. and Japan to make a full recovery if their currencies are strengthened by low risk seeking flows.

For the Eurozone in particular, current measures are not intended to solve the crisis, but rather to buy more time in order to reach a decision. This lack of a single approach will continue into 2013 as every nation is trying to look out for the interest of its citizens with sometimes opposing views on the same issue. Spain will continue to be in the financial press for the wrong reasons as the issues of sovereign debt and a decaying banking system will deepen. Italy could start showing signs of distress as growth continues to stagnate. Political gains have been won, but only time will tell if those victories can be transferred to economic results. The size of those two economies makes the contagion into France and Germany a clear possibility.

For investors, we see several key events having the largest potential to drive the currency markets next year. The Fiscal Cliff, if not resolved by the first of the year, will be a major topic of discussion in early 2013.  Important elections in Germany (September) and Italy (April) could set the tone for European economic policy and several important leaders will be taking office: China will officially appoint its next President, Xi Jinping, and Prime Minster, Li Keqiang, in March. Meanwhile on the central bank front, Mark Carney officially takes control of the Bank of England on July 1.

Regulation & the FX markets

Generally speaking, the greatest threat facing the global financial services industry is more regulation. Whereas regulators were once caught sitting on their hands, now the pendulum has seemingly swung in the other direction with a greater focus on regulatory compliance. The financial services industry has gone from being client-focused to more compliance-focused which has become a huge overhead burden and has forced many banks and other financial institutions to make drastic cutbacks.

The effects of regulation will not be felt equally around the world. In mature markets such as the US, UK and Japan, market consolidation is already evident.  No major regulatory changes are expected as the regulation has developed alongside the market. There will be more M&A activity and market entry by more sophisticated participants such as banks and discount brokerages. Regulation in emerging markets will continue to improve as other financial centers are hoping to attract investment capital and financial services talent.

How trading will change

In 2013, we at OANDA expect to see more changes in the way people trade. Social trading, whether through broad-based social media platforms such as Twitter and Facebook or on more industry or company-specific channels, will continue to grow. There will also be an emphasis on mobile trading and ‘affordable’ high speed trading, both in terms of access and functionality. Finally, we expect a shift toward platform-agnostic trading. APIs will allow for more plug-and-play platforms for clients, allowing them to use their independent platform of choice powered by their liquidity provider of choice.

With increased trading opportunities present in many markets and asset classes comes greater economic uncertainty and increased volatility and thus requires further trader vigilance and caution.  Stay tuned.

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