Elections, data will drive currencies

We see three main themes driving our outlook for the markets over the rest of the year. Political uncertainty takes centre stage globally due to a large number of governments in transition (for example, the French presidential elections in April/May, US presidential elections in November, and Chinese leadership transition in October).

Furthermore, the US continues to show some resilience in recent economic data and we expect US growth of around 2.25 per cent. We believe that the labour market will recover modestly in line with the overall economy, though the pace may remain sluggish. The housing market too has started to show signs of life, but is not yet contributing much of a boost either to growth or consumption.

The biggest uncertainty in the US continues to be around the government's debt level and how these issues might be addressed going forward. Finally, in Europe, the risk of an imminent meltdown has been reduced, but what remains is a slow burn from a recession in the periphery and a credit contraction due to long-term deleveraging pressures on European banks. Slower growth in Europe and monetary/credit tightening will likely impact Asian growth too, but we expect 2012 to be an improvement over 2011, even at lower growth rates.

The "soft-landing" scenario in China is supported by high saving rates, growing consumption in China, and a long history of current account surpluses.

Positive tone

The dollar performed on a more positive tone over the past few weeks. The dollar is now up nearly 3 per cent since the end of February. This is happening despite the confirmed low for long policy message from the Federal Reserve and it captures a context in which the US monetary authorities are telling us something while the market is telling us something else. While a few weeks ago, any strength in US economic releases were dollar negative to the extent that they boosted risk appetite, they should now be seen as dollar bullish to the extent that they boost short-term US rates.

Meanwhile, in the Eurozone, the Greek situation has been catching less headlines and the contagion risks are better contained in the post-LTRO context. So, the time may have come to focus on the data again, in the Eurozone too. The picture is not a pretty one at this point, but it would appear that we have moved away from some of the worse doom and gloom growth expectations that were built into the market earlier this year.

The forward-looking (and reliable) manufacturing and services PMIs are most important. Both indices stand just below the 50.00 expanding mark, which are levels consistent with a mild recession scenario. This is also in line with the ECB's main growth assumptions for this year. This comes in a context of externally/commodities driven upward inflationary pressures and implies that at this stage, any ECB rate cut seems to be out of question. An arguably less dovish than expected ECB is an important consideration in justifying a still relatively resilient euro outlook into the second half.

In Asia, we may to learn to live with a more volatile CNY (offshore yuan) and CNH (onshore yuan). Recent remarks by Premier Wen Jiabao who hinted that the yuan is fairly valued have raised question marks over the medium-term prospects for the Chinese currency, especially as he made those remarks at a time when the Chinese economy is losing momentum and following the recent downgrade to this year's GDP target (to 7.5 per cent).

In this context, there has been speculation that the authorities could be tempted to push for a weaker currency. We already had pencilled in a flat outlook for the CNY in the first half and the recent news flow is in line with this view. Indeed, we expect the CNY/CNH to be more data dependent/more volatile, especially in the next two to four months.

Perez is Chief Investment Strategist EMEA, while Childe-Freeman, Global Head of Currency Strategy at J.P. Morgan Private Bank.