"The FX markets are now under the influence of a trilogy of themes," says Société Générale strategist Vincent Chaigneau in his latest report.
The three themes driving markets, Chaigneau says, constitute a "regime shift" that the bank expects to dominate the investment landscape for the rest of the year.
The first theme, according to the report, is the American economic revival. Everyone is turning bullish on the U.S. economy – especially relative to its peers in Europe and in Japan – as the labor market slowly heals and industrial production heats up.
At the same time, investors are pulling money out of safe-haven assets like Treasuries and gold, causing those assets to underperform against riskier assets like stocks this year.
Finally, SocGen believes the Federal Reserve will begin to taper asset purchases – i.e., start rolling back quantitative easing – in the second half of 2013. If this happens, it will be very supportive of the U.S. dollar against its competitors in the developed world.
"The exit debate, we reckon, will heat up in H2," Chaigneau writes, "and this will propel the US dollar higher: we see the EUR/USD down to 1.20 by year-end, and the USD/JPY above 103."
That parlays nicely into the second theme: diverging expectations of policy moves from global central banks.
While the Federal Reserve begins to draw up an easy-money exit plan, other central banks around the world appear to be just getting started.
Take the Bank of Japan, for example, which is about to roll out the government's "Abenomics" game plan when it installs a big dove at the head of the central bank next month.
Britain is doing the same at the Bank of England. Incoming BoE Governor Mark Carney takes the helm in July, and the British government is discussing modifying the central bank's remit to allow Carney to get more experimental with monetary easing.
"Monetary policy expectations will remain a drag this year for the currencies of countries that are lagging in the recovery, mostly European currencies and the yen," writes Chaigneau.
The European Central Bank is a bit more of an open question, but one thing is for sure – the euro area continues to sink deeper into recession, and ECB President Mario Draghi took great care to emphasize at the central bank's most recent press conference that the ECB's monetary stance remains accommodative.
That brings us to the third theme. While the euro crisis has faded as a major driver of global markets in recent months, SocGen expects "another shockwave" in the euro zone "in the spring."
"It is far too early to dismiss EA crisis as a key driver," says Chaigneau. With political instability on the rise in Italy – and a positive outcome there for markets appearing less and less likely – there could be some turmoil.
Italian political instability doesn't come at a great time because of the German federal elections in September. Should Italian bond yields rise to unsustainable levels, Italy will likely find itself without much support from German politicians looking to get re-elected at home.
That's the recipe for another shockwave, which Chaigneau says " will be strong enough to undermine the euro in the coming months, and more so now that the key 1.2930/70 area is broken."
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