It is often useful to learn from one's mistakes, or in some cases from one's successes, and as they prepare for their 2012 Blueprint, Deutsche's FX research team focuses in on lessons they learned from the travails of an asset class that was at times chaotic and at others baffling in its stagnation. Digressing from the high levels of uncertainty accompanied by strange periods of low volatility to a recognition that emerging markets did not decouple and there are no more safe havens, the five key insights offer practical views on what worked and what didn't and critically going forward to focus on the flows emanating from the Euro-zone as opposed to monetary policy.
1) High level of uncertainty does not mean large market moves.
Given the shocks that hit markets over 2011 from earthquakes in Japan to US downgrade to the Euro crisis, one would have thought 2011 would have seen some of the largest market moves in recent memory. However, the ranges for G10 currencies over 2011 were below average and most currencies have ended the year close to where they started the year. Fear has been high as suggested by high levels of implied volatility, but it seems the fear has paralysed the market into small ranges (see first chart).
2) Monetary policy no longer mattered for FX.
For years, we've used rate expectations to determine FX moves in a linear fashion and it has worked well for much of the past five years. However, 2011 proved that correlations do not last forever as the rates/FX correlation collapsed to negative territory (see second chart). So it didn't matter that Aussie rate expectations were scaled back significantly over 2011, while Norwegian rates were not, their currencies performed the same.
3) Best way to play the Euro-area crisis was not to use the euro.
We were all trying to play the euro crisis through selling the euro, yet the best way was to have bought CHF as the euro crisis was building up in the first half of 2011 and then to have sold HUF as the euro crisis became global (see third chart). The moral of the story was to have followed the flows that were triggered by the euro crisis (first Euro-area safe-haven flows to Switzerland, and then Euro deleveraging flows out of Eastern Europe).
4) There are no new safe havens.
In the middle of the year, it became fashionable to talk of NOK or SGD as the new safe havens. They did briefly perform well as the USD dollar faltered. But when it came to the crunch, both the USD and JPY were the best performers as risk aversion escalated towards the end of the year.
5) There is no EM.
We split the world into developed (G10) and emerging, yet grouping currencies in such a way has no bearing to their performance. Over 2011 some EM did better than G10 and vice versa. One could argue that there is G10+Asia versus the rest, but the better grouping could be to look at the underlying features of the currencies. For example over 2011, we could have grouped currencies into five camps: 1) safe haven/managed FX, 2) solid FX fundamentals or reserve FX, 3) trade surplus/growth FX ,4) high beta/risk FX and 5) deficit/inflation (see final chart). That gives a truer sense of the world, rather than sticking to labels from the 1980s.