Currency Decoupling Ahead

The euro has been trading in tandem with key commodity currencies, but that could change - and create trading opportunities.

Ever since the financial crisis, the euro has been trading almost in lockstep with the Canadian dollar, the Australian dollar, and the New Zealand dollar. Nick Bennenbroek and Vassili Serebriakov, strategists at Wells Fargo, say it has been most pronounced when market conditions are extreme - either stress is high, or the Federal Reserve is aggressively easing.

"For 2012, however, our base case is that financial market conditions will move away from these extremes," the strategists wrote in a note to clients. And they expect the euro to move away from the commodity currencies at the same time.

How do you trade this? Bennenbroek and Serebriakov argue that the euro is going to move closer to being a 'funding' currency - a currency investors sell in order to buy a higher yielding one. This would mean the euro would soften against Aussie, the kiwi, and so on. "Should the European Central Bank continue to cut rates and otherwise ease liquidity, and considering the euro zone's relatively poor economic outlook, there may be increased willingness by market participants in 2012 to fund in euros, while investing in higher yielding commodity and emerging currencies," they say.

Bennenbroek and Serebriakov expect the euro to weaken significantly, to 1.20 against the dollar, in 2012 - and they expect the three big commodity currencies to outperform the buck.

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