As we enter 2011 three key themes are likely to dominate trade in the currency market. 

 

1. The Threat of Euro Fracture 

 As 2011 began Estonia became the 17th member to join the  European Monetary Union but even as the euro now covers more than 330 million people, its skeptics insist that its days are numbered.  Just as in 2010, the sovereign debt problem of the region’s peripheral economies will continue to dog the currency this year as credit markets remain on edge. The focus in 2011 will turn to the Iberian peninsula, specifically Spain which as a whole faces nearly 200 Billion euro of refinancing, although its actual  sovereign debt burden is considerably smaller. Recently the Spanish government announced that it will reduce its financing needs to 30 Billion euro from 40 billion  in 2011 in an effort to allay market concerns, but even it is able to slash its fiscal deficit, Spain continues to borrow funds at punitive rates and this dynamic is unsustainable. If Spain faces the type of funding crisis that befell both Greece and Ireland the euro may indeed become stressed to the point of fracture given the fact that its economy is the fourth largest in the EZ and may become too big to rescue. 

 2. China’s Hard Landing 

 News out of China over the holidays suggests that the worlds fastest growing major economy may be headed for a hard landing. The latest Manufacturing PMI data printed weaker than expected at   53.9 versus 55.7 indicating that production is starting to stall. Meanwhile, double digit food price inflation and a recent hike in rates could hamper consumer spending as the year progresses. China has been the primary driver of Asia Pacific growth since 2008 and if its torrid pace of growth finally slows to less than 10% per year, the impact  will most likely be felt in Australia which has benefited mightily from seemingly insatiable Chinese demand.  Up to now the Australian dollar has been unstoppable as a rally in commodities and  risk appetite flows have driven the unit to fresh post float highs of 1.2057. Nevertheless, the Aussie remains highly vulnerable to any slowdown in Chinese economic activity and could easily dip below parity in 2011 if investors begin to pare their growth expectations for the region.  

 3. US  - Recovery or Back to Double Dip? 

 As 2010 came to a close US economic data has generally surprised to the upside indicating that the recovery from the 2008 recession continues. However, labor markets remain horribly depressed with unemployment rate  still hovering near the 10% level. In order for the US economy to sustain its rebound, labor markets need to improve in 2011. Recent data has shown marked improvement in the weekly jobless claims with the latest reading dropping below the 400K level. However, the reduction in joblessness has yet to translate into any pick up in labor demand. To that end this weeks NFP report could prove crucial in determining whether US labor markets have turned the corner. If in 2011 US economy begins to generate consistent job growth the news should prove supportive to USD/JPY as US yields rise in response to pick up in activity. Up to now the pair has been contained within a tight 84.50-.81.00 range as traders views the US rebound with skepticism, but if the market becomes convinced that the US recovery is for real USD/JPY could trade to 90.00 by year end 2011.