LONDON, December 29, 2011 /PRNewswire/ --

With the year coming to a close, Neil Looker, Chief FX Dealer at City Index gives his overview of the foreign exchange markets and shares his thoughts on the Forex outlook for 2012.

The FX markets have ended 2011 broadly within 1-2% of where they started in the major forex pairs such as EUR/USD. The markets have been in a state of elevated risk aversion mode all year and the eurozone crisis is still firmly in the headlines.

However, with market volatility set to continue well into 2012, the coming year could offer renewed financial spread betting opportunity for traders.

Neil Looker, Chief FX Dealer, City Index:

The question now is where do you go in 2012 for growth stability and yield? Let's not forget, this year we have seen the US lose its AAA rating and re-emerge as the most aggressive policy makers in the Central Bank space, with rates on hold until 2013 and unconventional monetary easing (also known as Operation Twist). We can potentially add to this QE3 should the labour market fail to improve.

The US dollar could be set for a volatile year

The dollar could be bullish in Q1, though questions may arise in Q2 for a potential USD demise into Q4. The US dollar finished 2011 extremely strongly as it was sought after by most traders as a safe haven play. There is every chance this could continue into the start of 2012 if European woes continue to dominate the demise of the single currency. In this sense, the dollar's popularity could remain strong as traders look for quality and some safe haven status that will benefit the greenback, with European politicians continuing to kick the can along the street in terms of failing to announce credible bazooka gun solutions to the crisis. With financial spread betting you can speculate on the changing prices of over 50 major and minor currency pairs, including EUR/USD.

In May 2011 it may have been extremely hard to convince that the euro/dollar rate could fall as low as $1.10 but this is a real possibility if eurozone woes continue to dominate the headlines. There remain a few hurdles before that could happen though, with support seen at $1.29 and $1.19. This may not however be the end of the dollar's strengths as anymore European woes could help to trigger the dollar's gain against nearly all pairs, particularly risky commodity pairs such as the AUD and NZD that are historically affected severely by global growth slowdowns and specifically any weakness seen to Chinese growth.

The Pound Sterling versus the Dollar (GBP/USD) could well be another somewhat boring year of trade. The UK's dismal growth prospects and a gradual depreciation of the queen's currency, which could be triggered by yet more QE from the Bank of England as early as February, could keep the pound unable to prevent the dollar from gaining more ground in the exchange rate. However, let's not forget the AAA rating that the UK holds, which could soon become rare, given the negative outlooks that exist for other top notch rated states in Europe and this may help to keep the pound supported.

How Q4 could be a turning point

Given the high sensitivity amongst traders, there is every chance that the markets could punish uncertainty. A potential breakup of the euro could be triggered by certain events, such as a loss of France's AAA rating. This is likely to make the EFSF more difficult to leverage up, as well as other negative consequential factors.

However, if the euro does break up, it may not necessarily be bad for currency trading. The hallmarks of a potential break up could be long in the running before the event actually takes place and so from this sense, the FX market could be focusing on parity with the majority of positions potentially short in the single currency. As such, with the market getting some certainty, any breakup of the euro could in fact turn out to be a positive.

Let's remember the spiralling and unresolved American deficit is not going away anytime soon and although we have seen stronger growth numbers in late 2011 and even some sign that the labour market is turning, let's not forget the effect of a European recession is likely to have on the US. With the only powerful option left in the Fed's locker room being QE3, there is every chance that should the Fed start the printing presses again in the second half of 2012, the dollar could well have peaked out.

Should the dollar start to weaken in the second half of the year, EUR/USD could see a quick gain on shorting covering to potentially target as high as $1.5000. However, an important trade for the second half of the year could actually be in the USD/JPY forex pair, as the cash flows recycle to other safe havens should QE3 emerge. With this pair historically so sensitive to yield curves, there may indeed be little that the Japanese authorities can do to stop JPY appreciating should fresh flows of safe haven funds find their way to the yen. In this sense, should momentum start to build behind the yen, the tug of war target of 65.00 could well be a definitive target.

For more information about what could be in store for the stock market, read the 2012 Outlook at City Index, which includes further detail about the stocks and sectors to keep an eye on.

Spread betting and CFDs are leveraged products which can result in losses greater than your initial deposit. Ensure you fully understand the risks.

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As a group, City Index transacts in excess of 1.5 million trades every month for individuals in over 50 countries worldwide. They also provide access to a wide range of instruments including margined foreign exchange, CFDs and, in the UK, spread betting. For more information, visit http://www.cityindex.co.uk/.

SOURCE City Index