FX Forecast Update: Shoulder to Shoulder with Inflation Fears and Growth Scares
Closer to stabilisation. The four best-performing currencies during the past month have been SKK, TRY, HUF and BRL (up by 4-6% vs EUR), followed by CAD and AUD from the G10 group. SKK benefitted from the Slovakian 15% revaluation prior to the euro adoption at the beginning of 2009; TRY and HUF gained on speculation on higher interest rates due to surging inflation; and BRL advanced on the back of S&P's upgrade to 'investment grade'. The worst-performing currencies were the lowyielders CHF and JPY (down 0-1% vs. EUR) due to a higher degree of risk appetite, while KRW lost some 2% against euro and the South Korean central bank had to intervene to keep the currency above water. Generally, the exchange rate movements were limited over the month and volatility declined gradually. Volatility levels are now broadly down to levels from the start of the year. Yearto- date, the best performing currencies have been SKK, PLN and CZK while ISK, ZAR and KRW have lost the most.
Blurred picture. The one-month performance of our forecasts has been mixed over the month. We traded around our EUR/USD forecast of 1.56 during most of the month while our USD/JPY forecast of 102 proved to be on the low side. Our EUR/GBP forecast of 0.80 was actually reached on 21 May but the pair's rise was short-lived and it fell back to around 0.7850 at the end of the month. EUR/CHF traded somewhat higher than our forecast of 1.60 during the month while our forecasts on Scandinavian currencies were closer to the actual developments. We predicted EUR/SEK to end the month at 9.30 and EUR/NOK to decline to 7.85. The pairs traded around these levels during most of the month but ended a little higher.
Direction lost. The credit crisis has not been kind to the USD. The combination of a US-imposed financial distress and a collapse in the US housing market made forecasting relatively easy; USD was a declining asset set to earn a lower rate of interest. We forecasted that EUR/USD would reach a target of 1.60, which actually occurred during mid-April. As the credit crisis draws to an end, things are not crystal clear anymore. EUR/USD has stopped its continued upward drift and market participants have started to discuss whether we are beginning to see a turning point in the pair. It is evident that EUR/USD cannot drift higher eternally. The euro is historically overvalued to the dollar and a permanent misalignment is simply not an option. A deviation from 'fair value' can, however, last some time. That happened in 2000-01, where the EUR/USD traded in range, after touching a low of 0.83. We discussed the similarity between the 2000-01 experience and the current situation in EUR/USD: Will history repeat itself?.
The sky's the limit. Food and energy prices have recently sky-rocketed. This generates an upward price pressure and inflation is either on the rise or set to rise in most economies. While economists are busy discussing whether this represents a speculative bubble or if fundamentals (such as increased demand from emerging markets) offer a sufficient explanation, we are left with the risk that this marks the beginning of a prolonged or even permanent period of elevated commodity prices. The important issue for the FX markets is, however, not the rise in commodity prices in themselves but rather; which currencies are set to benefit and which are expected not to benifit due to higher food and energy prices. In G10: FX implications of rising food and energy prices we found that EUR/USD and perhaps CHF/JPY is likely to head higher in the near term, while CAD/NOK is expected to turn lower if energy and food price inflation remains high. EUR/USD and AUD/NZD are both expected to rise on the longer term on higher energy prices.
Central bank re-pricing... Over the past two months, we have seen a substantial re-pricing of global monetary policy. Markets have switched from a joint expectation of easing to tightening across the scale. Two months ago, the markets expected the Fed to cut once more by 25bp, the ECB to cut one or two times by 25bp, the BoJ to cut by 25bp and the BoE to cut by not less than 100bp in the following 12 months. Currently, the markets expect the Fed to hike rates at least three times by 25bp, the ECB to raise rates one or two times by 25bp, and both BoJ and BoE to hike rates by 25bp. In our view, the sell-off appears more excessive in the euro curve and a reversal of the latest repricing would therefore most likely leave EUR under pressure relative to both USD and JPY. Relative interest rates have, however, not been the main driver in the FX market lately, and it is therefore uncertain how large the effect would be from a re-pricing in the bond and money markets.
EUR/USD forecast maintained. We do not see any weighty reasons to change our EUR/USD forecast from last month. Second-order effects from the credit crisis are due to dominate both regions and the balance of risk is still perceived to be on the upside. Accordingly, the pair has potential to move in both directions and the best description for our EUR/USD forecast is 'range-trading on a mountain top'. We foresee EUR/USD at 1.55, 1.50 and 1.50 in 3, 6 and 12 months, respectively.
Higher USD/JPY 3M forecast... JPY reacted very little on macro data over the month. If that had been the case, JPY would probably have fallen even further. Instead the focus was pointed towards the incipient risk appetite and mounting leveraging. The steps here are cautious, as market participants continue to be nervous after the credit crunch. We believe JPY will continue to be dominated by risk aversion / risk appetite. JPY is the only currency that is undervalued relative to USD and we continue to see a potential in the Japanese currency. We acknowledge, however, that this strengthening will probably not take place in the near term and we have therefore raised our 3M forecast slightly from 102 to 103. Our year-end forecast is unchanged at 100.
...And a higher EUR/CHF forecast. In our previous FX forecast update we wrote about the historical high (positive) correlation between EUR/CHF and equity markets. We argued that there is no fundamental reason to believe it should persist. During May, however, this correlation increased and EUR/CHF has continued to take its cue from global equity performance and thus implicitly from changes in risk appetite. As a consequence, relative interest rates appear to have lost some of their importance and despite the two-year swap spread widening by some 20bp in May, CHF only lost marginally to EUR. One explanation for the widening interest rate spread is the difference in the choice of policy instrument in the ECB (the minimum bid rate) and the SNB (the three-month LIBOR). As a result, even though the policy spread has remained constant and monetary policy expectations have moved in tandem, continued problems in the European money markets have kept the interest rate spread high. We see some risk of the spread remaining elevated and take into account that relative interest rates could gain importance. As a result, we have opted to raise our 3-, 6-, and 12-month forecasts to 1.60, 1.58, and 1.56.
EUR/GBP still set to head higher. We believe the UK economy will soften further in the coming quarters and this will eventually lead to rate cuts as the slowdown dampens the medium-term outlook for inflation. Credit tightening, a housing market recession and dark clouds in the retail sector continue to be the biggest issues - and they are not a healthy cocktail. Although yields have risen lately, we expect these to moderate and the pressure on GBP to come back.
EUR/NOK forecast maintained. For quite some time, we have been positioned for a stronger NOK vs EUR. The traditional strong positive link between oil and NOK has, however, to some extent failed. An oil price around $130 per barrel should imply EUR/NOK closer to 7.60 than to 7.90, but recent soft data have given headwinds to NOK. Inflation is still on the rise in Norway and we expect the Norges Bank to react by raising rates in August, sending the deposit rate to 5.75%. Our call for NOK strength remains unchanged and, if anything, potential is present for even lower EUR/NOK than included in our forecasts.
Lower range for EUR/SEK. We expect the Riksbank to stay on hold for the rest of the year (and cut in 2009). However, in the near term, the risk is rather that the Riksbank will be more hawkish - not dovish - at the July Monetary Policy Meeting and may possibly express this by raising the repo rate forecast due to the recent aggressive rise in energy prices, which leads to inflation staying above the Riksbank forecast in the coming months and a still-strong labour market with employment growth year to date also coming in stronger than forecast. Privatisation flows are a latent theme. Vasakronan, worth some SEK 40bn, is in the midst of a due diligence process and thus is probably first in line. The general view is that it will be a pure domestic affair. If that is correct, it would leave no imprint on SEK of course. But if acquired by a foreign name, it might support SEK given the fact that currency debt is already down to its long-term target (15%) after the selling of Vin & Sprit even though some of the revenues would probably be used to repay maturing currency debt. Hence, we continue to see potential for lower EUR/SEK, while acknowledging the seasonally related risk for temporary SEK weakness in the summer period. We prefer strategies that benefit from EUR/SEK staying within the range of 9.22-9.42.
Mixed performance in the dollar-block. The dollar-block currencies generally performed strongly in May, with the exception of a mid-month fallout of the Kiwi and a late-month loss from CAD. The large and unexpected pick-up in commodity price inflation has brought support and all three currencies ended the month somewhat stronger than our one-month forecast. The global sell-off in bond markets also spread to the dollar-block and especially the short end of the AUD and CAD curve is looking somewhat aggressively priced. A re-pricing of the RBA and BoC would weigh on AUD and CAD, although downside risk is higher for the latter. We continue to expect weak performance from NZD and while the 2008 Budget triggered an improvement in sentiment and likely postponed the first rate cut from the RBNZ, data are still indicating that the economy could technically be in a recession. We have therefore not changed our NZD/USD forecast. Due to the pick-up in commodity prices, however, and the reaffirmed tightening bias of the RBA, we have opted to raise our 3-month and 6-month AUD/USD forecast slightly. We see some upside potential for USD/CAD from the current level, due to the poor economic outlook confirmed by latest GDP numbers showing that the Canadian economy actually back-pedalled in Q1.
Danske Bank http://www.danskebank.com/danskeresearch
Disclaimer
This publication has been prepared by Danske Markets for information purposes only. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. Danske Markets' research analysts are not permitted to invest in securities under coverage in their research sector. This publication is not intended for private customers in the UK or any person in the US. Danske Markets is a division of Danske Bank A/S, which is regulated by FSA for the conduct of designated investment business in the UK and is a member of the London Stock Exchange. Copyright (©) Danske Bank A/S. All rights reserved. This publication is protected by copyright and may not be reproduced in whole or in part without permission.
|
