FX Mid-Year Review 2008 - FX Changes Track
Fierce fight over FX main track
Q2 2008 did not write itself into the FX annals as a particularly remarkable quarter. The same old song about the trials and tribulations of the dollar and all the blessings of the euro characterised most of the quarter, thus only confirming the trend from the beginning of the year.
Right now, however, the outlook is quite different. Halfway into the third quarter of the year, we can see that the long-expected change of tracks in the FX market is finally happening. Following a new all-time high for EUR/USD, the battle for the FX main track has now broken out for real.
In the heat of the struggle, the dollar scored a new significant price increase as the EUR/USD rate dropped from 153.35 (486.50) to 149.95 (497.50) in a single trading day. As a matter of fact, we need to go all the way back to 2005 for a similar decline in the EUR/USD rate.
However, the large price fluctuations did not just affect the two combatants - EUR and USD - but have spread to the entire FX market. In other words, the volatility has again increased dramatically.
The fact that the dollar is quickly sidetracking the euro in order to get back on the FX main track is primarily due to the current shift of focus in the finance markets.
With the latest spate of poor economic fundamentals out of the Eurozone, the earlier hopes that the Europeans would succeed in decoupling the European economy from the US downturn have taken a serious nosedive. Focus is thus rapidly centring on growth rather than inflation, the ghost of which has haunted the market for large parts of the first two quarters of the year.
Eurozone thus no longer represents the economic 'sanctuary' which many players had hoped for, and the euro appears extremely fragile and vulnerable all of a sudden.
World demand for USD
Due to the shift of focus mentioned above, we are heading into an FX scenario in which investors from around the world will hunt the US dollar, which will no longer be available in unlimited amounts. Several factors will contribute to the expected curb on the dollar liquidity.
- Due to the economic slowdown in the USA, US imports are dropping nicely at the moment. The flow of US dollars to the rest of the world, which appeared to be inexhaustible, well driven by the apparently unrestrained US demand, has thus - if not dried up - definitely been curbed considerably.
- At the same time, dollar-financed investors are starting to suffer major exchange losses in the wake of the latest dollar increase, which may trigger a wave of stop-loss orders for financing in USD. Financing which, thanks to the former downtrend of the dollar and the low interest rate, was 'golden' financing.
- Moreover, the latest increase in the USD rate has caused concern among international investment managers who have earned huge sums of money for a long time on their foreign currency hedging of the US assets. If they are forced to adjust their USD weightings in respect of the price hedging, they will be buying continuously in a rising market, which will support the dollar further in the present scenario.
- Finally, there are emerging signs that US investors are repatriating their money to cover the many gaps created by the financial and economic crisis in the USA. Thus, the Americans themselves will be demanding the dollar in an already rising market.
When all is said and done, the world will demand the reserve currency that we all use - the dollar.
New USD uptrend
In light of the recent progress of the dollar versus the euro in particular, we conclude that a new general dollar trend has emerged here at the beginning of August (there is little reason to believe that we will ever forget the date 08.08.08). The old downtrend which has raged in recent years is thus a thing of the past for now.
In fact, we expect the new dollar uptrend to last for many months - if not years into the future. All important, long-term moving averages have been forced to give up in the face of the generally strong dollar - a phenomenon unheard of since 2006.
For our future targets, the above change of tracks means that we are adjusting our positive expectations for the dollar upwards. Our targets for EUR/USD (USD/DKK) in future are thus as follows:
- 3 mths - 143 (522)
- 6 mths - 137 (545)
- 9 mths - 130 (574)
- 12 mths - 125 (597)
EUR - danger of derailment
After having hit a new historical all-time high against the dollar of 160.38 (465.15) in July, the joint European currency is now in for serious trouble as it risks being unmasked as a currency version of Hans Christian Andersen's 'The Emperor's New Clothes'. The fact is that the historically high EUR/USD rate has profited from a choice between the devil and the deep blue sea, which initially benefited the euro at the cost of the hardpressed dollar.
As a matter of fact, the flow of poor economic fundamentals from Europe and the stubborn fiscal policy maintained by the ECB are finally bringing the euro to its knees. The illusion of a Europe decoupled from the ills of the USA has evaporated, and instead we now have an economically divided Europe in which the South European countries are rapidly approaching recession-like conditions. Thus, Europe did not succeed in decoupling itself this time either.
Compared with the USA, Europe is thus only seeing the beginning of the economic downturn, whereas the USA is already bogged down. At the same time, it is difficult to envision any kind of a helping hand from the ECB which, contrary to the FED, has done nothing to soothe the European growth concerns. Rather on the contrary, bearing in mind its latest interest rate hike.
It is therefore our assessment that the euro in general will be facing an extremely difficult period, and the possibility of an actual stress test of the joint European currency can therefore by no means be excluded offhand looking ahead. If the international investors zoom in on the current huge economic imbalances in the Eurozone in earnest, the euro runs the risk of a downright derailment in the form of massive drops in the exchange rate.
CHF & JPY - sidetracked
For most of the second quarter, CHF and JPY existed on the periphery of the financial markets which meant 'business as usual', i.e. steadily falling exchange rates. This picture has once again been turned completely upside down here in the third quarter.
The resurrected high volatility in the FX market in general has effectively cured investors of any desire to obtain cheap financing in either JPY or CHF. In other words, investors have once more turned risk aversive.
As long as the high currency volatility is raging, we see no reason to increase the sensitivity in financing portfolios, and we therefore still only recommend max. 25% financing in CHF and no financing in JPY whatsoever. We thus maintain our, by now old, recommendation of diversifying with 25% CHF, 25% SEK, 25% SGD and 25% CAD.
GBP - consolidation
It can hardly be said that the economic fundamentals from the UK have improved over the summer. On the contrary, if anything. More than any other central bank, the Bank of England is caught in the dilemma between suddenly declining growth on the one hand and unstoppable inflation on the other. The inflation trend in the UK is exactly the reason why the Bank of England has been unable to cut interest rates, which the development in the housing market in particular otherwise clearly calls for.
Monetary policy fix or not - the pound has still managed to stay strong and is thus still in a consolidation phase versus the euro. Conversely, the latest strengthening of the dollar has also made the pound bite the dust, and the GBP/USD rate is currently just above the psychologically important 190 level. Due to our overall positive outlook on the dollar, we believe that it is only a matter of time before 190 caves in and opens up for a new movement towards lower levels.
In relation to the euro, we are still expecting the pound to drop again. During the autumn, we are therefore anticipating a new rendezvous with 80 (932), which, in the long term, will probably not be able to keep a further decline of the pound in check. A pound bordering on the magical 900 is thus still our target one year off.
Minor blows to SEK & NOK
Historically speaking, the generally lower growth outlooks do not sit well with the Swedish krone, which is also why we have seen increasing pressure on the Swedish krone over the past few months. Europe's most open economy promptly becomes distressed when there is a hitch in the growth. With the current shift of focus in the financial markets, trouble is probably still lurking ahead for SEK. Domestic growth in Sweden has started to slump, which may put pressure on Riksbanken in respect of its current monetary policy. So even though SEK sellers will need patience in light of the so far moderate exchange rate fluctuations compared with many other currencies, we still expect SEK to steadily drop in future.
In addition to the repercussions of the tight monetary policy and lower growth, the Norwegian krone has also been impacted by the dramatic drop in oil prices we have witnessed lately. Consequently, the Norwegian krone has been driven to a relative low against both EUR and USD. With the increased focus on declining growth and thus also declining/adjusting commodity prices, we anticipate continued pressure on NOK, and we therefore maintain our 'sell' recommendation for NOK.
The recent minor blows suffered by both SEK and NOK will thus not lighten up anytime soon. Instead, there is a risk of more blows in the months to come.
AUD, NZD & CAD - from full speed to full stop - overnight
The three commodity currencies all went from full speed to full stop in the third quarter. After having ridden yet another wave of success in the second quarter (particularly AUD), investors had a rude awakening in respect of precisely these three currencies in the wake of the falling commodity prices and the strengthened dollar.
The Reserve Bank of New Zealand has now joined the Bank of Canada and has started to lower the interest rate. The market expects the Reserve Bank of Australia to follow suit before long.
In a scenario with focus on growth, highinterest currencies like AUD and NZD in particular may be further weighed down by their formerly so attractive high interest rate levels. This also explains the brutal exchange rate drops that we have witnessed within a very short time.
Furthermore, AUD and NZD in particular are also vulnerable to the large Japanese investments in the so-called Uridashi bonds issued in AUD and NZD. The majority of these very large issues are in the hands of 'Mr and Mrs Japan', which may very well contribute to forcing these currencies to even lower levels if, as has been seen earlier, Mr and Mrs Japan get the jitters due to the recent large drops in the exchange rates.
The long-term uptrends on AUD, NZD and CAD are thus a thing of the past, and we are instead seeing some new downtrends which have already demonstrated the danger they pose.
It will be a long time before these currencies get up to a speed even approaching the levels seen most recently. We therefore still recommend selling these currencies, particularly against the dollar, despite their temptingly high interest rate levels, as they will be driving in reverse for the next many months to come.
Jyske Markets - FX Research
http://www.jyskebank.dk/finansnyt
The analysis is based on information which Jyske Bank finds reliable, but Jyske Bank does not assume any responsibility for the correctness of the material nor for transactions made on the basis of the information or the estimates of the analysis. The estimates and recommendation of the analysis may be changed without notice. The analysis is for personal use of Jyske Bank's customers and may not be copied.
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