Hand in Hand for the Long Term
FX volatility historically high
General volatility in the FX market has long been historically high, which is a clear sign of extreme uncertainty in the market about the way exchange rates are likely to be heading. Exchange rates are still showing sweeping fluctuations, so FX trading is much more risky than it used to be.
One of the most important parameters of the trend correction expected earlier was falling exchange rate volatility. Obviously, that parameter has not been fulfilled - at any rate NOT in so far as the implied (traded) volatility is concerned. Although actual volatility (trade fluctuations) seems to have subsided somewhat, the implied (traded option) volatility has managed to remain historically high, which in itself is ominous.
Due to the sustained high implied volatility and what can safely be termed an uninspired correction to date, we are thus back to contemplating the long-run trend of the major currencies.
All our selected currencies are moving within very well-established long-run trends, so attempting to catch a correction in the making is as much as ever a dangerous game. It is a game that we do not play now.
USD - BUY
The long dogged uptrend of the US dollar is still completely intact. Because of its anticyclical status, the dollar thrives on bad news - economic as well as financial bad news - and there is no shortage of that at the present time.
Moreover, due to the erstwhile dollar downtrend, which lasted for years, there is a striking shortage of USD outside the US: the reduction of (USD) debt and the repayment of (USD) loans have generated an underlying requirement of USD. Moreover, the Americans are queuing up to buy dollars too, for they are selling assets abroad and are now also clamouring for dollars.
Finally, there is extreme focus on the problems of the US economy and less on the huge economic/financial problems which are piling up in Europe. For the future, this focusing is expected to home in on Europe/the euro with demand returning like an undesired boomerang due to renewed pressure against the euro.
Our 3-month exchange rate target for the EUR/USD rate agrees completely with the downtrend of 116. Only breach back above 135 will mean that there is a hitch about the above-mentioned exchange rate target.
JPY - BUY
In spite of a new Japanese recession, the yen is basking in the turbulent financial markets. The role of the yen as the world's most popular funding currency pushes up the value of the yen in step with the forced closure of investments. The value of the yen is thus fanned by financial uncertainty and general risk aversion despite the poor economic prospects of the Japanese economy.
However, it is important to stress that if the turmoil in the financial markets should subside, the yen is now in a very well-defined uptrend against both USD and EUR after a long downtrend, and the uptrend is not likely to turn round easily. The recent violent fluctuations in all the financial markets have caused investors funded in yen heavy losses which will dampen the urge for yen funding for a good long time.
Our 3-month target for the EUR/JPY rate agrees completely with the downtrend of 107. Breach back above 135 would cast doubt on our current target rate. The target for the USD/JPY rate is 92.
CHF - BUY
CHF of all currencies has been on a cannon ball run. After reaching a new historical high just above 521 in October, CHF lost momentum and plunged to around 480.
Particularly the otherwise good correlation with the equity market has not applied for a couple of weeks, which has caused the CHF rate to fall despite fairly dramatic equity price falls. If the correlation returns, there will be a catch up on CHF which, other things being equal, will pull the rate higher again.
The dramatic and very surprising unilateral interest-rate cut made by the SNB, of a full percentage point, also helped to push down the value of CHF. The exchange rate did not move much, after all, because the value of CHF had fallen a good way beforehand.
We maintain our overall recommendation of closing down CHF funding or, as a minimum, to set 'sensible' stop loss orders for remaining CHF financing. After the recent fall, stop loss should be put between 485 and 490.
Even if the dust should settle down over the financial market place, geared investment is probably going to be shunned, and market participants are likely to try and reduce risk in a new and probably more regulated world. In a world where everyone is endeavouring to lower interest rates as much as possible, investors will be able to obtain funding at a sensible rate in their own base currencies, at the same time reducing their overall risk. That in itself will help to support the CHF rate.
Given the foregoing and in line with the overall downtrend of the EUR/CHF rate we expect the 3-month rate to veer back to 521. Taking up CHF funding at that point may well prove a successful move. Of course, it requires that the investor is by then not fully financed in CHF!
GBP - SELL
The sterling and the British economy have suffered a sad fate which seems not yet to have hit the bottom. The drastic rate cut by the BoE of 1.50 percentage points clearly signals how serious the situation is for the finance-based economy. Lately, the GBP downtrend has again gained momentum.
Unlike the dollar, the sterling is highly cyclical and is thus hit from all sides at the moment. With respect to the fundamental economy, not only the British housing market is plunging but also the manufacturing sector just like the City of London is struggling to survive the global financial crisis.
The BoE still signals an aggressive relaxed monetary-policy line which has, however, so far collided with the struggling financial sector. A phenomenon which unfortunately not only impedes the effectiveness of the monetary policy in the UK but also globally.
We therefore maintain our generally bearish view of the sterling which is fully in line with the long-term downtrend. Our 3- month price target for EUR/GBP is thus 90.
SEK & NOK - SELL
The rising risk aversion and the resultant high volatility have turned out to be poisonous for the two Scandinavian currencies. The financial crisis has turned both currencies into small vulnerable 'side currencies' which are far too volatile for international investors. In scenarios like the current, the liquidity and thus the depth of the market are vital. Neither SEK nor NOK can offer this under the current circumstances. That is the reason behind this downturn for the two currencies.
With respect to the fundamental economy, it holds for both currencies that the economic prospects are on a hasty retreat although the monetary policy has finally geared up with resultant fair interest-rate cuts. Unfortunately, it is much too late. Moreover, the effectiveness of a relaxed monetary policy is limited since also in Scandinavia the policy collides with the debt and credit crisis.
It is therefore still down for both SEK and NOK, which is in line with the wellestablished long-term trends. Our 3-month price target for SEK is around the level of 1060 in EUR/SEK, and the price target for NOK is around the level of 930 in EUR/NOK.
AUD, NZD & CAD - SELL
The three commodity currencies have been thrown to the financial lions as the crisis has escalated. They have all been hit hard by the high volatility and the resultant risk aversion. From being lionised as FX darlings due to the relatively high and attractive interest rates, they are now at the very periphery of investors' interest.
The high rate of interest - a must to attract the necessary capital to finance the heavy current-account deficits - for notably AUD and NZD is now weighing heavily on both currencies. Moreover, the plunge of commodity prices has undermined the already weak currencies.
In a global scenario with significantly slower growth where low interest rates and commodity prices are high on the agenda, the commodity currencies will still be under pressure especially against the dashing USD.
We thus expect an encounter with the following levels against USD in the coming months. AUD/USD 58, NZD/USD 52 and USD/CAD 135. But the potential will be somewhat lower against DKK if our expectations of a generally stronger dollar prove right.
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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