• High write-offs at US financial institutions add to pressure on USD

  • EUR/JPY susceptible to a correction


US dollar

In the past few weeks, the USD slipped even further and dropped below the all-time low of the historic levels of the pre-euro phase USD/DEM. The downtrend of the USD was so steep that not even the better-than-expected US economic data or the damper put by the US Fed on expectations for interest rate cuts managed to provide support. The reasons for the insensitivity of the markets to the indicators could be fears regarding the uncertain outcome of the US housing crisis and the necessary write-offs by US banks in this context.

The sustained correction on the housing market seems to be the hardest to digest for FX markets. Market consensus is broad regarding that this trend will last well into next year. The major unanswered question is whether the other sectors of the economy will be affected, and if they are, to what extent. This question is hard to answer, of course, and thus speculation is accordingly lively. Up to now, the collapse of the real estate market has had little influence on the other sectors, which is illustrated by the robust growth rates of the economy in 3Q. This does not rule out any future weakening of the economy, but does show that whatever may hit the US economy in the future, it will encounter a solidly growing US economy. Despite all the risks, we perceive this as a confirmation of our scenario of slower but positive growth rates for the US economy in the future. The markets on the other hand are still pricing in a considerable recessionary risk for the US. As new reports of the high exposure of diverse US financial institutions on the subprime market keeps cropping up, this is heightening the pressure on the USD additionally. We believe that the coming economic data will indicate a moderate development of the economy, but not a recession. The downslide of the USD should therefore lose impetus and we expect the US currency to recover. Right after finishing this report Chinese officials indicated more diversification of the Chinese foreign exchange reserves. As this would mean less purchases of US-dollars the markets reacted immediately with another dollar sell-off. To which extent the comments are the official position of the government is still not clear, but an additional risk for the dollar is now on the market.


Swiss franc

The Swiss franc is still showing a close correlation to the developments on stock markets. The EUR/CHF failed to overcome the high just shy of 1.68 recently, and we expect this barrier to hold up in the future as well. Over the medium term, we expect a robust rise of the franc towards 1.55 EUR/USD, but over the short term, the franc should continue to be strongly influenced by the trends on stock markets, and accordingly move into a volatile sideways bandwidth.

The most recent economic data were positive and painted a brighter picture of Switzerland’s economy than in Euroland, at least for now. However, inflation rose surprisingly steep as well from 0.7% to 1.3% y/y, with the low external value of the Swiss franc being responsible for this development in addition to high oil and food prices. As the central bank representatives changed the wording of their statements to imply a bias towards higher key lending rates, the increase in inflation would be a good reason to hike interest rates. What is unclear is whether this move is planned for December or only for 1Q 2008. We expect it to happen in 1Q08, as the insecurity prevailing on credit markets and the high losses posted in some cases by Swiss banks in 3Q, will cause the SNB to hesitate at first.


Yen

After a short-lived recovery, the yen dropped again slightly versus the euro in the past week, but kept its distance to the lows of the summer of this year. Decisive for this movement was the general robustness of the European single currency. Versus the USD, for example, the yen hardly changed. There was no stimulation for FX markets from the monthly Japanese economic indicators, as they essentially continued on existing trends.

Employment continued to rise, without having any effect on wages and these are still sinking. The most recent figures on household spending was positive and thus private consumption seems to have developed well in 3Q; so, solid growth can be expected for the overall economy. All of this has happened without fuelling inflation. The most recently released inflation rate was -0.1% y/y, just like in the past few months. Thus, there was no doubt that the Bank of Japan would leave the key lending rates unchanged at both its October meetings. At the end of October, the half-year report on the economy and inflation was released. The Japanese central bank continues to expect sustained moderate economic growth for the business year 2008 (start: March 2008) and – albeit slow – acceleration of the inflation rate to 0.5%. Average prices are expected to remain unchanged for the rest of the current business year. This assessment and the corresponding statements by Governor Fukui clearly point to a continuation of the course followed up to now. Therefore, a gradual adjustment of interest rates is expected to continue based on long-term considerations. The Bank of Japan still has latitude in selecting the pace of action. We expect to see the next interest rate hike sometime between December of this year and February of next year, which will depend on the development of the US economy. The yen exchange rate will probably continue to be strongly influenced by exogenous factors (carry trades, chart constellations), with the generally high valuation of the euro being stressed in this context, as we believe it to be highly susceptible to a correction.