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EURUSD hits 1.46

Fri, Aug 22 2008, 07:35 GMT
by Erste Bank Bond Research Team

Erste Bank der oesterreichischen Sparkassen AG

Swiss franc moving sideways

Euro weakens, also vs. yen

US dollar

The US dollar rallied in the past few weeks the likes of which haven’t been seen in a while. A similarly vigorous movement took place last in February and March, however, in the other direction. At the time, the financial market crisis and the rapid pace of interest rate cuts in the US created pressure on the USD. The situation in the US has not improved since then, but has rather at best stabilized. By contrast, in Euroland the economic outlook deteriorated significantly and this had a sudden effect on the exchange rate versus the USD (and versus other currencies).

The ECB meeting of 7 August was mentioned in conjunction with the sharp drop of the euro, because after the meeting, the movement accelerated. In our view, the central bank did not disclose any news. The key lending rate was left unchanged and the outlook indicated continued unchanging interest rates. As a consequence though, EURUSD broke some important technical marks. Before, the EUR/USD had already failed for the second time to pass the mark of 1.6 which triggered a movement up to 1.54. The weakening of the euro was definitely justified from a fundamental standpoint. As recently confirmed by the corresponding GDP data, there was an abrupt downswing of the economy in Euroland in 2Q. But we are skeptical as regards the further potential of the US dollar, because the risks for the US are considerable. Horrifying news might crop up at any time from the financial sector and the economic data will remain weak (the latter also applies to Euroland though). We believe that the most recent movement of the EUR/USD caught many investors off balance and the scramble to adjust positions additionally contributed to the firming of the USD. This effect should be only short-lived though. Overall, we believe that the USD will not be able to fully retain it latest gains and expect a movement towards the 1.5 mark and over.

Swiss franc

The Swiss franc remained in a sideways channel around 1.61 EURCHF. Right now, we do not expect any interest rate change from the Swiss side nor from Euroland before 2009. The franc as a “safe currency” probably suffered from the crisis of confidence caused by the sustained weakness of UBS. The weak economy in Euroland is paired with a slowing economy in Switzerland, which does not lead one to expect any new impulses from this side for forex markets. If things remain calm on the financial markets, we expect the Swiss franc to continue its tendency to move sideways, but ultimately to firm somewhat versus the euro.

Japanese Yen

USDJPY reached the level it saw last at the end of 2007. The phase of weakening since mid-March continued a bit due to the deteriorating economic data and the lacking hopes of upside potential for interest rates from Japan. However, it is unclear if this was the start of a trend versus the USD. In our view, a sideways movement around the mark of USDJPY 107 seems more likely.
By contrast, the euro has weakened so massively versus the USD that EURJPY developed quite contrary to USDJPY and is now at 162. This 5% firming of the yen versus the euro within one week is due completely to the change in EURUSD.
The BoJ meeting this week did not result in any change in interest rates; such a move is expected only from next year on due to the ailing economy and neither do we believe that the BoJ will make its move before the Fed. Therefore, as regards interest rate developments, there is not much in favour of a firmer yen. On the other hand, the question is still open of to which magnitude the yen is being used for carry trades and if there will be renewed turmoil on the financial markets this year, in which case the yen could appreciate very fast. It will probably take until the beginning of 2009 for the latter risk to diminish and the yen to once again be determined by the fundamental laws of economics.

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Published on  Fri, Aug 22 2008, 07:39 GMT