Swiss franc: continuing strength
Yen: Crisis prompts capital transfers
US dollar
In the past two weeks, the EURUSD exchange rate moved into a sideways channel. Even though the situation on the financial markets has stabilized, it is still fragile. The macro indicators on both sides of the Atlantic Ocean are showing a massive contraction of the economy, which is due in both cases to the insecurity caused by the financial market crisis. How long this phase of anxiety will last and how strong it will affect the economy is highly uncertain and makes it hard to assess the further course of development. On the interest front, both central banks cut their respective key lending rates by 50 basis points each at their most recent meetings and left the door open for further interest rate cuts.
Essentially, there was no reason to show a preference for either of the two currencies. Nonetheless, we consider at least some of the latest gains of the USD as exposed to risk if the situation on the financial markets were to stabilize again. The only plausible explanation for the past firming of the USD is the shifts in capital triggered by the financial market crisis. The indicators would not justify the USD at the current level. Apart from the interest rate spread, Euroland is better off structurally than the USA. The degree of indebtedness is lower, real estate bubbles have developed only regionally, and Euroland has a balanced current account, while the US has quite a significant deficit. Overall, the macroeconomic risks for the US are higher, while the (short-term) interest rates are lower. Nonetheless, we do not expect a sustained firming of the euro. The level of government debt is expected to widen massively in the US in the coming year and will thus increase the inflows into the USD, which is expected to support the currency despite the relatively poor macroeconomic data.
Swiss franc
The Swiss franc has rebounded from its high of 1.45 EURCHF, but still quotes at a relatively high level of 1.50 EURCHF. The likely reasons for this are the ongoing inflow of investor money to Switzerland and the cancelling of carry trades.
The SNB surprisingly cut rates by 0.5% at the same time as the ECB. This was motivated by the increasing spillover of the financial crisis to the real economy. The timing suggested that the SNB was also trying to prevent a strengthening of the franc by leaving the interest rate differential unchanged. It was said that the franc would be carefully monitored; hence, we think that the SNB will adapt monetary policy to keep the exchange rate stable.
The implementation of the previously mentioned step required a lowering of the overnight rate at which banks can borrow from the central bank to less than 0.5%. Even so, it will still take some time until the 3M Libor, which is an interbank rate, reaches the middle of the target band of 1.5% to 2.5%. This means that money markets are still tense and the all-clear is still not within sight.
The expected exchange rate movements have contracted slightly, but remain at high levels (see the chart below). Thus, high levels of fluctuation, in particular towards a strengthening of the franc, seem to be ahead.
Japanese Yen
The rate cut in Japan was even more of a surprise than the one in Switzerland. A target rate of 0.5% seems to leave no place for lowering rates and a lowering of 0.2% is more of a symbolical nature in any case. Prior to this step, the market anticipation of a cut was announced, which might have put some pressure on the BoJ. In addition, Japanese banks have been hit by the financial crisis via the rapid decline of the Nikkei in October. As the vote was 4:4, Governor Shirakawa’s vote was decisive.
The yen was quoted at “normal” levels above 100 USDJPY in the short term, but then came back to very high levels in the end. Either Japanese investors taking their money back from abroad, due to the crisis, or hedge funds obliged to exit their positions to an unknown extent are likely responsible for this. To repay a credit in yen invested elsewhere, it has to have been bought back previously, implying a strengthening of the currency. To counteract this, interventions have been considered, in particular to prevent a further deterioration in Japan’s export-oriented industry. The finance minister declared that, in case of a further strengthening of the yen, Japan would not hesitate to intervene.
The previously mentioned capital flows will certainly persist for the time being and we expect ongoing high volatility and an increased risk of a further strengthening of the yen.
