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Dollar: Strong phase coming to an end

Fri, Feb 27 2009, 05:58 GMT
by Erste Bank Bond Research Team

Erste Bank der oesterreichischen Sparkassen AG  |  View company's profile

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EURCHF remaining around 1.50

Yen: significant weakening – of transient nature?

US dollar

The strong phase of the dollar has come to an end for now, and we should see the US currency decline to lower levels in the not too distant future. However, this will be more of a technical reaction, given that the generally gloomy picture on both sides of the Atlantic has not changed. This also means that the recent rise of the dollar has not been justified – in fact, a sideways tendency around EURUSD 1.3 would have been more reflective of the situation; at least for the time being.

The sustained strain on the global financial markets would probably also argue in favour of a sideways movement, because investors tend to shun taking positions in such an environment. The dollar scenario has already started to deteriorate. The massive widening in the US budget deficit pushes up the risks the US economy is faced with, which will lead to a weaker dollar. The increased debt in the USA will intensify the country’s dependence on capital inflow and interest rates. This is where the central bank enters the picture: the Fed is currently doing everything in its power to inflate the economy, and it will keep going until it has reached its goal. As a result, the US will be faced with higher debt and, sooner or later, higher interest rates due to higher inflation. While the economy should be able to cope with such a scenario, it will depress the long-term outlook on economic growth. This means the US will hardly be able to offer investors attractive yields commensurate with the risk assumed. That said, the economic data in Euroland will not exactly be anything to write home about either. But Euroland does not have to service as much debt as the US, which should support a higher valuation of the euro relative to the dollar.

Swiss franc

The Swiss economy is manifestly deteriorating: for instance, January’s exports decreased by -10% vs. the previous month. The SNB will revise its forecasts of GDP growth down to -1% y/y for 2009% only in march, but according to rumors council members have announced the need to lower the forecast. News surrounding the two big Swiss banks do not generate a positive year from this side either, hence the economical data are fundamentally against the Swiss Franc.
In contrast, the ECB’s anticipated rate cut in March could lead to a strengthening of the Swiss currency. We think that in this case, the SNB would lower (and hence also narrow) their target range to 0-0.5% that have been seen historically. The national bank has acted in an innovative way until now to reach monetary policy targets, and should not refrain from doing even more so to counteract a possible appreciation of the Franc.
But Finally, for the Swiss Franc too the financial crisis is overshadowing fundamental data: the inflow of Investor and Companies Capital as well as the quest for a safe haven have certainly contributed to the current exchange rate levels, and negative news from the Swiss financial sector are not coming to a halt yet. Thus a short-term Strengthening of the Franc can still not be ruled out.
The most likely option though is a sustained oscillation – with wide amplitude - of EURCHF around 1,50.

Japanese yen

The Yen has weakened significantly against the Dollar, and lost more than 5% in the last two weeks.
Even though the BoJ is pursuing an expansive monetary policy, and does even purchase corporate bonds by now, we do not think that this movement can be caused by this alone – especially as the Feds policy is increasingly expansive too.
For example, the massive and rapid deterioration in Japans external trade could have contributed to the Yen’s weakening too.
Nevertheless, the financial crisis still seems to dominate all these facts, which implies large exchange rate swings and appreciation of the Yen in case of negative news flow. Even though it seems that the current situation is assessed to be more stable by the markets, leading possible to a weakening of the Yen, a renewed firming cannot be ruled out in the short term.

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Published on  Fri, Feb 27 2009, 06:27 GMT

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