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Equity markets as decisive factor

Wed, Aug 26 2009, 12:14 GMT
by Erste Bank Bond Research Team

Erste Bank der oesterreichischen Sparkassen AG

Currencies without initiative

Equity markets as decisive factor

US dollar

EURUSD has shown only little movement in the past weeks. The exchange rate fluctuated within the well-known band of 1.41 to 1.43. The data from both economic regions coincided in indicating a recovery, with Euroland coming up with the bigger (positive) surprises. However, ultimately this was not enough to induce any substantial positioning on the foreign exchange markets, which was not the least due to the holiday season

The largest Euroland economies, i.e. Germany and France, posted positive quarterly growth rates for the second quarter and have thus made it out of recession. This came as a positive surprise; alas, the foreign exchange markets took hardly any notice of it. The dollar rate is still determined by the general risk appetite (i.e. the sentiment) of the investors, which is measured on the basis of the development of the equity markets. And hardly any stimulus has come from that side in the past couple of weeks. After the July rally equity markets entered a sideways channel in August. One thing that has certainly changed in recent weeks is the outlook for the Euroland economy. Generally experts had expected Euroland to follow the US recovery with a lag. These expectations were based on experience gained from previous economic cycles, but they turned out unjustified according to the latest data. Even if we, too, underestimated the dynamics of the Euroland economy, this development does support our forecasts. Although we still see the expansive US monetary policy and the exploding US budget deficit as main reasons for the weakening dollar, the better-than-expected Euroland economy is supportive to our forecast.

Swiss franc

The Swiss franc remained close to EURCHF 1.51. We believe that the exchange rate will continue to be determined by the backflow of investor capital (or the settlement of carry trades) on the one hand, and from SNB interventions on the other hand. As highlighted in the recently published quarterly accounts of the SNB, the bank stepped up the volume of foreign exchange purchased yet again from the first quarter. This has above all prevented any potential further strengthening of the franc. Indeed, it is not the SNB’s goal to substantially depreciate the franc, as this would entail accusations of anti-competitive practices, but it mainly intends to prevent the franc from appreciating extensively. So far, the SNB has been successful in its efforts. We think that the franc will remain exposed to upward pressure for still some time, and the SNB will manage to take the pressure off the currency. Therefore we still expect the franc to move sideways in a range of EURCHF 1.51.

Yen

The yen temporarily hit its lowest value relative to the US dollar since mid-June and then launched a rebound. All in all, however, the Japanese currency remained within the bandwidth of previous months, with the exception of a few short-lived spikes. The yen, too, saw its movements determined mainly by the perceived sentiment of investors, with the equity markets serving as barometer.

From the most recent set of macro indicators, the GDP data of the second quarter stand out. Although there are only preliminary estimates available for the three large economic areas, Euroland, Japan, and the USA, the Japanese economy has undoubtedly outperformed its peers in the second quarter as far as growth rates go, recording an economic growth of +0.9% q/q (Euroland: -0.1%, USA: -0.3%). However, this had been expected, and Japan had in fact posted the most substantial declines in the previous quarters. But at least Japan seems to have bottomed out. In line with the other markets, this has so far had no bearing on the exchange rate, because it is still a long way for the economy to gain enough momentum to put the notion of interest rate hikes even on the table. This means that bets on the interest rate development make little sense. So, for the time being the assumed willingness of investors to take risks remains the crucial factor for the yen to the dollar. In other words, weak equity markets result in a strong yen, and vice versa. Overall, the sideways movement should be prolonged. The developments on the stock exchanges come with particularly strong repercussions for the EURJPY exchange rate, because the movements of EURUSD and USDJPY amplify each other. In our medium-term forecast we expect the euro to appreciate against the yen.

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Published on  Wed, Aug 26 2009, 12:19 GMT