EURUSD bottoming
Franc: Strengthening continues
USDJPY roughly stable
US dollar
The EURUSD exchange rate has not seen much movement in the past weeks, continuing instead to form a bottom – a development that started after the massive slump around mid-February. The economic data on both sides of the Atlantic do not suggest imminent interest rate hikes. The Open Market Committee of the US central bank has confirmed at yesterday’s meeting that interest rates will remain at their current, extremely low level for a while. No statements regarding the exit strategy were made, i.e. when and to what extent the emergency liquidity will be withdrawn from the economy. We expect the central bank to act quite cautiously in the process. Any withdrawal of liquidity, even at low levels, will not start soon. Currently, the central bank is still injecting liquidity by purchasing mortgage bonds. However, as long as the route of the central bank is unclear, speculations about the exit strategy are likely to occur and to affect the foreign exchange markets accordingly.
The initial interest rate hike will take at the end of the year the earliest, in our view. The overall subdued US economy and the lead-time to the actual implementation of the exit strategy made us shift this step to the fourth quarter in our models. Since we also pushed back our expectations in this respect for the ECB, we expect a somewhat firmer dollar than previously. Nonetheless we stick with our expectations of a slight depreciation in the US dollar due to the rising level of debt of the public budget. Moody’s has only recently pointed out the long-term risks (2013) for the US rating should the current budget strategy be maintained.
Swiss franc
As expected, the franc has strengthened further. The SNB did not change its monetary policy stance at the last meeting. The target rate for the 3M Libor remains at 0.25%, while an excessive strengthening of the franc will be prevented by the SNB. Similar to December, the franc’s strengthening has accelerated since the meeting. Thus, it seems as if the SNB tried to slowly prepare for the exit from FX interventions by leaving more room for market forces. Indeed, the strengthening pressure on the franc would need to reduce significantly and the exchange rate find a longer-term bottom before it would make sense for the SNB to end interventions (otherwise, the threat of a short-term excessive strengthening could materialize). The big question is the level of this bottom.
Due to the strengthening of the franc since December (which was only prevented before that by the SNB’s interventions), loans in franc (also carry trades) might have been reduced, which in turn supports the franc. This feedback loop could remain in place for some time. As long as interest rates in the Eurozone do not increase significantly, there are a few reasons pointing to a weaker franc: the economic outlook for Switzerland is clearly more positive (the SNB has also revised its growth forecast upwards), government debt is relatively low and the Swiss banking sector seems to have stabilized. Nevertheless, inflationary pressures remain low, as the strong franc exerts downward pressure on prices (the SNB pointed out once more that rates cannot be kept low indefinitely, as inflation should exceed 2% by 2012 in case rates are kept at their current level). Thus, the franc also benefits from a safe haven status. On the whole, we expect strengthening pressures to persist until the end of the year, but they should be dampened by the SNB’s interventions and hence not be “excessive”. We do not expect the SNB to announce an end to the interventions before the franc has reached a bottom, nor should they hike rates until then. Thus, it should take some time after the first ECB rate hike (which we now expect only in 1Q11) for the franc to weaken once more, due to the increasing interest rate differential and approach levels of EURCHF 1.50 once again.
Japanese yen
The yen has weakened slightly and currently quotes close to USDJPY 90. We think that the US Fed’s expansive monetary policy is still the most important driver of the exchange rate, implying that today’s meeting might cause exchange rate fluctuations. Once the exit from the expansive policy gets more concrete, we expect the yen to weaken vs. the US dollar (the BoJ should keep rates low for an extended period). The exact timing for this to happen is hard to predict, though, as we also postponed our rate hike expectations for the Fed and the whole exit process might still take some time. Overall, we stick to our forecast of a moderate yen weakening vs. the dollar throughout the year.
