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FX Strategy

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FX forecast update: Shoulder to shoulder with inflation fears and growth scares

Mon, Jun 2 2008, 10:46 GMT
by Kasper Kirkegaard, John Hydeskov

Danske Bank A/S

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Here are our latest thoughts on the G10 currency markets:

• • Closer to stabilisation. The four best-performing currencies during the past month have been SKK, TRY, HUF and BRL (up by 4-6% vs EUR), followed by CAD and AUD from the G10 group. SKK benefitted from the Slovakian 15% revaluation prior to the euro adoption at the beginning of 2009; TRY and HUF gained on speculation on higher interest rates due to surging inflation; and BRL advanced on the back of S&P’s upgrade to ‘investment grade’. The worst-performing currencies were the lowyielders CHF and JPY (down 0-1% vs. EUR) due to a higher degree of risk appetite, while KRW lost some 2% against euro and the South Korean central bank had to intervene to keep the currency above water. Generally, the exchange rate movements were limited over the month and volatility declined gradually. Volatility levels are now broadly down to levels from the start of the year. Yearto- date, the best performing currencies have been SKK, PLN and CZK while ISK, ZAR and KRW have lost the most. 

• • Blurred picture. The one-month performance of our forecasts has been mixed over the month. We traded around our EUR/USD forecast of 1.56 during most of the month while our USD/JPY forecast of 102 proved to be on the low side. Our EUR/GBP forecast of 0.80 was actually reached on 21 May but the pair’s rise was short-lived and it fell back to around 0.7850 at the end of the month. EUR/CHF traded somewhat higher than our forecast of 1.60 during the month while our forecasts on Scandinavian currencies were closer to the actual developments. We predicted EUR/SEK to end the month at 9.30 and EUR/NOK to decline to 7.85. The pairs traded around these levels during most of the month but ended a little higher.
  

• • Direction lost. The credit crisis has not been kind to the USD. The combination of a US-imposed financial distress and a collapse in the US housing market made forecasting relatively easy; USD was a declining asset set to earn a lower rate of interest. We forecasted that EUR/USD would reach a target of 1.60, which actually occurred during mid-April. As the credit crisis draws to an end, things are not crystal clear anymore. EUR/USD has stopped its continued upward drift and market participants have started to discuss whether we are beginning to see a turning point in the pair. It is evident that EUR/USD cannot drift higher eternally. The euro is historically overvalued to the dollar and a permanent misalignment is simply not an option. A deviation from ‘fair value’ can, however, last some time. That happened in 2000-01, where the EUR/USD traded in range, after touching a low of 0.83. We discussed the similarity between the 2000-01 experience and the current situation in EUR/USD: Will history repeat itself?.

• • The sky’s the limit. Food and energy prices have recently sky-rocketed. This generates an upward price pressure and inflation is either on the rise or set to rise in most economies. While economists are busy discussing whether this represents a speculative bubble or if fundamentals (such as increased demand from emerging markets) offer a sufficient explanation, we are left with the risk that this marks the beginning of a prolonged or even permanent period of elevated commodity prices. The important issue for the FX markets is, however, not the rise in commodity prices in themselves but rather; which currencies are set to benefit and which are expected not to benifit due to higher food and energy prices. In G10: FX implications of rising food and energy prices we found that EUR/USD and perhaps CHF/JPY is likely to head higher in the near term, while CAD/NOK is expected to turn lower if energy and food price inflation remains high. EUR/USD and AUD/NZD are both expected to rise on the longer term on higher energy prices.

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Published on  Mon, Jun 2 2008, 10:53 GMT