The U.S. Dollar during the rest of 2014?

Douglas C Borthwick, Managing director/Head:FX, on the US economy and USD

There has been a slew of positive economic data out of the U.S., with GDP growing 4.2% in the second quarter and the Dollar has recently been strengthening versus its major counterparts. Taking this into account, can we finally say that the U.S. economy is now back to normal?

I would rather disagree with the statement - if we look at the U.S. Q1 data, we can see that there has been a negative run of 3%, and the Q2 was up 4.2 %. Thus, it would be right to say that the U.S. is still limiting along. As long as this situation develops further, when we will be getting employment numbers like today, and there is a sudden surprise in the market, in that case we will be able to say that the U.S. economy continues to move just a little bit side-by-side.

From my point of view, most important, is to look at the current situation in the U.S. labor market, where the number of jobs is being reduced. In other words, higher paid jobs are getting replaced by the ones, which are paid lower. Hence, that does not support the economic growth, but keeps the United States moving along in the stagnation. Looking back on the number of unemployed people - it is still at restraining levels. Thus, I believe U.S. economy is stabilized and is not beginning to grow. Moreover, I would say this situation is being seen by the Fed as well, since it is getting more dovish. Thereby, the Federal Reserve is likely to raise rates at exactly the same time, while the ECB is looking to cut rates.

Speaking about raising rates, when do you expect this to happen and what king of further monetary policy developments do you anticipate from the Federal Reserve?

First of all, the Federal Reserve has to stop QE, which we expect to happen probably next month. After this happens, we will be able to talk about raising rates, which to our mind, is likely going to happen by June 2015 during the Q2. However, as the Fed becomes more hawkish in its speeches, we will be able to witness the U.S rates start to rise related to other countries. Since the market will, obviously, price it in before the Fed makes that happen. Thus, I suppose the timetable remains the same.

What will be the main drivers for the U.S. Dollar during the rest of 2014?

To my mind the main driver is a carrier place for safety. In fact, if we pay attention to the peripheral yields right now in the tier sector in Italy, Spain and Portugal, we can see that these countries are all trading on a lower level compared to U.S. rate by almost 20-30 basis points. Hence, if I invest in Italy or Spain - I will earn significantly less, than if I invest in the United States.

Therefore, the U.S. is becoming carrier trade related to peripheral Europe. As long as the Fed is likely to raise rates along with the ECB, that is looking to cut rates and raise their balance sheet by about 1 trillion euros. Thus, the Euro is going to be under pressure and the greenback will advance.

Probably the most important part of the statement during the ECB press conference in Frankfurt on the 4th of September, was that they are going to be raising their balance sheet back to the levels of year 2012, when the Euro was trading around 1.21-1.32, but the average ran 1.2880, which is, obviously, very far from where we are now - 1.2970. Moreover, I would say we will move into 1.20 – 1.25 area. To sum it up, I am very bearish on the Euro and quite bullish on the Dollar for today.

What are your forecasts for the EUR/USD, the GBP/USD and the USD/JPY for the end of this year?

I believe that the Sterling is going to be under pressure from the results of Scotland vote. There is a high risk that Scotland will vote for independence next week, which would surprise the market considerably. If Scotland votes “yes”, we can see the Sterling heading from 1.6325, where it is today, to end of 1.55-1.56 level. At the same time, I consider that the Euro will be traded around 1.25 by the end of the year, and the USD/JPY I can see rolling up 1.06-1.07.