FYI | Mar 20 2008
By Chris Shaw
The ongoing financial crisis has been felt hardest by the US dollar, which has dropped sharply in recent weeks. According to Danske Bank the latest data coming out of the US economy indicating further weakness in the housing sector, higher energy prices and credit rationing, along with the continued volatility in financial markets, makes further declines in the US dollar likely.
While this is a medium-term view Danske notes the speed of the recent falls increases the risk of a corrective rally in the short-term, a view shared by CIBC World Markets. On CIBC’s calculations when the US dollar breaks through large, round numbers, such as 1.40 and 1.50 against the euro, it tends to continue the trend with an average move of 6% in the 49 days after the currency moves through a major price point.
As an example the group notes when the US dollar/euro rate broke through 1.50 the currency ran to 1.5905, which was an increase of almost exactly 6%. Its study also points out such a break through major price points usually doesn’t happen the first time the level is tested and this is followed by a pullback in the exchange rate.
The average size of such a pullback is 4.4% in 29 days and using the high closing price for the US dollar against the euro of 1.5727, meaning its first attempt at 1.60 failed, there is scope for a short-term correction. A 4.4% adjustment would indicate a price target of 1.5035, while the group suggests as a stop using a daily close above 1.60.
Looking beyond the short-term Danske Bank still sees further weakness as there is little to suggest the subprime crisis has passed by, while the problems in credit markets mean central banks have more work to do to address liquidity and solvency concerns.
While asset prices are falling and there is now value in some markets such as the US credit and mortgage markets the risk of forced selling continues to outweigh the desire of investors to pick up bargains, so until this condition changes the bottom is unlikely to be reached.
There is now increasing speculation of central bank intervention to address the movement in exchange rates but in the bank’s view the conditions required for a concerted intervention have not yet been satisfied. The most likely to act in its view is the Bank of Japan, as further weakness in the US dollar against the yen may force further unwinding of the carry trade, particularly if the dollar falls below its previous low of 95.90.
Given most of the problem positions in the current financial crisis are occuring in the US market the dollar remains the most vulnerable and so Danske Bank has revised its forecasts for the currency for periods from three to 12 months.
Against the euro the bank is now forecasting a 3-month rate of 1.60 against its previous forecast and current level of around 1.55, on a 6-month basis it is forecasting a rate of 1.58 against 1.52 previously and on a 12-month view it has moved its forecast to 1.50 from 1.45 previously.
For the US dollar/yen rate the bank’s 3-month forecast now stands at 98 against 100 previously, in six months it now expects a rate of 96 against 100 previously and in 12 months it is forecasting a rate of 100 from 105 previously.
All charts below are from CIBC.
(If you happen to read this story though a third party distribution channel you may not be able to see the charts – we apologise for this).
