FYI | Feb 19 2009
By Andrew Nelson
Whether we like it or not, the USD is still the world’s reserve, invoicing and funding currency and in times of financial hardship, such as the current global recession, US loans are repaid and more importantly, US investments abroad are repatriated. In such a USD intensive climate, it’s no wonder that the global FX team at Standard Chartered Bank predicts continued strength ahead for the USD. At least for the time being.
The USD has been supported for the past six months by this trend of de-leveraging and repatriation and while there has been much focus in recent years on diversification by sovereign wealth funds and central banks, the world’s real diversifiers are still US and Japanese money managers. This is particularly so in terms of investments into emerging markets. It is for this reason, points out Standard Chartered, that as the global economy tanked from H208 onwards, the USD and Japanese yen were the star performers in global FX.
But at least for the JPY, the stellar gains have run their course and if anything, the risk for the JPY, especially from H209 onwards, is on the downside, says Standard Chartered. Conversely, the team thinks there are still some short-term legs for the USD, especially over the next few months.
So what’s the difference? For one thing, USD de-leveraging isn’t over yet. The team from Standard Chartered notes that US bank credit/GDP was at record levels heading into this crisis, while the repatriation of offshore investments may take quite a while to unwind after what was ten years of serious expansion abroad in the wake of the emerging market crises of 1997 and 1998. At the same time, the bank is expecting to see further downside economic surprises outside of the US, notably in the Eurozone, UK, Japan, much of Asia ex-Japan (AXJ) and Australia.
In line with this view, central banks around the world are continuing to cut policy interest rates towards levels now seen in the US and Japan. While the FX trading world has recently been ignoring the size and scope of interest rate spreads, currencies are still tracking in the general direction these spreads indicate. This too favours the USD notes the team, for now
But change is starting to blow on the wind and there are factors emerging that are beginning to limit USD gains. Most notably, upturns in national PMIs and sentiment indices and then there’s the recent bounce in the Baltic Dry Index. The team explains it uses the Baltic Dry as a leading indicator for the USD because it reflects the state of global trade. As the Baltic Dry increased in the past, global trade increased and so did the US current account deficit, with the USD in to a tight correlation.
The Baltic Dry started to collapse in mid-June last year, providing a clear signal that the USD was bottoming, and so it did. But in just the last few weeks, notes the team, the Baltic Dry itself appears to have bottomed, which may signal some USD weakness at some stage in the not too distant future.
Standard Chartered suggests it is still too early to make any clear predictions, given other market indicators, such as equities, continue to support the view of continued USD strength. However, and Standard Chartered FX analysts “note this with interest”, the environment is surely beginning to support the call for broad-based USD weakness emerging in H2.
Want to take advantage of the news? The team at Standard Chartered thinks the best way to do this is to go long USD and short AXJ. The bank notes that the AXJ region has the highest trade/GDP exposure of any emerging market region and while it benefits more than any other in times of global expansion, it gets hit the hardest during times of global downturn. Given the current global recession is one of, if not the worst, in living memory, the AXJ’s openness to global trade will continue to act as a major handicap for this basket of currencies.
Sure, policymakers across the AXJ region have been active in conducting some extensive programs of monetary and fiscal easing. Interest rates have been slashed, government spending levels have been increased and taxes have cut, but it will take time for this stimulus to work its way through the system. No surprise that the team is thinking H2 will be the earliest before the region sees any meaningful benefit from these programs. This will continue to play into the hands of the USD.
