Currencies | Apr 16 2009
By Chris Shaw
Currency markets have seen significant levels of activity in recent weeks, with the Australian and New Zealand dollars gaining 8-10% against the euro on expectations of stronger commodity prices and the British pound adding 4% on better than expected domestic economic data.
At the same time the US dollar recently experienced its worst week since the 1980s after the US Federal Reserve announced it would pursue quantitative easing measures in an attempt to lift economic growth, while poor economic data out of Japan and rising stock markets have seen the yen fall sharply over the past month or so.
As currency specialists at Danske Bank point out, the moves reflect a rising optimism on the behalf of investors, the recovery coming as no great surprise given the depth of the downturn in recent months. Danske Bank suggests the current recovery signs can be classed into four main groups, these being political initiatives such as stimulus packages, improving monetary conditions given less restrictions and lower interest rates, improvements in economic activity data such as Asian PMI numbers and changes in the perception of risk by investors.
While Danske Bank takes the view a recovery has not yet arrived given indicators such as the OECD global leading indicator are still in decline such a recovery nevertheless appears to be getting closer, especially as the political initiatives will impact at some point and monetary conditions are providing a basis for both financial and economic growth.
This has implications in foreign exchange markets as in the bank’s view the current misalignments resulting from the global de-leveraging process are simply too large to ignore, with the effect on various currencies likely to kick in over the next few months.
Previous studies by the bank have shown the Australian, Canadian and New Zealand dollars tend to appreciate when leading indicators recover, while the euro and the Swiss franc usually depreciate under the same environment. As well, the bank sees it as likely other under-valued currencies, and here it lists the British pound as a prime example, should also enjoy support in such a market.
Looking at specific currency pairs and taking the AUD/USD pair first, Danske Bank takes the view favourable global conditions should add to support for the Aussie over the course of 2009 but there may be a correction of some sort in the shorter-term given the magnitude of recent gains.
To reflect this the bank is forecasting a rate of US71c in three months, US74c in six months and US76c in 12 months, the gains later in the year coming from a gradual pick up in commodity prices that will support the currency via an improvement in Australia’s terms of trade.
As well, Danske Bank takes the view the Australian recession should be relatively mild compared to elsewhere in the world, while the fact around half of Australian exports go to Asia and this region is expected to emerge from the downturn first should also be supportive for the currency in the medium-term.
TD Securities agrees a correction in the Aussie dollar is likely as the recent rally has pushed the currency too far given the weak economic data over the same period. The group notes GDP expectations have fallen and unemployment risen in recent weeks and with inflation pressures continuing to ease this offers the Reserve Bank of Australia scope to cut interest rates further.
If this happens the TD Securities view is support for the Australian dollar will erode further, especially as commodity prices haven’t really offered much support to the currency given the CRB Index is down around 55% from its mid-2008 peak and only slightly higher than its lows in February. To justify current levels even higher commodity prices are needed and these are not a given in the group’s view. TD Securities suggests the currency should be trading closer to US65c and Euro 2.0 rather than its current levels of US73c and Euro 1.85.
But rather than suggesting traders look for a correction against the US dollar the group has looked elsewhere, suggesting weakness against the euro and British pound are more likely and so these are better positions to take in coming months.
Danske Bank is adopting a reserved view on the NZD/USD, as while the Kiwi currency has recovered by almost 20% in recent months against the greenback, Danske doesn’t see the run going much further in the next few months.
The reason is the deep NZ recession will keep the pressure on the Reserve Bank of New Zealand to continue cutting rates, while the economy overall continues to struggle given the nation’s debt levels and the difficulties in obtaining funding in the current financial environment. It will only be later in the year the improvements in the global economy outweight domestic issues and so the bank is forecasting a rate of US56c in three months, US57c in six months and US60c in 12 months.
In Danske Bank’s view, the trough for the US dollar against the yen has passed and gradual outperformance is now most likely, especially as markets are likely to start pricing in a US economic recovery while the outlook for the Japanese economy will remain quite poor.
As this is priced in, interest rate differentials should again come to the fore so the bank is forecasting the US dollar to reach 100 against the yen in three months and six months and 105 on a 12 month view.
For the EUR/USD Danske Bank notes there is currently no clear trend but the overall direction remains downward as the US leads Europe in terms of both the monetary and business cycles, meaning little in the way of support for the euro as the US has already been through its easing cycle but the European Central Bank (ECB) has further to run.
Danske Bank also suggests there is something of a US dollar funding shortage at present in world markets and for as long as this situation persists there will be underlying support for the greenback. In terms of forecasts, the bank expects the euro will fall to US$1.26 in three months, US$1.22 in six months and US$1.25 in 12 months.
It is a similar story for the euro against the British pound as Danske Bank notes signs of improvement in the UK economy are emerging quicker than had been expected, with the housing market in particular showing clear evidence of progress.
As well, the Bank of England’s quantitative easing measures appear to have served their purpose and are likely to be scaled back, this at a time when the ECB is still in rate cutting mode. With the pound seen as the most undervalued currency among the G10 at present and the euro the most over-valued Danske expects this situation will correct itself, forecasting a euro rate of GBP0.87 in three months, GBP0.85 in six months and GBP0.80 in 12 months.
Economic conditions are not great in Canada but as TD Securities notes, conditions remain better than in many other economies around the world. This is providing some de facto support for the Canadian dollar. This has the currency at around fair value at present and the group’s view is being short the US dollar relative to its northern neighbour is a reasonable position as further modest appreciation is expected.
Danske Bank tends to agree as while it sees a short-term risk from the possibility of a further rate cut in Canada in coming weeks, the improvement in global risk appetite should be a positive for the commodity currencies, of which Canada is one.
As well Danske notes the Canadian economy is in structurally better shape than is the US, which supports the bank’s view of further gradual appreciation of the Canadian dollar. Danske’s forecasts call for a USD/CAD rate of 1.23 in three months, 1.20 in six months and 1.18 in 12 months.
