Currencies | Apr 30 2009
By Chris Shaw
The last few months in foreign exchange markets have, according to TD Securities global strategist Stephen Koukoulas, largely been a period when fundamentals have taken a back seat to other influences such as investor risk appetite, liquidity and an assessment of the policy vibrancy of various governments.
As these factors have come to the forefront, the usual currency market fundamentals of relative economic growth, carry, current account balances, inflation differentials and commodity prices have generally been if not ignored then discounted. Koukoulas notes for example if these had been important the US dollar and Japanese yen would have been very weak and the euro quite strong.
This presents problems when playing the market as, in Standard Chartered’s view, the preferred course of action is to decide on a strategic course of investing and then follow it through, rather than trying to chase currencies based on stockmarket movements and the associated impact on foreign exchange markets.
Using more normal measures such as economic fundamentals, Standard Chartered suggests the most likely outcome for the global economy at present is a recession and not a depression, with economic data likely to turn positive as we enter 2010. While it probably won’t feel like an economic recovery as it occurs, the improvement in economic data should boost global asset markets, which the group suggests is what is being priced into markets in the current rally.
Assuming such an outcome, Standard Chartered suggests the above scenario spells trouble for the US dollar as that currency has typically thrived in times of misery but retreated in the face of optimism. All this can be expained due to the fact the greenback is generally used as the world’s funding currency for other investments.
This suggests investors should prepare for weakness in the US dollar later this year, with Standard Chartered expecting any retreat in its value to be relatively gradual given authorities will be conscious to avoid a US dollar crisis. Particular beneficiaries of a weaker greenback in the group’s view are the emerging market currencies.
But given the current mindset in forex markets is to largely ignore fundamentals, TD Securities suggests the currencies most likely to benefit are the Canadian dollar, the yen and the British pound, while TD is neutral on the Aussie dollar and the euro given existing conditions and bearish on the US and New Zealand dollars.
The group’s bullish calls are linked to a mix of current account positions, domestic savings levels and a reversal of market positioning, while TD’s negative calls on the US and Kiwi dollars reflect expectations of deep, protracted recessions, current account imbalances and poor government debt positions.
As Koukoulas points out, while it is possible for fundamentals to periodically get swamped by other factors such as sentiment, fund flows and the herd mentality of investors, they do work over the longer-term, meaning there is no reason not to be bearish on the US dollar in particular at present.
