Currencies | Oct 16 2009
By Andrew Nelson
Just three short months ago the global economy appeared to be rebounding at a fast pace, with a V-shaped recovery looking increasingly likely. Higher risk currencies that were sold off in the previous months were making a remarkable come-back and all at the expense of the greenback.
The run of economic data has been mixed of late and the sustainability of the economic recovery is now being questioned. Most central banks (Australia aside) have been reluctant to put too many chips on the economic improvement square, instead keeping the bias set at “emergency levels” for their respective monetary policies. This, in turn, has helped keep a lid on yields for government bonds the world over.
FX analysts from Dankse Bank aren’t put off by this latest bump in the road. Despite moderating consensus forecasts, the Danish bank still has a very positive view on the economic outlook. The most important factor, notes the team, will be an expected stabilisation of inventories at current, relatively low, levels. This, in turn, will provide a strong boost to global GDP growth. In fact, Danske sees this push lending an extra 1-2 percentage points to annualised quarterly growth from Q309 to Q110.
The team also expects to see continued strength in company earnings, which will probably drive stocks higher, with commodity prices likely to follow. From a currency perspective, this will be to the definite benefit of the AUD, NZD, CAD and the Swedish and Norwegian krone to name a few, while USD and JPY will be the major bearers of the downside.
As we’ve all noticed, relative interest rates have not been a major driver of currency fluctuations for over a year now, as policy rates just about everywhere have converged at a very low level. Yet with the timing of exit strategies likely to be varied, the team at Danske still thinks relative rates will gain importance in the months ahead. In fact, the team notes we are already seeing that the strong link between currencies and risk is fading.
Danske expects this trend will evolve further as the global recovery takes root. Thus as we head into 2010, the team expects we will soon see the end of what have been fairly “bizarre” market dynamics, such as better-than-projected US macro data weakening the US dollar.
The analysts break the world up into three separate types of central banking philosophies.
The first group it labels the “First movers” and we already know some of the players in this group. Australia has already hiked rates, Norway is expected to follow this month, while a Canadian rate hike has become increasing likely after some surprisingly good activity data. These currencies are already singled out by Dankse as being beneficiaries of a commodity boost as well, and the two benefits together could see the AUD, NZD and CAD especially, deviate even further to the upside from normal levels over the coming quarters.
Then there are the “Followers”, a group that includes the Eurozone, the UK, New Zealand and Sweden, which could all see tighter monetary policy by mid-2010. Danske notes that while a policy tightening in the UK may seem unlikely right now, especially after some recent doveish comments from the BoE, Danske bank’s expectation of high inflation through 2010 means that rate hikes on the six-month horizon can’t be ruled out. While there is also significant uncertainty about the timing of European tightening, the team notes the ECB will want to hike rates at least before the Fed does.
That brings us to the “Laggards” team, which is captained by the US and Japan. The bank thinks neither of the two are likely to even think about the reintroduction of a tightening of monetary policy before late 2010, at the earliest. However, once hikes in these economies are priced in, Danske thinks we could be staring down the barrel of a very steep US curve, which means lower EUR/USD levels from mid-2010.
However, the team notes that the if the US dollar’s reserve status comes further under pressure, with countries like China, Russia and Iran having recently intensified their arguments for an alternative to the US dollar, then there could be some serious doubts as to whether we will ever see a return to EUR/USD’s previous so called fair value of 1.25.
