Currencies | Aug 10 2010
By Chris Shaw
Having pushed out its expectation for the first Fed funds rate hike from the end of this year to the middle of 2011, Commonwealth Bank has revised lower its estimates for the US dollar.
Richard Grace, the bank's chief currency strategist, notes the US economy has lost some of its earlier momentum and it now appears it will be difficult for the US to significantly outperform peer economies over the next few years.
US bond yields have also declined to what are seen as unattractive levels, Grace attributing this to the moderation in the economy's growth, the risk of further quantitative easing measures and the Fed's commitment to keep rates low for an extended period of time. Grace also suggests the downward trend in the core CPI has impacted on bond yields.
At the same time there have been relative improvements in economies outside of the US, as these economies are now responding to previous falls in the value of their currencies. Grace also notes European growth is performing better than had been expected.
Having adjusted expectations for the US dollar, Grace has made changes to his forecasts for other currencies which include a lifting of estimates for the Australian dollar against the greenback. What also supports higher Aussie dollar forecasts is a higher expected trading range for the Australia-US two-year bond spread and an extended period of relatively firm global growth.
Grace expects global growth will be above 4.0% both this year and in 2011, which should support both commodity prices and Australia's terms of trade. But with growth in 2011 expected to be lower than in 2010 Grace suggests it will be difficult for the Australian dollar to appreciate further.
This means while forecasts for the Aussie dollar have been lifted, Grace still expects the currency will trend lower on a 12-month time frame. His forecasts call for rates against the US dollar of US90c at the end of September, US88c at the end of December, US87c at the end of March next year and US85c at the end of next June. These compare to previous forecasts of US87c, US82c, US81c and US82c respectively.
As with the Australian dollar, Grace expects the New Zealand currency will trend lower against the US dollar on a 12-month basis but forecasts have been lifted from previous levels. This reflects not only revisions to weaker estimates for the US dollar but resilience in the New Zealand dollar despite slowing momentum in the Kiwi economy.
What should be supportive in Grace's view is firm growth for New Zealand's major trading partners and the likelihood the market is under-pricing further interest rate hikes by the Reserve Bank of New Zealand (RBNZ).
Against the US dollar, Grace is now forecasting and end of September Kiwi rate of US71c, declining to US70c at the end of December, US69c at the end of March next year and US68c at the end of next June. This compares to previous forecasts of US72c, US68c, US67c and US68c respectively.
For the New Zealand dollar against the Aussie dollar Grace notes the Australian economy is the better relative performer at present. With the RBNZ likely pausing on rates the Australian yield curve should remain above the New Zealand yield curve for longer than previously expected.
Grace has lifted his forecasts for the Australian dollar relative to the New Zealand dollar as a result, now forecasting rates of NZD1.2676 at the end of September, 1.2571 at the end of December, 1.2609 for the end of next March and 1.2500 for the end of Next June. These are up from NZD1.2083, 1.2059, 1.2090 and 1.2059 respectively.
Similarly Grace has lifted his forecasts for the euro to reflect a weaker US dollar, while he also points out an easing of the sovereign debt crisis and more stable European money market rates should offer some support to the currency.
Grace also suggests the recent depreciation in the euro was something of an overshoot by the market, so central bank currency managers are showing some interest as they look to diversify out of US dollars.
Grace is now forecasting euro against US dollar rates of 1.31 at the end of September, 1.30 at the end of the year, 1.28 at the end of next March and 1.25 at the end of next June, up from previous forecasts of 1.20, 1.15, 1.10 and 1.12 respectively.
Grace has been bullish on the British pound (GBP) for some time but has lifted his forecasts again as there are signs the UK economy continues to improve and as higher inflation is likely to force interest rates higher. The potential full extent of these hikes is currently not being priced into the market in his view.
Grace is now forecasting a GBP rate against the US dollar of 1.60 at the end of September, 1.64 at year's end, 1.68 at the end of March next year and 1.70 at the end of June. These compare to previous respective forecasts of 1.42, 1.45, 1.43 and 1.45.
With respect to the Japanese yen, Grace also sees an ongoing bias to further strength as US-Japan interest rate differentials continue to decline and as Japanese can earn a higher real yield on their local bonds than on money invested in US and Eurozone bonds.
As well, Grace suggests the current account surplus enjoyed by Japan is supporting its currency against the US dollar on a purchasing power parity (PPP) basis, something he suggests also argues for further yen strength.
Grace expects the yen will finish the September quarter at 85.00 against the US dollar, then 84.00 at the end of December, 83.00 at the end of next March and 85.00 at the end of next June. Previous forecasts were for respective rates of 93.00, 95.00, 98.00 and 100.00.
