FYI | Oct 11 2011
– FOREX.com expects further deterioration in global growth outlook
– Risk aversion levels will thus also remain elevated
– US dollar, yen and Swiss franc may strengthen on risk aversion
– Risk assets such as commodities unlikely to be favoured
By Chris Shaw
Entering the final quarter of 2011, FOREX.com expects further deterioration in the growth prospects of major economies, with an increasing spillover effect into emerging markets. This has the potential to raise the risks of a global recession.
Assuming such an environment, FOREX.com expects risk aversion will remain elevated. This implies the volatility seen on global markets in recent months will continue and suggests a more defensive approach is justified. FOREX.com has a bias towards safe haven assets and against riskier assets such as equities and commodities.
As FOREX.com notes, the September update from the International Monetary Fund (IMF) included cuts to global growth forecasts. The IMF now expects the major economies will deliver growth of just 1.6% this year and 1.9% in 2012, down from previous estimates of 2.2% and 2.6% respectively.
The 2012 forecast is based on Eurozone leaders being able to contain the debt crisis, the US finding a balance between further stimulus and reducing deficits and a stabilising in market volatility. As there is little certainty with respect to any of these factors, FOREX.com remains of the view investors are likely to remain risk averse.
IMF forecasts for emerging economies were also lowered but by a smaller degree, but FOREX.com continues to see risk of weak demand from major economies generating a more pronounced slowdown in emerging nations. Potentially this could deliver a global recession.
There are few bright spots at present, as even in the US FOREX.com notes the jobs/stimulus package proposed by the Obama administration is likely to be watered down at best. Assuming signs of partisanship in the process of passing a package investors are likely to be further unnerved, which would add weight to the risk aversion argument.
What should keep investor sentiment fragile in the view of FOREX.com is the key fundamental drivers of weak growth at present, such as high unemployment and consumer and business de-leveraging, are long-term sources of weakness. This suggests no material improvements in the shorter-term.
In such an environment, FOREX.com expects the US dollar will strengthen further on a safe haven basis against other major currencies. Other traditional safe haven currencies such as the yen and the Swiss franc should also see support, though upside here may be limited by interventionist policies by governments and central banks.
Downside volatility is expected to continue for the commodity linked currencies such as the Australian, Canadian and New Zealand dollars, as well as for various emerging market currencies.
The volatility of recent months has delivered a shift in market expectations. FOREX.com notes a few months ago central banks in the likes of Australia, Canada and Europe had been expected to be lifting interest rates but now these markets are pricing in rate cuts over the next 6-12 months.
These rate cut expectations are another limiting factor for the upside of many of these currencies, even if central banks largely remain on hold through to the end of the year. The FED is also expected to remain on hold into 2012,as the bar to any QE3 appears quite high at present, notes FOREX.com.
The biggest risk in coming months is global markets go into another tailspin, so necessitating emergency rate cuts.
Entering the fourth quarter, FOREX.com notes the issue for Europe's banks is not only a liquidity problem but a solvency issue as buffers are not large enough in the event of a default by Greece. This is likely to mean large scale re-capitalisation moves and asset sales.
As part of this an increase in the size of the European Financial Stability Facility is expected, but political wrangling over this could cause delays and so disappoint investors. Eventually an extension to the facility will be achieved, as FOREX.com suggests the core economies of Europe will have no choice but to bail out Greece.
As the sovereign debt crisis has knocked confidence levels for both consumers and business, FOREX.com expects growth in the Eurozone will fall into negative territory in the fourth quarter. This is likely to pressure the European Central Bank (ECB) with respect to rate cuts in either November or December.
Any ECB action will impact on the euro, as avoiding a rate cut may see the euro perform well. FOREX.com expects the euro will trade in a range of 1.2900 to 1.3900 against the US dollar. The caveat is any fall below US1.2650 may cause a sharper move lower towards 1.1800, the low of April 2010.
For the UK quantitative easing is on the cards, even while rates are likely to stay on hold through the quarter. Ongoing weakness in the UK economy is fuelling concerns with respect to the economy's fiscal position, especially as budget forecasts appear harder to achieve.
With growth likely to get worse before it gets better, FOREX.com expects the Bank of England will have to stop in and fill the growth gaps. This implies further weakness in the British pound, FOREX.com expecting a range this quarter against the greenback of 1.5000-1.5800. Risk is for a fall to 1.4500.
Since the earthquake and tsunami in Japan earlier this year, the yen and the Swiss franc have strengthened, apart from one period of currency intervention for the yen in early April. Both respective central banks face the problem of whether or not to pursue further intervention, as Japanese exporters in particular are struggling with the strength in that currency.
FOREX.com suggests further strength in the yen will be needed before the Bank of Japan intervenes, which implies a break below 75 yen to the dollar before action is taken. The Swiss National Bank has set a 1.20 floor against the euro and to date this level has not been tested, but any test would be an opportunity to establish a bullish euro/Swiss franc position in FOREX.com's view.
With the Australian economy continuing to deliver solid growth numbers, FOREX.com expects the Reserve Bank of Australia (RBA) will be on hold with respect to rates through the rest of this year. But persistent high volatility in financial markets and ongoing global economic uncertainty is likely to keep equities under pressure, which should weigh on the Australian dollar.
FOREX.com expects a range for the Australian dollar against the US currency of 92.00-102.00c, with risk of a move to US85.00c if there is a move below US92.00c.
In New Zealand the cash rate has been held low since the Christchurch earthquake but the economy remains export driven and so at the mercy of global growth. The uncertain growth outlook means the Reserve Bank of New Zealand is likely to stay on hold shorter-term, something FOREX.com expects could deliver outperformance against the euro and the British pound. Forecast range against the US dollar is 73.00-83.00c, with risk of a move to 65.00c if the cross falls below 73.00c.
The Canadian economy remains vulnerable to any slowdown in the US, while the Bank of Canada is expected to remain on hold given risks to the economy at present are tilted to the downside. Forecast range for the quarter is 1.00 to 108.00c against the greenback, with the risk of a move to 113.00c if 108.00 is broken.
With respect to commodities, FOREX.com suggests silver will tend to underperform gold when the economy slows, given silver's larger industrial usage. Gold may yet fall further before a more meaningful bottom is found, while any move to the US$1,700-$1,740 per ounce level would be seen as attractive for establishing a bearish bias.
There is further downside scope for silver in the view of FOREX.com, especially given ongoing volatility in global markets. Any break below the 2011 low near US$26 per ounce could give way to a test of the 2010 highs around US$20 per ounce.
The deteriorating macro outlook may also weigh on crude oil prices, as lower growth expectations are likely to translate to lower demand. This leads FOREX.com to suggest crude may continue to head lower in the December quarter, with trading likely to be in a band of US$65-$90 per barrel in the US and US$85-$110 per barrel in the UK.
For equity markets, FOREX.com takes the view share price direction will depend on whether a solution to the sovereign debt crisis in Europe can be achieved and what the impact of the solution is on growth. The major risk is weak growth feeds into corporate profits, a risk expected to weigh on equity prices for the next three months.
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