Currencies | Mar 21 2012
– Risk-on, Risk-off mantra no longer rules US dollar
– Ongoing regional issues to weigh on euro
– Australian dollar may hit parity against greenback
By Chris Shaw
Over the past few years, CIBC World Markets notes US dollar crosses were driven by a simple mantra of selling the dollar and yen to buy the euro and commodity currencies on good economic news and doing the reverse when bad news was released.
But lately CIBC notes this mantra has not worked, as while commodity currencies will still rally against the US dollar on positive global economic reports, the risk-on/risk-off has not applied to the dollar/euro and dollar/yen crosses.
In CIBC's view the logic behind this shift is the US economy is at the stage of the cycle where strong economic reports could materially alter expectations for Fed policy moves. While rates are unlikely to be raised anytime soon, progress in closing the output gap can dampen the odds of any further quantitative easing.
At the same time, CIBC notes the ongoing Eurozone recession increases the downside risks for the euro if the European Central Bank (ECB) is forced into its own program of Quantitative Easing (QE).
For the yen, CIBC suggests the earlier risk trade was associated with the expectation Japanese investors would accelerate yen repatriation, so boosting the currency. But with the Bank of Japan effectively setting a line in the sand for the dollar/yen and a commitment to an inflation target offers an offsetting flow.
CIBC suggests the weaker the backdrop for the global economy, and therefore the Japanese economy, the more the Bank of Japan will commit to intervention to prevent further yen strength.
With respect to the euro, CIBC suggests the structural problems in Europe are far from over, especially given currently high oil and gasoline prices. Upcoming elections in Greece and France are likely to add to uncertainty with respect to planned budget cuts and this uncertainty could weigh on the euro in CIBC's view.
This leads to the suggestion any strengthening in the euro relative to the US dollar late this year and into next year will reflect renewed weakness in the US economy rather than any significant improvement in the Eurozone.
For the Australian dollar CIBC takes the view recent reductions in excessive long positions have reduced the over-bought position of the currency, but there remains scope for a further reversal against the US dollar.
This is because domestic data continue to undershoot expectations, something CIBC expects will add to doubts the Reserve Bank of Australia (RBA) will be able to maintain its current inertia. This is especially the case as concerns seem to be growing within the RBA with respect to the effect the strong AUD is having on the domestic economy.
CIBC sees further disappointing domestic data in coming months, while also seeing scope for external trade to weaken given signs of a deceleration of growth in the Asian region. A weaker export environment and a negative domestic setting could see a further 50-basis points of rate cuts by the middle of this year.
If this was to occur, CIBC expects investors would continue to unwind excessive long Australian dollar positions, which could bring the currency to parity against the greenback. A weakening US dollar will be the driving factor of the Australian dollar again appreciating before the end of the year, predict the analysts.
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