FYI | Sep 25 2007
SVB Silicon Valley Bank’s senior advisor, and currency specialist, Dave Bhagat has jumped to the defense of the Federal Reserve Bank’s decision to cut official interest rates by 50 basis points last week.
In a market update today, Bhagat acknowledges the interest rate cut was larger than his own prediction of a cut by 25 basis points, but he believes the move makes perfect sense as it allows for some added insurance, while sending a strong message, and it may possibly prevent the Fed from falling too far behind and needing to play catch-up.
Bhagat says the main questions now are how will the US economy respond, and what does the future hold for the US dollar?
Cutting a long story short on the US economy, Bhagat sees GDP growth in the US falling to circa 1% for a few quarters next year, but not into negative territory. This would imply the world’s largest economy will not experience a recession, but also that US interest rates will be cut much further in the year ahead.
Bhagat believes official US interest rates are likely to bottom at 4.00 to 4.25% in 2008 from the present 4.75%. He believes the Federal Reserve will cut in the next few months, and possibly in early 2008 but will be finished by mid next year. At that time he also expects the US housing market and the US economy in general to start trending upwards again.
While the economic slow down in the US should diminish inflationary dangers, Bhagat believes growth elsewhere in the world could well remain strong and therefore inflation might become a problem in some Asian countries. He is not so worried about the UK, Europe and Japan as economic growth is likely to disappoint there as well.
All this has turned him into a US dollar bear, at least for the period between now and mid-2008. The only positive influence for the greenback, says Bhagat, is the improving trade deficit for the US, but this will only have a slow, longer-term impact, he says.
In the near-term, this minor positive is expected to be dwarfed by many other negatives, such as a reduced demand for USdollar assets (as yields are falling and risk aversion declining) and continued out-performance by global equity markets relative to the US (on better growth prospects).
Bhagat says with the recent interest rate cut and more to follow, the US dollar may soon be viewed as a “funding” currency for carry trades; not to the extent the yen is, but certainly the allure of high rates may fade and that may pressure the currency, he says.
Bhagat’s personal year-end 2007 currency predictions are (all against the USD): EUR 1.43, GBP 2.00, JPY 112, CAD 1.00, CNY 7.35 and INR 40.00.
He predicts a US dollar recovery by mid to late 2008, as an economic recovery combined with a lower trade deficit should kick in as support for the currency. His personal year-end 2008 predictions are: EUR 1.35, GBP 1.88, JPY 114, CAD 1.05, CNY 6.90 and INR 38.00.
