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Danske Bank Sees Further US Dollar Weakness

FYI | Apr 02 2008

By Chris Shaw

A few months ago Danske Bank predicted the US dollar would hit levels of 1.55 and 100 respectively against the euro and the Japanese yen and these targets were subsequently achieved, though via more orderly moves than the bank had expected given the economic conditions when it made those forecasts last November.

The bank’s chief strategist, Teis Knuthsen, points out the extent of the move in the euro in particular has been a surprise as the currency is now more than two standard deviations away from fair value, the first time this has occurred since 1992 and enough to force the bank into a review of its currency estimates.

Factoring in the latest data sees Knuthsen predicting the US economy to contract in the current half year and to be evidenced by a fall in the ISM Manufacturing index to below 45, an increase in unemployment and no stablisation of the housing market outlook. The proposed stimulation package should provide a modest pick-up in the September quarter but Knuthsen doesn’t see this as sustainable, meaning signs of weakness should again emerge in the December quarter.

As the Federal Reserve continues to fight the weak economy Danske Bank expects official interest rates will be cut to 1.5%, so while a recovery through 2009 is expected it should be mild given the influence of inflationary pressures, falling house prices and more restrictive bank lending.

This raises the question of will the rest of the world de-couple from the US or re-couple and suffer through a slowdown of its own, with the bank suggesting while the former is less likely as there is some evidence the US slowdown is impacting on other economies the latest economic data continue to support some level of de-coupling.

If a re-coupling between the US and the global ecconomy was to occur Knuthsen would view it as supportive for the US dollar but a negative for commodity based currencies, though short-term he expects the de-coupling argument to continue to be more heavily supported and this means further weakness can be expected in the US dollar.

If the weakness is substantial it raises the risk of some form of intervention by authorities, though short-term Knuthsen views such a move as unlikely as currency markets have yet to display much in the way of disorderly movements. Complicating any policy is the fact the US is attempting to promote growth and the EU is attempting to contain inflation, these objectives being better served by a weaker US dollar and interest rate related support for the euro.

To reflect its outlook for the US and global economies Danske Bank has revised its currency forecasts, now expecting the euro to trade as high as 1.60 against the US dollar and for the greenback to move as low as 96 against the yen from its previous forecasts of 1.55 and 100, with a more prolonged period of dollar weakness being factored into its view.

With the Bank of England now looking set to join the US in fighting against poor liquidity in financial markets this bodes poorly for the pound and consequently Danske Bank forecasts a move to 0.82 in the euro/pound rate, while signs the economies of Australia and New Zealand are now weakening slightly and the lack of a rate hike by the Reserve Bank of Australia this week mean the pillars supporting both currencies are now looking a little more wobbly.

As a result Danske expects both currencies will trend lower against the US dollar in the second half of the year and its 12 month forecasts are US85c and US72c respectively, while it continues to expect the Canadian dollar to perform strongly against its US counterpart and so the bank sees it holding around current levels over the next 12 months.

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