FYI | May 06 2008
By Chris Shaw
The US dollar has been dogged for some time by a growing interest rate differential between the US and most other countries. The slowing US economy has also worked against the US dollar by generating negative capital flows, but as SVB Global Financial Services senior FX advisor Dave Baghat points out here at least there has been some stabilising in recent weeks rather than a continuing of the worsening trend.
Baghat’s view is the trend of a weaker US dollar may now begin to reverse itself, though he suggests it is likely to take some time rather than be a sudden adjustment. The dual headwinds of falling short-term interest rates and different stages of the economic cycle that have worked against the world’s reserve currency for so long appear to now be turning slowly in its favour, with Baghat suggesting the Fed is likely to be near the end of its monetary policy easing and the US economy is a good chance of picking up just as other regions of the global economy and Europe in particular enter a period of lower growth.
Traders have also picked up on this as Danske Bank notes there has been a reversal in terms of positioning in the global foreign exchange market in recent weeks, with net short positions against the US dollar falling significantly from around US$17 billion to close to US$6 billion as long euro and pound exposures were trimmed.
As well the bank points out the bullish view on the euro against the US dollar held by many traders for some time has also changed, with futures markets showing euro positions are now net short for the first time since December 2005. CIBC World Markets also noticed the shift, pointing out the change was the largest weekly shift in sentiment for three years.
A further factor supportive for the US dollar’s outlook is the fact on Baghat’s measures at least it is significantly undervalued against other developed nation currencies such as the Canadian and Australian dollars, the euro and the British pound. The same is not true for emerging currencies though and so he suggests the USD is likely to reverse the trend against currencies from other developed nations. However, Baghat believes the US dollar should continue its trend of falling relative to the currencies of developing economies such as China.
In terms of the US dollar against the euro Baghat suggests 1.50-1.60 is likely to remain as the trading range in coming months as the timing of any sustainable shift in trend remains uncertain, though in a year’s time he suggests a rate of 1.40-1.45 is possible.
CIBC also doesn’t see any significant support for the US dollar in the short-term, the group suggesting the state of the American economy means the Fed is unlikely to have finished easing rates and this in turn means it is still too early for a significant revaluation in the currency.
On its numbers the US dollar is more likely to end the third quarter at around 1.62 against the euro than the 1.55 it is trading at now, though a decline to around 1.56 is possible by the end of the year and 1.50 is a chance in the first half of 2009.
Earlier, chartists at CIBC suggested the USD was on its way back towards EUR1.41 on a longer term time scale. This would correspond with the 1.40-1.45 suggested by SVB.
