FYI | Sep 18 2008
By Chris Shaw
With AIG needing a rescue package, Merrill Lynch being sold and rumours of HBOS in the UK being in trouble, it is clear the global financial crisis has further yet to run. Danske Bank points out one implication of this is more losses for investors across all asset classes, including bonds, equities and carry trades in currency markets.
The group expects this cycle to continue until the point is reached where capital being created exceeds the capital being lost, or when a new group of investors move in to take advantage of low priced assets. When the crisis began in 2007 that investor group was sovereign funds, but now it appears that it is central banks and finance ministries acting as short-term investors as financial de-leveraging continues.
At the same time, the bank notes global economic data has worsened of late and while US growth is also likely to weaken, the EU is on the verge of a recession and the UK, New Zealand and Japanese economies are no better off and facing an increased chance of a hard landing.
In the face of all this, the standout performer has been the US dollar, which has rallied strongly over the past several weeks and delivered its fourth-best run since 1980. After such a strong move, a correction appears overdue, but as Danske Bank notes, both the global and the local outlook for the next few months actually remains supportive for further gains in the greenback.
The bank suggests the framework created by the credit crunch and the slowdown in world growth is positive for the US dollar, as locally there are supportive factors such as hopes the worst may be over for the US economy by 2009 and the actions of the Federal Reserve in moving to prevent a financial and economic meltdown.
In contrast, the European Union appears about to enter a recession and policymakers there have done little as of yet in terms of offering support. This suggests future weakness in the euro against the greenback, while weaker commodity prices are also dollar supportive.
Technically, the bank acknowledges there are signals suggestive of a US dollar correction given the size and speed of the recent rally and the fact speculators are now long the currency. But while a move back to around 1.45 against the euro is possible, it would be a correction and not the beginning of a move to new dollar lows in its view.
Reflecting its view, the US dollar has further to go against the euro. Danske Bank has adjusted its 12-month forecast from 1.40 to 1.35, while by 2010 it expects the dollar to move even further and to hit 1.30. This forecast remains unchanged at present.
In contrast, the bank expects the dollar to largely range trade against the yen with 100-110 being the likely limits of any moves over the next few months. The news is much worse for both the Australian and New Zealand dollars, as the bank expects both will continue to suffer from the combination of external deficits and turns in both the monetary policy and economic cycles.
The Aussie dollar has fallen by 17% against the US dollar in the past couple of months and the Kiwi dollar is down 19%, but the bank suggests both remain overvalued on long-term measures. With little support expected from relative interest rates, relative growth rates or commodity prices, the bank expects further falls and now forecasts US76c for the Aussie dollar and US63c for the Kiwi dollar against the greenback over the next 12 months.
