FYI | Oct 28 2008
By Chris Shaw
While most of the attention in the financial crisis has been on the big name collapses in the US banking sector, CIBC World Markets points out the European banks are in just as much trouble, as those with large operations in the US have been forced to take large write-downs in relation to assets connected to the US housing market.
As these exposures were primarily funded by short-term US dollar denominated debt, these banks are now stuck with US dollar liabilities well in excess of the value of their US dollar assets. The group suggests this is forcing the banks to buy US dollars through either swap agreements or outright on foreign exchange markets.
This in turn is putting significant downward pressure on both the euro and the British pound, as while financial markets experience the current bout of de-leveraging, the banks simply can’t access enough short-term capital to meet their liabilities and so are being forced to turn to central banks and the forex markets.
CIBC expects this de-leveraging process will continue for some time, which suggests at the very least a subdued outlook for the euro against the greenback.
Looking at the currency pair from a technical perspective offers a similarly grim picture, with the group noting the euro has fallen more than 20% in just 100 days, which is an almost 75% retracement of the medium-term trend and almost 50% of the long-term trend of the past seven years.
The group had a year-end target of 1.25, but with this having been reached a couple of months ahead of schedule, the implication is further weakness is to follow, particularly as speculative positioning is just beginning to show a net short position developing.
While the pace of the decline is unlikely to be maintained, in the group’s view, it has revised its forecasts to account for the latest movements. CIBC is now targeting a euro/US dollar rate of 1.165, which it sees as the next level of support for the currency.
