FYI | Nov 03 2008
By Andrew Nelson
One of the symptoms of recent market turmoil has been the unceasing rise of the US dollar, with investors forced to buy up the currency to cover short positions created by losses on US dollar denominated assets. This has seen exchange rates shoot a mile high in the greenback’s favour, but at least a partial reversal of these recent gains is becoming more and more likely as markets are expected to become more orderly in the months ahead.
Analysts at CIBC point out that even though the Fed’s fund rate is closing in fast on zero, it appears that the strength of the US dollar has little to do with the difference in yields lately. “Who cares about yields when a one-day currency move can potentially wipe out a one-year interest differential?” wonders CIBC.
This unprecedented volatility in foreign exchange markets has seen the US dollar skyrocket against all other major currencies in the last few months and while many have been quick to call it a flight to safety, the analysts at CIBC point out that the US dollar, right now, is far from a safe bet based on economic fundamentals alone. CIBC highlights a massive US current account deficit and an economy that is now most certainly in recession as its evidence. This leads the bank to suggest current trends are more about forced buying than any sort of move to safety.
Added to the need to buy US dollars to repay US dollar denominated debt that cannot be not refinanced, the bank also notes that demand for the US dollar is equally being driven by redemption calls from US based hedge funds that had/have assets abroad in other currencies, thus seeing a further forced repatriation of US dollar investment. These factors have added up to what is the worst month on record in terms of the collective depreciation of other major currencies, says CIBC.
But this run can’t go on forever, say the analysts, as the US simply can’t afford the continued drag on exports that the currently rampant US dollar is causing. Right now, they point out, exports have provided just about the only private sector source of growth in the past year. This leads the analysts to predict that at least some of the US dollar’s gains should be reversed when global markets return to a more calm footing and the forced buying of dollars abates
When? CIBC doesn’t know, but the analysts do expect to see evidence of such a move emerge after the end of this calendar year, especially if global markets begin to react to the various and multiple rescue and stimulus measures that have been put in place.
CIBC singles out the Aussie dollar as about the hardest hit of any of the established trading currencies, noting that it has lost around a quarter of its value against the greenback so far this year. But by this point, all of the bad news about falling commodities and a declining interest rate should be priced in, says the bank, so we should see a bit of stability at current levels.
With the government seemingly having done the right things for the banking industry in specific and the economy in general, the last piece of the puzzle is commodity prices. CIBC expects these will begin to recover later next year and will help bring the Aussie back to US75c by the end of 2009.
What to do?
CIBC has one idea for the brave at heart, which is buy a 2-week 1.2500 EUR/USD put. Chartists at CIBC note that while there was a recent correction of sorts, the Euro was held up at 1.33 by the 38.2% Fibonacci retracement target. With event risk increasingly prominent and risk aversion sentiment expected to remain high, the analysts don’t see much short-term positive upside for the Euro.
The clear rejection of the 1.33 topside is a definitive sign that current EUR/USD strength is a selling opportunity, say CIBC, especially given Friday’s sell-off happened during what was a very buoyant and upbeat trading session for equities the world over. This leads the chartists to predict that a break below the key 50% Fibonacci level at 1.23 is likely. If it happens, then look out 1.20 and points below.
