Erste Group - Forex News September 9, 2009

US dollar
During the past couple of weeks EURUSD has traded in an even narrower bandwidth than before. The exchange rate fluctuated around 1.43. The summer slump on the markets though should now have come to an end. At the time of writing, the EUR/USD exchange rate had climbed above 1.44, which may not have been a big jump, but in the event the euro reached a new high relative to the dollar year to date.
If the news will be sustained on the very short term remains to be seen. But we do see recent movements as the beginning of a further appreciation of the euro, i.e. a movement towards EURUSD 1.50. We have repeatedly discussed our rationale behind this expectation. The massive US budget deficit in the coming years and the difficulties that the US central bank faces in managing liquidity in the wake of the substantial liquidity injections of the past twelve months are the crucial elements of our forecast. On top of all that, the USA is not ahead in the economic cycle this time around. Currently the USA and Euroland are moving in synch out of the recession, although the speed in the coming quarters will differ. The point is that the USA may not be able to fulfil its role as leading economic growth engine, a fact that affects the relative attractiveness of the US dollar negatively. The EURUSD movement will without a doubt become more erratic in the coming months after the holidays season. But the most recent events have supported our opinion with regard to the further depreciation of the US dollar.

Swiss franc
Due to the positive economic data and the good evolution of equity markets during the summer, markets started increasingly to speculate about a possible return to a more restrictive monetary policy. This is particularly true for Switzerland, as the SNB has taken numerous measures to relax monetary conditions. Nevertheless, the risk of a renewed deterioration on equity markets, as well as a slowdown of the recovery, should not be underestimated. SNB council member Jordan recently explicitly indicated this risk: At the same time, a potential reversal of the equity markets should not be underestimated, and the economic recovery should not be called sustainable too early. The monetary policy should adopt a wait-and-see position in this environment, until the recovery has stabilized and deflationary risks have vanished. This is in our opinion a clear statement pointing to unchanged interest rates for some time, as well as a continuation of interventions to avoid excessive strengthening of the franc. A deterioration of sentiment would indeed put strengthening pressure on the franc, which would be counteracted by the SNB. Thus, we expect the franc to move sideways.

Japanese yen
The yen has strengthened vs. the dollar and quotes close to USDJPY 92 (our September forecast). This evolution is surprisingly uncorrelated with equity markets. Less good expectations for the economy, which are also reflected in decreasing yields, might possibly have contributed (see Macro Markets Japan September). In addition, the markets' fear of the consequences of the increase in the monetary aggregates of the Fed could have led to a weaker dollar. Interestingly, though, the monetary aggregate (M0 put in relation to GDP) has increased much more rapidly in the US than in Japan, but has still not reached the same level. Thus, markets seem to put the accent on the dynamics, which is indeed unique from a historical point of view. Hence, we think that, in the short term, the yen still has some strengthening potential; in the longer run, the fair value should be close to USDJPY 95.

Bandwidths for next two weeks
The following bandwidths were prepared based on market estimates of future exchange rate risks. Starting with today's exchange rate, an upper and a lower limit can be estimated for the exchange rate two weeks from now. This covers the most likely scenarios. We have compared the forecasted bandwidth with the actual exchange rate in a chart. The markets expect much wider fluctuations in the future than seen in the past as well, although we have noticed a decline most recently. Thus, the forecasting risk has increased.