Forex News - Macro/Fixed Income Research - 9 June 2010

US dollar

The US dollar continued to appreciate against the euro, which was mainly due to the negative spin Hungarian politicians were giving their own budgetary situation in a statement. High government officials did not want to rule out a Greek scenario nor a default.They also cast some doubt on the budget deficit as previously agreed with the IMF.

But after a sharp reaction on the markets - the forint and Hungarian government bonds incurred massive losses - Hungary's politicians were rowing back at the beginning of the week and confirming the budget deficit of 4% in terms of GDP (along the lines agreed with the IMF).

Apparently the statements made last week were mainly directed towards the Hungarian voters and were supposed to lay the foundation for a range of unpleasant fiscal measures. Yesterday, the Prime Minister reveiled his package of measures. We think that the budget target will be reached, or it will at worst be marginally exceeded. Even though the Hungarian politicians were overshooting reality in their earlier statements and we regard a sustainable fiscal policy as the most likely scenario in Hungary, the most recent slump of the euro highlighted yet again the lack of confidence of international investors in the common currency.

The focus on the situation in Hungary was so strong that hardly anyone was taking note of the surprisingly weak labour market data in the US. In fact, these data are actually detrimental to the growth prospects of the US. The EURUSD exchange rate remains therefore dominated by the crisis and the sentiment triggered by it, which was fuelled by the events in Hungary.

The consolidation of the public budgets in the EU does of course put numerous risks on the agenda, both in terms of whether said consolidation will be implemented at a sufficient degree, and with regard to the resulting effects on economic growth. However, the US faces similar problems, given that it cannot escape the consolidation of the public budget either.

We do not know at what point in time the markets will trust the budget consolidation in the EU, and therefore the short-term forecast of the EURUSD exchange rate is very difficult. But either way, the US still faces the whole of what Europe has already started with, and this point of view should ultimately burden the US dollar.

Swiss franc

On Friday - earlier than we anticipated - the franc broke through the EURCHF 1.40 mark in one big movement and is currently quoting close to EURCHF 1.38. We think a further strengthening is likely and we have revised our forecasts accordingly.

Swiss GDP growth lost momentum in the first quarter but still amounted to 0.4% q/q. Besides the stable robust consumption this was mainly due to strong export growth, implying that these did not suffer too much from the stronger franc (in April too, exports increased further).

One should take into account that the franc has weakened versus Asian currencies (on a trade weighted basis) and that exports to Asia contributed significantly, however. Nevertheless, the current exchange rate does not seem to pose a huge problem to the Swiss economy so far. Inflation might already have reacted to the exchange rate and decreased slightly in May, even though it is still above the SNB's expectations, pointing to lower deflationary threats.

Overall, the SNB's need for action does not appear to be overly urgent. The Bank is likely to continue to fight any excessive strengthening of the franc (which might also be seen in terms of the speed of the movement) due to speculation or safe haven flows.

The extent of previous interventions might already be reflected in the decrease of the Libor to 0.08%. Nevertheless, we expect strengthening pressures on the franc, which have been accentuated by problems within the Eurozone, to persist for some time and think that a further appreciation is likely.

Japanese yen

Japan's new Prime Minister, Naoto Kan, already had a position in government as Minister of Finance. He already mentioned back in December that a weaker Yen was desirable, and had later put repeated pressure on the BoJ to fight deflation more decisively.

Hence, it could be the case that he might increase pressure on the Bank to extend the amount of Yen liquidity in any way, which would exert a weakening pressure on the Yen.

The Yen has recently continued its volatile path and could now and then return to USDJPY 90 in the future too. In the medium term, we expect a weakening to USDJPY 95 though - under the assumption that we rule out any serious renewed turbulence on the financial markets.