Euro/US Dollar interest rate forecasts have become somewhat bearish, but recent FX market price action suggests the EURUSD will continue to trade off of risk sentiment in broader financial markets. Indeed, the historically strong correlation between interest rates and FX market price action faded quickly through the onset of the global financial crisis. Overnight Index Swaps predict that Euro and US Dollar interest rates will be roughly equal in 12 months’ time.
Such forecasts should be bearish for the Euro, which currently enjoys a 100 basis point yield advantage over its US counterpart. Yet we believe that these developments may have little impact on the Euro/US Dollar exchange rate. It will be far more important to monitor trends in the US S&P 500 and other key global risk sentiment indicators.
Euro / US Dollar Valuation Forecast
The Euro remains the most overvalued major currency against the US Dollar, trading nearly three thousand pips above its “fair” exchange rate. Although EURUSD has seen decisive gains on the back of a rebound in risk appetite beginning in early March, a decisive turn may be ahead as stocks show signs of topping having risen to the highest level since August 2004 relative to earnings. Global GDP grew 4.1% in real terms in 2004, virtually every credible forecasting outlet including the IMF, OECD, World Bank, and assorted central banks all call for global GDP to shrink this year. This suggests stock markets are highly overvalued, pointing to a forthcoming correction downward as the euphoria subsides. The long-term fundamental picture is also supportive of a broadly bearish scenario: a survey of economists conducted by Bloomberg suggests US GDP growth will outpace the Euro Zone by an average of 1.43% through the end of next year, pointing to the likelihood that the Fed will lead the ECB in raising interest rates. On balance, a confirmed reversal in risky assets in the near term may open the door for long-term Euro weakness, allowing traders to exploit the vast valuation disparity as EURUSD sinks lower.
US Dollar Japanese Yen Exchange Rate Forecast
Interest rate traders forecast that the US Dollar yield advantage over the Japanese Yen will pick up significantly in the coming 12 months, but recently apathetic FX speculators have shown little interest in interest rate developments. The US Dollar/Japanese Yen exchange rate has instead moved off of shifts in global financial risk sentiment—especially as seen through key risk barometers such as the S&P 500 and Nikkei 225 indices. We predict this will continue to be the case through the foreseeable future.
Recent flare-ups in market tensions bodes poorly for the USDJPY pair; further equity market declines could fuel Japanese Yen appreciation. Further deterioration in risk sentiment could bring USDJPY losses, and it will be important to keep track of relevant indicators. Interest rate expectations, by comparison, are unlikely to influence FX market direction.
US Dollar / Japanese Yen Valuation Forecast
The Japanese Yen is effectively at its “fair” value against the US Dollar for the fourth consecutive month. However, both the yield outlook and comparative economic growth expectations are biased in favor of the greenback. Indeed, the States are forecast to outpace Japan’s performance both this year and in 2010. This suggests a broadly bullish bias for USDJPY in the months ahead, though any downward reversal in risky assets could stand to benefit the Yen as traders flock to the stand-by safe haven currency. On balance, current positioning does not offer an attractive mispricing to be exploited from a valuation standpoint; it seems prudent to remain flat for the time being until a cleaner disparity presents itself.
British Pound US Dollar Exchange Rate Forecast
The British Pound/US Dollar exchange rate has shown little sensitivity to interest rate forecasts, and we predict financial risk sentiment will continue to be the major driver of GBPUSD price action. Indeed, the short-term correlation between the GBPUSD and US S&P 500 Index remains near record-highs—emphasizing that the exchange rate has moved almost exactly in tandem with risk sentiment. Overnight Index Swaps predict that the British Pound-US Dollar yield differential will likewise remain nearly unchanged.
It will be far more significant to monitor shifts in unconventional monetary policy measures. Both the Bank of England and the US Federal reserved have engaged in aggressive Quantitative Easing plans. Any abrupt changes to these programs could cause substantial GBPUSD volatility.
British Pound / US Dollar Valuation Forecast
The British Pound remains substantially overvalued compared to its PPP-implied exchange rate on the heels of a rebound in risk appetite that has weighed heavily on the safety-linked US Dollar. The prevailing outlook for economic growth appears to favor the greenback, with a survey of economists conducted by Bloomberg suggesting the US will outperform the UK by an average of 0.9% through 2010. Notably, the States’ expected growth advantage has been trimmed from last month’s assessment, where it stood at 1.4%. In the near term, risk appetite will likely retain the upper hand in guiding price action with GBPUSD 90.7% correlated with the MSCI World Stock Index (using a 90-day rolling correlation) and positioning seemingly supportive of safety-related assets. Looking farther ahead, interest rate expectations remain roughly balanced and could mean the Pound’s weakness against the Dollar is shorter-lived than that of the Euro.
US Dollar Swiss Franc Exchange Rate Forecast
Negligible US Dollar/Swiss Franc interest rate differentials have meant that the USDCHF remains largely removed from shifts in rate forecasts. Interest rate traders anticipate that the US Dollar will yield over 100 basis points more than the Swiss Franc in 12 months’ time—normally a positive sign for a given currency. Yet the USDCHF trades near important lows, and FX traders have shown little concern over yield developments. It may be far more significant to monitor another important fundamental theme: central bank intervention.
The Swiss National Bank has defended the important SFr 1.5000 mark on several different occasions, and open-market intervention may continue to sway the USDCHF as well. It remains critical to monitor SNB rhetoric and actions.
Swiss Franc / US Dollar Valuation Forecast
On balance, the outlook for the Swiss Franc position is much the same as that of the Euro: the currency’s substantial overvaluation against the US Dollar bolsters other catalysts working in the greenback’s favor, including the yield outlook and economic growth expectations that see the mountain nation trailing the States by an average of -0.3% through the end of 2010. Switzerland’s dependency on external demand as a key driver of economic growth further bolsters the argument that the mountain nation will lag in the recovery. The recent selloff in the Dollar has widened the disparity between spot and the PPP-implied exchange rate, offering bulls an increasingly attractive entry point once growth and yield considerations re-capture traders’ attention.
US Dollar Canadian Dollar Exchange Rate Forecast
it is interesting to note that broader USDCAD moves have generally followed shifts in yield expectations. The Bank of Canada made it quite clear that it would leave interest rates unchanged through much of 2010, and the Canadian Dollar showed little reaction to said news. Yet we look to the time of the release, and the USDCAD set a noteworthy bottom just a day before and rallied significantly through following trade.
Overnight Index Swaps currently show that US Dollar yields will grow by 74 basis points over their Canadian counterparts in 12 months’ time—an arguably bullish sign for the USDCAD. Of course, we will need to wait and see whether future central bank rhetoric will force major shifts in said predictions—producing commensurate moves in the USDCAD.
US Dollar / Canadian Dollar Valuation Forecast
The past month has seen USDCAD retraced higher after the pair dropped sharply lower following an impressive rally in crude oil and other commodities. Continued upward momentum is likely if assets confirm cues of a looming bearish reversal, with a valuation gap of 448 pips yet to be filled. Notably, a bullish run may extend substantially beyond closing the current disparity between spot and PPP, with the US almost certain to precede Canada in raising interest rates. Indeed, Canada’s close trade links with the States all but necessitate that the US economic recovery materializes as a precondition for a return to healthy growth.
Australian Dollar US Dollar Exchange Rate Forecast
The Australian Dollar/US Dollar currency pair is one of the few that remains sensitive to interest rate forecasts, and currently bearish outlook underlines a key risk to the high-flying AUDUSD. Overnight Index Swaps predict that the Australian Dollar’s yield advantage over the US Dollar will shrink by another 50+ basis points in the coming 12 months. Given that strong yields remain one of the biggest sources of AUD demand, we could expect bearish forecasts to have a negative effect on the AUDUSD.
It remains important to monitor any and all policy shifts by the US Federal Reserve and the Reserve Bank of Australia.
Australian Dollar / US Dollar Valuation Forecast
The Australian Dollar looks likely to begin correcting a formidable 961-pip overvaluation as risky assets look increasingly likely to reverse lower: relative to earnings, the MSCI World Stock Index ended June trading at the highest level since August 2004. In real terms, the world economy grew at an average pace of 4.1% that year, whereas virtually every credible forecasting outlet including the IMF, OECD, World Bank, and assorted central banks all call for global GDP to shrink this year. This suggests stock markets are highly overvalued, pointing to a forthcoming correction downward as the euphoria that began in March subsides. Technical positioning is supportive of near-term turn lower, showing the makings of a head-and-shoulders top on the Dow Jones Industrial Average. AUDUSD is now 92.9% correlated with the Dow (using a 90-day rolling correlation), hinting that any major selloff in risky assets will put tremendous downward pressure on the Aussie.
New Zealand Dollar US Dollar Exchange Rate Forecast
The New Zealand Dollar/US Dollar currency pair likewise remains sensitive to interest rate differentials, and bearish forecasts for yields could have a negative effect on the NZDUSD. The New Zealand dollar currently enjoys a sizeable 225 basis point yield advantage over its US namesake, but interest rate traders anticipate that said spread will contract by 16 percent in a year’s time. We believe that interest rate-seeking speculators have bid the New Zealand dollar higher against the extremely low-yielding US Dollar. Any sign that the NZDUSD will no longer offer an impressive carry trade return could sink the Kiwi versus the US dollar.
New Zealand Dollar / US Dollar Valuation Forecast
In a similar fashion to its Australian counterpart, the New Zealand Dollar is showing signs of topping having reached deep into overvalued territory as capital shifted out of safety and back into risky assets in the four months through June. The bottom line is also effectively the same: risk trends are the indicator to watch as stocks show signs of a looming bearish reversal having started July at the highest level relative to earnings since August 2004. A meaningful reversal there is likely to coincide with a downward correction in NZDUSD. Indeed, the pair is now is now 91.5% correlated with the Dow Jones Industrial Average and 92.8% correlated with the broader MSCI World Stock Index (using a 90-day rolling correlation).
Written by Joel Kruger, Technical Currency Strategist; David Rodriguez, Quantitative Strategist; Ilya Spivak, Currency Analyst
Article Source - Monthly Forecasts for US Dollar - June
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