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How will the dollar and other currencies fare in 2008, with global equity markets showing no sign of the much discussed economic de-coupling between emerging and developed markets?
Will sterling’s continued slide lead to it becoming the ”dollar of 2008”? For the euro, can the European Central Bank maintain its position of not cutting rates? How far will the unwinding of carry trades lift the Japanese yen? And can the Japanese and global economy handle further appreciation in this, the ”world’s funding” currency?
Ashraf Laidi, chief currency strategist at CMC Markets, answers your questions on the prospects for currencies.
Taking the view that oil and commodity prices will stay high for at least a few more years which currencies do you think will fare best in 2008?
Adam Keats, London
Ashraf Laidi: Based on our assumption of a retreat in oil towards the mid-$70s, the Canadian dollar is likely to lose some of its 2008 lustre, until a recovery is anticipated in Q4 when Opec starts to show resistance to the combination of falling oil and USD weakness.
An expected Q3 rebound in gold following an anticipated pullback (in Q2) will likely boost the Aussie. Despite the negative impact of weaker global growth on demand for agricultural commodities, we expect supply factors to soften the decline and provide support for the Aussie and Kiwi. Any supply shock in China will exasperate the decline in copper prices, which may be especially negative for the Aussie.
Since the dollar usually outperforms during US recessions, against which G10 currency is it expected to show the greatest gains in 2008?
Sarah Mitwalli, Tampa, Florida
Ashraf Laidi: We expect the US dollar to largely outperform the British pound and to show negligible gains versus the Canadian dollar. The unavoidable question becomes whether 2008 will be a repeat of 2001, when markets rewarded currencies of growth-oriented central banks.
Two business days into January 2001, the Fed delivered an inter-meeting 50-bp rate cut to start a 475-point rate reduction campaign, which took the Fed funds rate to a 43 year low of 1.75 per cent by end of the year. Yet one of the many factors distinguishing the current environment from that of 2001 is the purpose of the Fed’s easing.
The rate cuts of 2001-02 were driven by conventional dynamics of macroeconomic slowdown (cooling business activity, weak GDP growth, rising unemployment and falling equities). Today, the Fed is forced into uncharted territory highlighted by: i) a housing market crash ii) pronounced shortage of money market liquidity, iii) an increasingly untenable dilemma facing the Fed between rising inflation and looming threat of recession.
Unlike in 2001, 2008 will be accompanied by the economic spillover of broad erosion in the housing sector, dictated by falling prices, sales, construction and layoffs in related industries. Relative strength in Asia is expected to help fill in the slack from the US and Western Europe, which will likely support the eurozone’s external economy and stabilise the anticipated downdraft from the US.
Should the US dollar freefall, wouldn’t all paper currencies come under pressure? It seems to me that gold is the only way to go in an environment where people lose faith in government backed currencies.
Michael Seamon, US
Ashraf Laidi: While the 2007 increase in gold versus the dollar was largely associated with an acceleration of the dollar’s declines, the strengthening of the metal was broad-based throughout the year. The global growth-backed commodity story as well as emerging inflationary pressures played a significant role in gold’s advances. One theme expected to continue triggering further advances in gold is that of real interest rates.
The modest declines in gold relative to the more protracted and uninterrupted recovery in the dollar since mid-November are due to falling bond yields. As the Federal Reserve, Bank of England and Bank of Canada blitz the money markets with nearly $1,000bn in liquidity injections in the last two weeks of 2007, market interest rates headed lower while inflation continued to push upwards.
Persistent liquefying operations of central banks are likely to highlight the lustre of the precious metal relative to paper currencies, especially as the real cost of money is dragged down by high inflation and lower interest rates. The inflationary consequences of these expansionist monetary practices coupled with persistent robustness in commodity prices are expected to offset any downward pressures on inflation resulting from cooling economic activity. While the relationship between strong commodities and cooling economic growth may prove untenable, agriculture, energy and metals are likely to remain supported by supply constraints rather than demand factors.
But the $990 per ounce target isn’t expected to be realized before a temporary decline to as low as $770. Periodic bouts of reduction in risk appetite are likely to trigger episodes of profit-taking in the metal. The expected pall on the metal is also expected to emerge from a modest slowdown in Chinese demand for commodities. The People’s Bank of China’s policy tightening coupled with the yuan’s 10 per cent appreciation as well as the slowdown in the US, Canada, eurozone and UK is likely to temper China’s appetite for metals and energy.
How will the currencies in the Persian Gulf countries, specifically the Iranian rial, fare in 2008? The rial is not pegged to the dollar. How will it be affected by the decline in the value of dollar?
Salman Ansari Javid, Tehran, Iran
Ashraf Laidi: Neither Saudi Arabia nor the UAE will be able to delay the inevitable need to adjust their currency regimes into a more highly valued and diversified currency. Falling oil prices and dollar weakness will prove an ominous combination as far as further escalating inflationary pressures and eroding the public’s purchasing power. A switch to a basket of currencies by the UAE by year end is highly probable.
Looking to a five year horizon - do you see the US dollar regaining any of its strength against the other major currencies due to cyclical reasons?
William Broderick, New York
Ashraf Laidi: For such a long term horizon, we still expect the US dollar to end predominantly lower against all major currencies as well as those of emerging Asia.
What would it take for the carry trades to significantly unwind? Will it take something as drastic as a slowdown in the Chinese economy or something much less severe?
Azman Mohamed, Kuala Lumpur
Ashraf Laidi: The carry trades are unwinding aggressively as we speak. Global equities have already fallen 12-20 per cent off their November highs and are expected to shed at least another 20 per cent into Q2 which should further support the lower yielding JPY and CHF. With US rates expected to drop to as low as 2.50 per cent (priced in the yield curve spread), the US dollar may gain the status of a low yielding currency.
Although futures speculators have boosted yen long contracts to 2-year highs against the dollar in early December, there remains wider scope for yen buying amid fresh revelations of write downs from US banks. But we must also heed the yen’s downside risks from the downdraft of slowing growth. With 22 per cent of Japanese exports going to newly industrialised Asian economies (Hong Kong, Korea, Singapore and Taiwan) and 21 per cent to the US, cooling economic growth should cast a pall on Japanese exports, especially with the risk of a US contraction weighing directly on Japan and indirectly via Japan’s trading neighbours. China’s absorption of 15 per cent of Japan’s exports does play a significant role in filling the slack. But the downside risks to China’s economy may provide an indirect negative spillover on Japan, thereby exacerbating the already slowing demand from the US.
With the combination of lower US demand for Chinese exports, a prolonged correction in Chinese equities, the transmission effect of the People’s Bank of China’s rate hikes and further strengthening in the yuan, the risk of a region-wide slowdown can be significant.
Any predictions on how the commodity currencies (CAD, AUD) will perform in 2008/9, given the current global credit situation?
Keenan Teylouni, Sydney, Australia
Ashraf Laidi: The unwinding of high yielding FX carry trades has overshadowed the strengths of the Australian dollar and the currency’s potential to re-test parity with the USD. Baring any negative price shocks in agriculture and minerals, the Aussie is set to be among the highest performing currencies in the G10 in 2008. In addition to a strong yield foundation, the currency stands to gain from a favourable price environment for commodities, as the sector makes up 65 per cent of exports.
The downside risks to the Aussie include a prolonged decline in commodities prices resulting from a global growth slowdown and extended bouts of risk appetite hitting global investor confidence as well as high yielding currencies. Accordingly, these dynamics may drag the pair down to as low as US$ 0.84, before a rebound towards 0.92 in Q4.
Prospects for the CAD are dimmed by our anticipation for further declines in oil and the downdraft from the US, which will likely boost USDCAD to as high $1.07 before a subsequent pullback towards $1.03 in Q4. We don’t expect Canada to slip into recession as the housing sector doesn’t sustain the erosion of the US. We expect CADJPY to test the 100 yen level later this year.
Where do you see the US dollar going against the pound in 2008? I sold my holdings in USD at 1.98 but feel whilst the dollar remains in trouble the pound has a rough ride ahead.
Duncan Jennings, London
Ashraf Laidi: Our year-end forecast for GBP/USD stands at $1.88, as high UK interest rates signify more ground for rate cuts by the Bank of England. Sterling’s 2007 damage is expected to broaden into 2008, which may reduce chances of the UK slipping into recession. The currency remarkably faces considerable downside potential against JPY, CHF, EUR and even the higher yielding AUD and NZD.
What is the real value of the sterling based on fundamentals (and how is that theoretically calculated) and how will that move in relation to the Indian rupee and the dollar in 2008?
Neeraj Sharma Rochdale, UK
Ashraf Laidi: The British pound may be more fairly valued at 60 rupee due to projected declines in UK rates, GDP growth and widening current account/budget deficits.
Do you think the yen will strengthen further in the first half of 2008? And what about the Swiss Franc? Do you anticipate that the carry trade using the Franc will unwind to some extent and push it higher?
B.A. Wilson, Oklahoma/United States
Ashraf Laidi: Prolonged unwinding of the yen carry trade is likely to continue into most of 2008 amid our expectations for fresh dislocation in global equities, which is likely to render 105 yen as the next major anchor point for USD/JPY throughout the year.
The Swiss franc characteristically benefits during a falling interest rate environment and this year will be no different. CHF appreciation against GBP, CAD is set to continue. Less so against EUR and AUD.
Do you think that the recent acceleration of the Chinese yuan’s appreciation bodes ill for western consumers as essentially all export-reliant countries will be more inclined to let their currencies strengthen? On the contrary, could it be that 2008 will hear less of yuan-bashing as western politicians try to contain inflation at home?
Panuwatana Ittigusumaln, Bangkok, Thailand
Ashraf Laidi: A weaker Chinese yuan is beneficial for western consumers as it reduces the cost nations’ imports, especially as China is expected to move into further revaluing its currency. In light of the 10 per cent decline in the US dollar, it wasn’t exactly a bad development that China did not heed the calls of Washington of seeing the dollar depreciate 30-30 per cent against the yuan as that would have triggered a dangerous run on the greenback.
We may expect further calls from Europe on to China to adjust its currency regime, but we don’t expect it to be a major issue in 2008.
Is there any realistic possibility of seeing the euro at par with the pound within 2 years?
Ian Victor, Gibraltar
Ashraf Laidi: Yes, the possibility of seeing the euro reach parity with the pound within two years stands as high as 80 per cent.
If you want to park some cash for six months to a year, what currency(ies) would you recommend?
Hatem Cairo, Egypt
Ashraf Laidi: The high yielding advantages of the Australian dollar may be beneficial, but the currency’s vulnerability during the deteriorating global market landscape requires diversifying holdings into Yen and/or Swiss francs. Remember, falling global equities are not kind to high yielding currencies.