Forex Investment and Currency Trading

• EUR/USD expected to fall to 1.20/1.25 in the first half of 2009, while GBP/USD is expected to test 1.40. The ECB and the BoE will cut rates further, with the ECB having the most work to do.
• Both EUR and GBP will strengthen against the USD in 2009 H2 but neither currency is likely to re-visit its highs against the USD from earlier this year. Look to sell EUR/ GBP in Q2 of next year, as GBP should benefit more from global reflation and lower risk aversion across global markets.

FX Strategy - Sell EUR/USD to open the new year, looking for a move down to 1.20-1.25 in 2009 H1. Markets have already discounted further likely USD negative policy measures from US authorities. Fed purchases of Treasuries are certainly already priced into US fixed income markets.

Other than the unlikely prospect of US intervention to weaken the USD, there is simply little left in the way of aggressive USD negative measures for US authorities to enact. European authorities by contrast have plenty of scope to ease. Markets expect 60bp in ECB easing in 2009Q1, taking rates down to 1.9%.

Euroland authorities will argue they are well placed to weather the global slowdown. Neither Germany, France nor Italy saw large housing bubbles and Euroland households are not overly leveraged, compared to their US and UK counterparts. But European banks are on far shakier ground.

European banks are substantially more exposed to a slowing in the emerging markets than either the US or Japan. Surprisingly, European banks have more exposure to Latin America than US banks and larger claims on developing Asia than Japan. EUR is expected to post a recovery in 2009 H2 as extremely accommodative Fed policy and a US fiscal deficit around 10% of GDP start to gain traction. But EUR/USD is not expected to trade back to its former 1.60 highs. Energy prices will not return
to their old highs given a likely continuing soggy global growth picture in 2009H2. That implies less “petrodollar” recycling into EUR/USD.

GBP has been very close to the worst performer within the G10 over the past 12 months, falling just under 25% against the USD (the NZD is actually the worst performer, off right on 25% against the USD). So will it be more of the same in 2009? For the first half of the year sterling is expected to remain under pressure. The BoE has more work to do on the interest rate front, with rates likely to fall to 1% in the first quarter. While this is fully priced in by the market, at this stage the BoE seems most
at risk to follow the US Fed and Japan’s BoJ in adopting some form of quantitative easing in the new year. UK lending rates remain stubbornly high despite the BoE’s aggressive easings in recent months. A move to QE, even if it is temporary, would weigh heavily on the pound and a fall back towards the 1.4000 level seems a real risk in the first quarter/first half of next year. The relative yield differential is unlikely to provide much support to GBP through this period.

A sustained decline in risk aversion will eventuate when the global economy begins to reflate. We see the risk of this occurring in the second half of 2009, which would be a more conducive environment for GBP. Look to buy dips in GBP/USD below the 1.4000 level in the second quarter of 2009 for a
move back to 1.8000 in the second half of the year.

The key barometer of the UK economy’s health will continue to be the housing market. To date the aggressive cuts by the BoE have yet to stimulate the housing market. Further policy action is likely before definitive signs of improvement are evident in the housing market. Europe typically lags the global cycle - hence the beginning of the global reflation trade is likely to represent a good opportunity to sell EUR/GBP. This cross has more upside in the first quarter of next year but a move towards the high 0.90 region would represent a good opportunity to sell. Look for a move back to 0.8000 in this cross through the second half of next year.