Forex Investment and Currency Trading

GBP
The outlook for sterling is further weakness. BoE Governor King recently said that interest rates would not have to fall to zero before credit/quantitative easing is implemented in the UK. Nonetheless, a Fed-style reduction of the bank rate to 0.25% would likely be a prerequisite for an aggressive move in this direction. The market is now favoring a rate trough of 0.50%, suggesting that all the “bad news” is not yet priced in and some additional weakness could be in store for GBP, pushing EUR-GBP back toward 0.9200. However, intra-European monetary convergence is likely to eventually take the steam out of the EUR-GBP rally when the deterioration in the economic data forces the ECB to implement more aggressive easing. In this context, analysts expect an eventual narrowing of the 2-year Eurozone-UK swap spread of 25bp to 50bp when the market comes to price in the monetary policy outlook, pressuring the EUR-GBP cross.

CAD: stay short
The outlook is for weakness. Canada’s economy entered recession in the fall. The cushion to Canada’s economy from the commodity price surge of recent years – and the related supportive income effects – has largely reversed. Canada’s economy is less reliant on commodity revenue than other large G10
commodity exporters Australia and Norway, but Canada is clearly more exposed to the slowdown in the US economy than those two economies, as the US is still the destination for three-quarters of its exports. So far this has been most keenly felt in the auto and forest product sectors, which are only about 4% of Canadian GDP; however as that weakness starts to spread more aggressively into other sectors of the Canadian economy and the Canadian labor market, the CAD will feel more of the negative impact of bad economic news than it has to date. watch for new lows in the Midwest, where sentiment has recently been hit hard given layoffs in the auto sector – this index stood at 6 in January. Sentiment in the West was even lower at 4 last month. While mortgage rates have eased lower and housing affordability has improved, weak economic fundamentals will restrain housing activity through most of 2009.

Importantly, market believes the burgeoning overhang of new housing supply in Canada is a primary driver of the view toward further substantial house price declines and a well-beyond-consensus contraction in real residential investment (and thus GDP) ahead. If that is the case, and if Canada’s commodity price index were just to stay where it is right now, a shift toward 1.40 in USD-CAD is quite feasible.

Housing starts are forecast to drop to an annualized 525K in January versus a previous record low level of 550K in December. To date, starts have already corrected by a record 72% from the peak in January 2006 (figures date back 50 years) led by a 75% decline in single-family construction. However, problems in the new home market continue apace with over 1M single-family completions in December adding to already bloated supplies. Depressed sales activity and a more pessimistic outlook drove home builder sentiment to an all-time low of 8 in January. Additional cutbacks in housing starts will be necessary to work down inventories – a trend which one believes will last through all of 2009. Even an outright halt of single-family construction would still take more than three years to clear the inventory overhang at the recent sales pace.

CHF: appreciation, but with sizable policy risks
The outlook is for appreciation, but with sizable policy risks. Analysts expect CHF to appreciate against EUR over the near term, with a medium-term target of 1.40 by the end of Q3. In the macro environment, market continues to expect CHF to outperform along with other defensive currencies such as JPY and USD. Market continues to favor defensive posturing, as market expects risk appetite and the fundamental macro picture to remain exceptionally weak over the near term. Moreover, rates have already been pushed to 0.50% by the SNB, meaning little leeway for conventional monetary policy to weaken CHF, despite the weakening Swiss macro picture. However, the key risk to watch out in the medium term would be for additional SNB talk directly around the CHF.

Most recently, Governing Board member Jordan said that they watching CHF “carefully” and that a “weaker franc would be welcome”, while VP Hilibrand has already made previous comments on possible direct action by the SNB to help mitigate currency strength. But for the moment, intervention is still unlikely without a more substantial appreciation from this current point, and much more preparation by the SNB both for markets and for other G10 central banks that could object to such a move.

NOK: on the road to recovery
The outlook is for NOK appreciation. The Norwegian krone has recovered significantly from the sell-off induced by the financial crisis. Norges Bank data on FX order flows highlight a substantial drop in net NOK demand as the crisis struck. It appears outflows of foreign capital from the Norwegian equity market and the liquidation of speculative short USD, long NOK positions which were made harder to fund by the money market dislocations drove a sharp drop off in underlying NOK demand. Notably NOK inflows have now returned to pre-crisis levels, allowing EUR-NOK to retrace nearly two-thirds of its H2 2008 rally. The move is likely to continue as the dislocations in global money markets recede. Any recovery in crude prices could add momentum to the EUR-NOK decline. Further NOK appreciation should not be hampered by the respective monetary policy outlooks with BAS-ML economists looking for a rate trough of 2.00% in Norway versus 1.00% in the Eurozone. The market is currently pricing in a trough of 1.50% for both monetary jurisdictions.

SEK: brighter days ahead
The outlook is for appreciation. SEK experienced a period of extreme depreciation during the height of the financial crisis, a development also seen during previous periods of market turmoil such as the Asian financial crisis and the “dot-com bust”, as market participants likely fled the relatively illiquid currencies of Scandinavia. The decline in financial market volatility from extreme levels should help EUR-SEK fall back toward 9.50, the upper end of the pair’s multi-year range. Monetary policy developments are likely to add momentum to this move as the EUR faces an additional loss of yield support. The Riksbank has aggressively cut interest rates by 375bp to 1.00% since September, and Governor Ingves recently stated that a zero rate scenario cannot be completely ruled out. The market presently looks for a rate trough of 0.50%. However, the ECB has more work to do in terms of monetary easing with the refi rate still at a relatively elevated 2.00%. BAS-ML economists expect a rate trough of 1.00%, while the market is only pricing in a drop to 1.50%.