Forex Investment and Currency Trading

USD: For USD, the outlook continues to be for a bit more depreciation in the near term, and then appreciation through 2010 against most of G10. In general there should be no substantial pullback in risk appetite over the remainder of the year, and the correlation between positive risk and a weaker USD will continue to hold at the same time.

EUR: The near-term outlook for EUR is for a bit more appreciation for the rest of the year. The relationship between positive risk sentiment and gains in EUR has really been a force, one that is unlikely to shift in the near term. But such a strong EUR does pose a substantial threat to the nascent recovery. Ultimately much EUR strength will reverse itself.

JPY: The outlook for the JPY is gradual depreciation despite short-run volatility. Recent USD-JPY gains partly reflected exaggerated speculation of the new Democratic Party of Japan (DPJ) cabinet’s support for a strong JPY. As the DPJ’s policy initiatives are failing to attract global equity investors, the JPY’s recent gains should not be sustainable. But a sustainable USD-JPY rally probably requires not only favorable risk sentiment but also a widening of US-Japan yield differentials, most likely triggered by market expectations of the US Fed’s exit policies. The BoJ is not likely to begin a rate hike cycle at least for another year. A full-fledged USD-JPY rise is likely in 2010.

GBP: The outlook for sterling between now and the end of the year is negative. The BoE remains the only central bank in the developed world that continues to contemplate additional easing of monetary policy. In such an environment, sterling is likely to continue to underperform. A clear signal from the central bank that easing has come to an end will probably be required for GBP to stabilize.

CHF: The outlook for EUR-CHF is one of stability. During periods of heightened risk aversion Switzerland is unable to smoothly recycle its large current account surplus, putting upward pressure on CHF. This move has also been helped by an unwinding of the CHF carry trade in Eastern Europe. Franc appreciation risks exacerbating the serious economic downturn and the resultant potential of deflation. The SNB has responded with a range of unconventional policy measures, including FX intervention, and appears to be defending the area around EUR-CHF 1.5000. However, the exact level and timing of their intervention operations have not been predictable.

SEK: A downward bias is maintained for EUR-SEK, but the krona’s period of significant outperformance has probably come to an end. SEK has been the strongest performer in the G10 space versus EUR and USD over the last three months. However, the currency’s appreciation should be viewed as an unwinding of the severe undershoot induced by the financial crisis and not as a rally sparked by the country’s growth prospects or near-term tightening from the Riksbank. On a regional basis, SEK is expected to underperform the currency of its resilient neighbor, Norway.

NOK: The future is bright for NOK as the negative impact of the financial crisis continues to dissipate. The crisis had two major negative effects on NOK. First, liquidity concerns and the correction in commodity prices prompted significant foreign selling of Norwegian equities. Second, the fall in oil prices and the global slowdown dealt a serious blow to the Norwegian economy, leading the Norges Bank to cut interest rates and reducing yield support for the currency. Nonetheless, the relative resilience of the Norwegian economy, partly due to the recovery in oil prices, should help NOK appreciate in the months ahead.

CAD: The outlook for the CAD is positive for the remainder of the year and negative for 2010. The risk appetite and inflation pressures are expected to drive USD-CAD lower, with a target of 1.02 for the end of Q4. However, we see CAD retracing against the USD in 2010 on the back of a shift in investors expectation surrounding USD denominated assets as well as Federal Reserve credibility.

AUD: AUD-USD is seen increasing from present levels on the back of risk appetite, stronger commodities and supported in part by an EM-Asian led recovery. AUD has benefited from the pick-up in risk sentiment and optimism around commodities, as indicated by the gains since March. Such a trend is expected to continue over the coming year, with commodities strategist forecasting upward paths in energy, industrial and precious metals alike. What started as a risk appetite play is now well into a cycle with stronger fundamental support in the macro data.

NZD: The outlook for the NZD is for near-term appreciation followed by weakness in 2010. NZD should remain supported over the near term similar to AUD, based on its connection to the Asian cycle, improving terms of trade, high beta nature, recent external improvement and outlook on longer trends.