FX research roundup: Predictions for 2011, part one
It is possible to find something to back any view on the markets you can think of in the 2011 FX outlooks seen by theweeklyFiX.
Predictions for EUR/USD are largely dependent on your take on US fiscal laxity and how you rate the efforts (and determination) of the European authorities to “do what it takes”. End-2011 levels range from 1.20 to 1.42. Predictions for sterling are similarly wide, depending on whether you believe fiscal austerity can foster growth. On balance, the consensus looks more positive than not: GBP/USD predictions range from 1.46 to 1.82.
Japan is not hot – predictions for USD/JPY range from unchanged to as high as 93.00. Australia certainly is a favourite, but the upside forecasts for AUD/USD are strangely muted – 1.03 is often the target level mentioned – though one naysayer sees it down at 0.9000. And there is disagreement regarding EUR/CHF, which will either slip down as far as 1.2000 or reverse back to 1.4400.
Finally, there is general agreement that one should be long both SEK and NOK, although there is debate over their relative prospects. If I were a cynic, I’d say that they are the only certain short then.
Bank of America Merrill Lynch
BAML was in the same camp as Morgan Stanley about EUR/USD. In Global rates and currencies year ahead, BAML sees the most-traded currency pair down at 1.2000 by the end of 2011 (indeed it believes it will be there by the end of the second quarter.) However, when the facts change it is always prudent to reconsider your view, to paraphrase Keynes, and appropriately it is the extension to the Bush-era tax cuts that is making David Woo, the bank’s head of rates and currencies research, think again: “We believe there are no issues more important than the US fiscal policy outlook for financial markets in 2011. In our opinion, almost every macro investment theme is tied, directly or indirectly, to this issue.”
But, for the time being the BAML forecasts are unchanged. Apart from concerns over US monetary and fiscal laxity, the bank also sees continuing European sovereign problems. It sees dangers in the UK’s fiscal tightening “when there is no room for conventional monetary policy support, and when so many major trading partners of the UK are also undergoing severe fiscal, consolidation.” The bank feels that the probability of renewed economic weakness means that the Bank of England “might be forced to restart QE at a time when inflation is sure to be running well over its 2% target.” End of 2011 targets for EUR/USD and GBP/USD are 1.2000 and 1.4600
BAML sees AUD prospects as unpredictable. The limiting of currency inflows by EM nations should be a positive to Australia with its sold rating and high yields but against that is the possibility of China over-tightening. The bank isn’t fond of AUD shorts against USD though and sees a “relative value argument for being short AUD/NOK”, not a cross you often see touted. BAML sees AUD/USD at 0.83 at the end of 2011; its objective for the AUD/NOK trade is 5.55 (compared with spot of 5.94 at time of writing) with a stop at 6.11
Although the FX forecasts in Citi’s Global economic outlook and strategy are a joint venture between the bank’s myriad FX, global macro, technical strategy and economist groups, they do present a coherent view for 2011. Although it appears to reflect the consensus of the whole market rather than just Citi’s analysts.
Broadly, Citi sees a resumption of the USD downtrend on the back of “the most aggressive monetary easing in the G10”. It sees continuing strength in most EM currencies, although increasing use of capital controls might cause some deflection. It thinks it probable that there will be “outperformance by dollar bloc currencies backed by commodities, especially AUD, and better quality/undervalued ones like SEK.” And it expects the euro to benefit if monetary policy normalization is not derailed by further sovereign problems.
Citi sees the ECB as starting to achieve its desire to separate support for the periphery from liquidity provision and the setting of official policy rates. Should this continue (it is dependent on “the EFSF, EFSM, EU, IMF and maybe the UK” shouldering the burden of peripheral credit support), rate differentials, as QE II bond purchases continue, should lend support to the euro. Citi’s opinion is that November’s move in EUR/USD from 1.4250 to 1.3500 was much more about the rise in US yields than Ireland. Accordingly, the bank sees a rebound in EUR/USD to reach 1.45 over the next six to 12 months. The one risk to this view, and not an insignificant one, is that the scale of real-estate losses in Spain should turn out to be more than the authorities can handle.
Citi’s USD/JPY view ends up as being rather unchanged from current levels: “general USD weakness is a negative, valuation type factors a possible positive. It may be that the lows are in for USD/JPY but this remains unproven at this stage.” That last phrase is doubtless a nod the Citi’s Japanese FX strategists who, in a separate paper posit the “beginning of the end of JPY appreciation”. The Global economic paper sees USD/JPY at 84.00 at the end of 2011 while the Japanese “believe that USD/JPY may rebound as high as about 90” by Q2 2011 and continue upwards thereafter.
On commodity currencies, Citi is in agreement with most commentators that AUD, CAD and NZD will all appreciate against a weak USD; again it is the AUD that will appreciate most: Citi thinks another 1% in rate hikes by the RBA, more than currently priced in, is in prospect in 2011 while “Australia is operating with high levels of employment and little economic slack and is in the middle of a resource boom.” Despite that analysis, Citi’s expectations for AUD/USD are muted – at 1.03 for the end of 2011.
Sterling’s 2011 will be a mixed bag according to Citi. There is a possibility that if the fiscal tightening bites too hard, a further round of QE will be necessary and, with likely policy normalization by the ECB, EUR/GBP would move higher: indeed, if monetary policy divergence was the only factor, Citi believes that the cross should even currently be around 0.9200–0.9300. But recent UK economic data has been “relatively robust”, inflation is more persistent than models would indicate and Citi’s expectations are in fact for above consensus UK growth. This could end up with monetary policy being unchanged and Citi sees EUR/GBP only moderately higher as EUR/USD appreciates and sees a rally in GBP against USD over the next six to 12 months. End-2011 targets are 0.8800 and 1.6400 respectively.
In the beauty parade of the Scandinavians, Citi sides with Barclays Capital in seeing more mileage in SEK appreciation than in the NOK. The bank thinks “most of the move lower in EUR/NOK is done”. Citi focuses on the softer Norwegian recovery relative to that in Sweden, monetary policy that appears to be “on hold for an extended period” with core inflation under-shooting forecasts and “price action in the cross [EUR/NOK] looks like a major base. ” Citi sees NOK depreciating against EUR in the first quarter of 2011 to 8.37 before retracing the move over the remainder of the year. The Swedish currency is another story. Citi notes “evidence of a broadening economic recovery and rising household debt”. Riksbank monetary policy is now on a declared upward path with a further 75bp of tightening expected in 2011. Citi sees EUR/SEK falling throughout 2011 to end the year at 8.9800.
In EUR/CHF Citi sees a greater reversal of CHF strength than BarCap. Switzerland may have strong growth and a large current account surplus but “the economy has slipped back slightly into deflation.” If the EFSF/EFSM mechanism succeeds in stabilising European sovereign debt worries and risk appetite is maintained, Citi sees EUR/CHF at back to a 1.40 handle or further. The actual end-2011 target is 1.4400.
Ulrich Leuchtmann and his team at Commerz see euro concerns remaining centre stage throughout 2011. But the bank believes that fears of contagion are overdone, that bailouts will continue to flow where necessary, and that in fact “the overall fiscal position of the eurozone as a whole will improve, not deteriorate”. On balance, while pressures will continue, “the existence of the euro is not at stake.” Commerz sees EUR/USD around 1.2500 by the end of 2011
Asian currencies will be underpinned by solid economic growth, general monetary policy tightening and of course proximity to China – CNY strength “will continue and maybe even accelerate in H2 2011”. The bank sees USD/CNY at 6.32 at the end of 2011 and believes that all Asian manufacturing currencies will outperform. The pick of the crop though is KRW, which, it says, is “deeply undervalued”; Commerz targets USD/KRW at 1060 for the end of 2011.
Among commodity currencies, Commerz favours AUD, seeing it continue to profit from the dynamic Asian economies and prices for coal and iron ore particularly. The labour market will continue to tighten, as will the RBA. In fact, to Commerzbank almost everything Australian – economic data, public finances, small relative size of capital markets – points to AUD outperformance. The only riders are weaker than expected Asian economic development and an increase in risk aversion but even here “setbacks should be used as opportunities to buy.”
Unfortunately Commerz doesn’t give a price objective for its positive stance on AUD nor for calls it makes for SEK and NOK appreciation.
Morgan Stanley doesn’t paint the members of G4 with the same brush. It sees US growth forging ahead to run at around 4% in 2011 with a turnaround in employment, and it sees European woes continuing with 2011 proving “a tougher test than 2010”. Tellingly, “raising the size of the EFSF is unlikely to solve the problem if interest rates remain this high.” Considering the vast size of bond redemptions in 2011, Morgan Stanley believes that at some point the ECB will have to expand its balance sheet from the current €1.9 trillion. While this will provide some relief initially, the euro “is likely to be punished as a printer”, leading to a fall to 1.22 (what Morgan Stanley believes is fair value) and beyond.
Morgan Stanley views the UK, with its fiscal austerity as positively “ahead of the game” and forecasts EUR/GBP down to 0.7800 at the end of the year (GBP/USD is seen little changed at 1.5400). JPY, on the other hand, is due a turnaround: Japan is beset with deflation, a weak domestic economic growth outlook and a likelihood of further monetary easing. USD/JPY is forecast at 93.00 at the end of 2011 and EUR/JPY practically unchanged at 112.00
Morgan Stanley’s forecast for commodities is too close to current levels for comment but one unrelated recommendation did catch the eye: “It’s worth holding some DKK just in case”. In the last few years trading DKK was seldom done for any reason other than to pay brokerage. The thinking is that an outright short EUR/DKK is “a fairly cheap way of positioning for a break-up of the euro.” If Germany left the euro, it is likely that Denmark would want to peg against a new Deutschemark rather than any weak euro-remnant.
Bank of Tokyo-Mitsubishi UFJ
Derek Halpenny and Lee Hardman at Bank of Tokyo included only one or two of the usual suspects in their Top five FX trades for 2011.
The BoT analysts are calling a top to AUD/USD (objective 0.9000, stop 1.0350). They cite AUD as the most over-valued of the G10 currencies and the crowded nature of the long-AUD trade, the vulnerability to “the slightest evidence of slowdown in China” and likelihood of that, given the Chinese shift of “focus on to containing inflationary pressures”, evidence of cooling consumer spending in Australia, the massive levels of Australian household debt and the technical picture “with a head and shoulder formation from the highs [in Q4 2010] suggesting downside risks.”
Less controversial is BoT’s recommendation to be short EUR/CHF (objective 1.2000, stop 1.3100). Unlike, for example, Paul Robinson at Barclays Capital, the BoT analysts believe there has been a “lack of progress in terms of policy initiatives to convince the financial markets that sovereign debt markets in the eurozone periphery will stabilize”. The possibility of a new Irish government attempting to renegotiate the bailout and concerns that Spanish yields be further pressured are mentioned, but the trade might also work if eurozone debt concerns attract less market focus: continued divergence in economic performance between “Germany and to a degree France and the rest of the eurozone” will continue to weigh on EUR/CHF.
Although BoT has now taken against the most overvalued of the G10 currencies, it has not become enamoured of GBP, the most undervalued G10 currency since the crisis began. The bank recommends establishing a short GBP/CAD position (reference a spot rate of 1.5700, objective 1.4850, stop 1.6100). Looser monetary and fiscal policy will “reinforce the strength of US economic recovery in 2011.” CAD has felt the effects of subdued external demand from the US; if demand comes back sharply, CAD could strengthen sharply. A long position in CAD rather than USD is preferred because of the vast difference between national public finances. As regards GBP, BoT sees the UK economy suffering weak demand from Europe and restrained by the austerity measures: “UK growth could fall back below trend in the first half of 2011.” Further, any escalation of European sovereign debt tensions will also weigh on GBP, given UK bank exposure to Ireland and Spain. Finally, the Bank of Canada is predicted to tighten policy before the Bank of England, which will “tolerate higher inflation to support growth.”
Confident of a sustainable US recovery, BoT is bullish for USD/JPY and sees a bounce to 87.00, but the bank is also mildly bearish for USD/TWD. Taiwan benefits from links to both the Chinese economy and resurgence in the US economy (its “exports to the US still remain substantial”). Accordingly, BoT recommends a long TWD/JPY position (reference a spot rate of 2.8000, objective 3.0050, stop 2.7000)
Lastly, BoT anticipates European peripheral sovereign debt spreading to Hungary, which “has the worst public finances in central Europe”. With no debt backstop in place, loose fiscal and monetary policy and a moribund recovery (exports account for “80% of GDP leaving it the most exposed to still-weak external demand from Europe”), the bank recommends establishing a long USD/HUF position (reference a spot rate of 208.50, objective 225.00, stop 198.00)
There was an optimistic undertone in Barclays Capital’s Global outlook. Indeed, the publication is subtitled Don’t fight the reflation trade: the first line of the foreword reads: “Economic data over the past few months clearly indicate that the global recovery is intact and fears of a double-dip have abated.”
Broadly, BarCap’s currency strategist Paul Robinson believes that the European crisis is manageable (although “Greece faces significant problems”) and, while EUR/USD might be pressured in the first quarter of 2011 (possibly down to 1.2800), the “authorities will do what is necessary to calm markets”.
In the US QE II bond purchases are due to last until the summer, but while BarCap is “notably more optimistic about US growth” than it believes is the consensus, it does not think that the measures are unlikely to lead to enough growth to substantially reduce unemployment. The large USD current account deficit will continue, it is unlikely that the US consumer will increase private savings, and foreign ownership of dollar assets will continue to increase, leading to “an ongoing desire for global investors to diversify away from the USD”. Such a scenario will mean that the currency wars rhetoric we’ve heard so much of will not go away. A further dollar negative is continued price pressures on commodities, including oil. Accordingly, Robinson sees USD weakness for the final three quarters of 2011 leading to EUR/USD being at 1.4200 at the end of 2011.
The austerity measures imposed by the UK coalition are GBP-positive, according to Robinson: “The UK is getting its house in order, the restructuring of the economy is likely to bring about some appreciation of the currency”. So much so that Robinson sees GBP/USD at 1.8200 by this time next year. But cable is not the trade Robinson most keenly advocates to reflect his bullish sterling view; he sees Japan “mired in deflation” and facing a “prolonged period of weak growth” that will result in USD/JPY approaching at 89.00 in 12 months’ time. Accordingly, the trade would be to buy GBP/JPY, which “is likely to prove an attractive investment”.
Robinson also sees the economies of northern Europe continuing to impress and suggests long position in both SEK and NOK, although, unlike RBS, he sees the SEK’s prospects as superior. He sees end-2011 levels for EUR/SEK and EUR/NOK at 8.60 and 7.75 respectively, compared with current levels around 9.11 and 7.96.
Given that BarCap’s view of the eventual effectiveness of the European authorities contrasts so massively with that of BoT, it is little surprise that the EUR/CHF predictions also conflict. That is not to say that Robinson is negative on CHF – which “remains one of the more attractive hedges for euro area weakness” – but the BarCap view is that such weakness will dissipate throughout 2011 and EUR/CHF will end the year up at 1.3800.
Royal Bank of Scotland
Robert Sinche’s strategy team at RBS, in its FX top themes and trades: 2011, warns that 2011 might be a more difficult year that 2010 for “investors to generate sizable gains [in FX] relative to other asset classes”. While RBS sees challenges to the continued out-performance of emerging market currencies, particularly from the maturity of the growth cycle and developing inflationary pressures, they are still deemed to be a better bet than the currencies of the more mature economies. RBS wants to sell G3 currencies (USD, EUR, JPY) against near enough everything: it recommends selling the G3 basket against one containing emerging market currencies belonging to countries with what it believes to be the most hands-off approach to their currency regimes – PLN, ZAR, CLP, ILS and KRW; it recommends selling the G3 basket against an Asian basket comprising SGD, MYR and INR; and it recommends selling the G3 basket against an AUD, NZD and CAD commodity currency basket. All three trades have a 10% profit objective and 5% stop loss.
RBS also suggests selling EUR and USD against the ADXY Asian currency index. The relative ratio of EUR and USD can be amended by reference to how EUR/USD trades within the bank’s prediction of the year’s main trading range for the pair of 1.24 or 1.26 to 1.36 (elsewhere RBS says the broad range will be 1.20 to 1.40).
The bank sees some pick-up in US growth: “a further gradual acceleration in real GDP from roughly 2.50% in 2010 to around 3.25% by the end of 2011.” But the suggested associated trade is in fact short USD against MXN: “Mexican exports do well as US demand picks up.”
Finally, RBS is in the opposite corner to BarCap when debating the relative merits of NOK and SEK. RBS concedes that Norwegian growth during 2010 was more sedate than in Sweden, but says that Norway has far less spare capacity than Sweden, which is recovering from a particularly savage recession. RBS also sees “Sweden’s small open economy” as being more likely to be affected by a euro-area slowdown. Accordingly, the bank sees the Norges bank having to tighten monetary policy more significantly than the Riksbank. Norway’s petroleum sector is another obvious positive for NOK relative to the SEK over the coming year, as is the fact that, in RBS’s analysis, NOK is not “a high beta trade on euro-area recovery”.
But flexibility will be key: “2011 is expected to be a year that rewards a consistent review of positioning and active trading rather than holding positions for the entire year.”