December 08, 2008
Posted by: Fernand Kong, CFA
Since this past summer, USD has rebounded forcefully from a
seven-year bear cycle that started in Q1 2002. The global financial
crisis has created massive demand for the USD that propelled the
currency to stage a dramatic comeback. Since mid-July, the USD
index has gained 24 percent. Against the EUR and GBP, the USD has
surged 23 and 27 percent respectively.
The initial driver for the strong USD came from the liquidity
crisis among financial institutions triggered by the collapse of
Lehman Brothers. The lack of USD liquidity drove banks around the
world to buy USD in the foreign exchange (FX) markets to meet their
funding needs. But as central banks took steps to inject liquidity
into the system, the tension in the short-term money market was
somewhat eased and so did the demand for USD. However, the USD
strength did not retrace, saved by the burst of repatriation demand
from U.S. investors.
Capital Preservation and De-leveraging
Sharp declines in the global equity markets have greatly reduced
investors' risk appetites, resulting in mass liquidation of
overseas investments and repatriation of trillions of USD of
foreign assets. The contagious subprime crisis had caused stock
markets in both major and emerging countries falling roughly 50
percent year-to-date. U.S. investors, who have put around $1
trillion into foreign assets over the past three years, began to
liquidate their foreign holdings and bring the money home.
The financial crisis also led to the unwinding of structural
positions established over the course of the past few years.
Typically, investors have sold short of USD and JPY and bought
high-yielding currencies such as EUR, GBP, AUD and NZD.
De-leveraging from these carry-trade positions has resulted in
exodus from these high yielding currencies into USD and JPY.
Together with JPY, the USD becomes a safe-haven currency in times
of financial stress.
USD Remains Buoyant
The USD will remain well supported at least through out H1 2009,
though the uptrend might be choppy. As global economies are
entering or have already entered recessions, USD will benefit as
foreigners seek safety in U.S. Treasuries while U.S. investors sell
foreign assets and repatriate.
The fate of the USD has essentially tied to the intensity of the
global financial turmoil. As long as the outlook remains depressing
and investors remain risk-averse, billions of USD will potentially
be channeled back to the U.S. in the coming months, albeit at a
slower pace. In addition to the bleak outlook for the U.S. economy,
markets expect economies outside the U.S. to be equally gloomy and
the responsiveness of policymakers in these countries to be
restrained and somewhat behind the curve. Other central banks,
particularly the ECB, will have more room in cutting interest
rates, to catch up with the Fed. This expectation will reduce the
attractiveness of carry trades to next year, keeping the USD in
Fears about the lingering credit crunch and global slowdown will
keep demand for liquid, safe-haven assets such as the USD, as
evidenced by the record low yield in U.S. Treasuries. This means
further repatriation of overseas assets by U.S. investors will
continue to support the USD.
Once the world economy recovers, perhaps during second half of
2009, risk appetite will return and U.S. investors will probably
seek higher returns overseas which will reduce support for the USD.
But given the financial markets are not yet clear of any meltdown
danger and the global economic outlook still has plenty of room to
be revised lower, the prospect for this USD negative factor is
highly uncertain. Also, historic data suggests that investors are
slow to return to risky investments after substantial market
setbacks, which argues for a prolonged period of USD
EUR at $1.15?
EUR will remain pressured by the risk aversion and repatriation
flows mentioned above. The large long EUR position built up against
the USD and JPY over the past five to seven years will continue to
haunt on EUR as investors continue to reverse their positions. In
addition, central banks of emerging countries have been buying EUR
in the past few years as their reserves grew. Now that their
reserve balances are shrinking, they need to rebalance by selling
The bigger issue for EUR is that the Euro economy is in a very
tough state with the Eurozone GDP shrinking in both Q2 and Q3.
Ironically, the ECB was still hiking rates in July, citing
inflation concerns at that time.
The EUR got temporary relief after the aggressive 75 bps rate cut
by the ECB on the December 4 meeting. Expectation is for the ECB to
be more aggressive in quantitative easing going forward. However,
rate cuts will eventually undermine its currency, especially with
deterioration of the underlying Euro economy, posing substantial
downside risk to the single currency. With a buoyant USD going into
2009 as mentioned above, it is possible for EUR/USD to fall further
towards 1.15, albeit in a choppier mode after the big drop
experienced this year.
GBP Faces Severe Challenges
GBP has been hurt by weak UK fundamentals and de-leveraging so
far. The UK economy, given its reliance on the banking sector and
the slumping housing market, has been the worst hit by the
financial crisis so far. Recent data points to a bleak economic
outlook and a sharper contraction in Q4 2008 and Q1 2009, prompting
expectation of a further interest rate cut by the Bank of England.
The outlook remains vulnerable going into 2009 and will continue to
exert pressure on GBP/USD towards 1.40.
JPY with Hidden Strength
JPY has been well supported throughout 2008 by the de-leveraging
flows. The deteriorating fundamental picture in Japan continues to
be ignored in a highly risk averse environment. Global financial
uncertainties will leave JPY well supported as a safe haven
currency going into 2009.
Japan's deteriorating economy will potentially be adding to the
demand for JPY. With exports falling and recent government warning
that fiscal stimulus might not help, risk aversion among Japanese
investors will rise. As Japanese investors are still sitting on
sizeable foreign investment with huge paper losses, the
deteriorating Japanese economy might prompt these investors to
liquidate these foreign investments to stop future losses. The
resulting repatriation flows could lead to further JPY
The strong JPY placed an extra burden on the already weakening
Japanese economy and could trigger BOJ intervention. However, JPY
strengthening so far has been orderly without the gaping price
action seen in EUR and GBP. As long as this trading pattern
continues, it will be difficult for the BOJ to prevent the USD/JPY
from gradually grinding towards 85.
Asian EM Currencies Depressed by Capital
Over the past few years, significant foreign capital portfolios
have been built up among Asian Emerging Market (EM) countries. But
the global financial crisis and sharp slowdown in global growth
have finally impacted these growing economies. Investors have
started to unwind investments in these countries and have depressed
local asset markets which will likely compromise future economic
growth. Thus, Asia economies are not immune from the global
slowdown as evidenced by the declining trend in their exports.
Policymakers have been intervening and may move to use less
conventional measures such as capital controls should de-leveraging
With the USD in demand as foreign capital flees, Asian EM
currencies - KRW, INR, TWD, THB, MYR, SGD, IDR and PHP - have come
under considerable pressure this year with the INR and KRW both
falling at least 20 percent. Over the next 12 to 18 months reduced
de-leveraging may allow for small retracement for these currencies.
But downside risk against the USD dominates into H1 2009.
Those EM currencies, including INR, KRW, PHP and CNY, that manage
to rely on domestic demand, are in a better position to rebound
first should their domestic demand recover some time next year. By
contrast, currencies with high dependency on external demand such
as SGD, MYR, THB, TWD and VND might underperform.
In the near term, focus is on the fear of the devaluation of the
Chinese CNY. Chinese authorities have allowed consecutive higher
fixing in USD/CNY, up to the limit of 0.5 percent away from the
central parity fixing, resulting in the largest CNY devaluation
since its revaluation in 2005. Back in October, after a slew of
weak data, China had stepped up its initiatives to boost export
growth, including higher export tax rebates for thousands of
products. Fears are increasing that China will favor competitive
devaluation in the currency to boost growth, a favored tactic used
by Asian nations in the past. Further CNY devaluation could depress
other Asian countries as well.
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FX Outlook for 2009October 22, 2012 Posted by: Fernand Kong, CFA
Since this past summer, USD has rebounded forcefully from aseven-year bear cycle that started in Q1 2002. The global financialcrisis has created massive demand for the USD that propelled thecurrency to stage a dramatic comeback. Since mid-July, the USDindex has gained 24 percent. Against the EUR and GBP, the USD hassurged 23 and 27 percent respectively.
The initial driver for the strong USD came from the liquiditycrisis among financial institutions triggered by the collapse ofLehman Brothers. The lack of USD liquidity drove banks around theworld to buy USD in the foreign exchange (FX) markets to meet theirfunding needs. But as central banks took steps to inject liquidityinto the system, the tension in the short-term money market wassomewhat eased and so did the demand for USD. However, the USDstrength did not retrace, saved by the burst of repatriation demandfrom U.S. investors.
Capital Preservation and De-leveraging
Sharp declines in the global equity markets have greatly reducedinvestors' risk appetites, resulting in mass liquidation ofoverseas investments and repatriation of trillions of USD offoreign assets. The contagious subprime crisis had caused...Read More