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Forex Research - 2009 Currency Market Outlook

2009 Currency Market Outlook

Last Updated 12/31/2008 12:28:49 PM EST (GMT +5)

US Dollar 2009 Forecast

How Did the Dollar Trade in 2008? It has been an exceptionally active year in the foreign exchange market as currency volatilities hit record highs.  In the first half of the year, everyone was worried about how much further the dollar would fall but in the second half of the year the concern became how much further the dollar would rise.  After hitting a record low against the Euro in the second quarter, in the beginning of the fourth quarter, the US dollar actually surged to a 2 year high.  From trough to peak, the dollar index rose more than 23 percent in 2008.  

3 Themes for 2009    The US economy and the dollar’s fate in the years ahead could be determined by what happens in 2009.  We are focusing on 3 big themes that will impact the US dollar and each of these themes encompasses a lot.  

1.    Will there be a U or L Shaped Recovery?  The US is in recession and the slowdown is expected to deepen in 2009.  Before a recovery is even possible, the economy has to work through more weakness and negative surprises.  Non-farm payrolls declined by 533k in November, sending the unemployment rate to a 15 year high of 6.7 percent.  With many US corporations forced to tighten their belts, the unemployment rate could rise as high as 8 percent in 2009.  We expect this to happen because over the past 50 years on average, recessions have boosted the unemployment rate by 2.8 percent.  When the current recession started in December, the unemployment rate was 5.0 percent.  If you tack on 2.8 percent to that level that would put the unemployment rate at least 7.8 percent.  

Non-farm payrolls could double dip, just as it has in past recessions. In this case, we would expect a rebound followed by another sharp loss that rivals November’s job cuts.  A rise in unemployment spreads into incomes, spending and then usually leads to more layoffs.  We need to see this toxic cycle end before we can see a recovery.  Consumer spending has already been very weak and the trade deficit is widening as the dollar strengthens.  As the 2 primary inputs into GDP, we expect fourth quarter growth to be very weak.  The strength of the US dollar in Q3 and for most of Q4 will also take a big bite out of corporate earnings, leading to disappointments for the stock market.  This is why we expect more weakness in the US dollar and the US economy in the first quarter of 2009. However towards the middle of the second quarter, we may begin to see the US economy stabilize as it starts to reap the benefits of Quantitative Easing and President Barack Obama’s fiscal stimulus plan.  New Administrations usually hit the ground running and as such we fully expect the rest of the TARP funds to be tapped shortly after his inauguration.  The shape of the US recovery will have a big impact on the price action of the US dollar but there is no question that the path to a stronger dollar will be through a weaker one.  

The following chart illustrates how non-farm payrolls double-dipped during the 2001 recession.

Although we expect the US economy to start its slow recovery in the second half of 2009, GDP growth next year will still be negative.  Retail sales and non-farm payrolls will be particularly ugly in the first quarter, but we are optimistic that monetary policy and fiscal stimulus will begin to help the economy.  The record decline in mortgage rates should also help to stabilize the housing market in 2009.  Something between a L and U shaped recovery is likely.  

2.    What Matters More to the Dollar - Safety or Yield?  The dollar’s rally in the second half of 2008 has been largely driven by risk aversion, deleveraging and repatriation.  In other words, despite the next to nothing yield offered by dollar denominated investments, a flight safety into US dollars and government bonds has kept the greenback  from collapsing against other currencies like the British pound, Canadian and Australian dollars.  The concern for safety was so high that investors were willing to take negative yields just to park their money with the US government.  A bubble is brewing in the Treasury market and any improvement in risk appetite will take the market’s focus away from safety and back to return on money at which time ultra low interest rates could become a detriment for the US dollar. The dollar’s performance against other currencies would be contingent upon growth in the rest of the world. For example, if the UK economy is in the process of recovering, demand for yield and the prospect of return could send the GBP/USD higher, but if there is a prolonged recession in the Eurozone, then the Euro may no longer be the flavor of the month.  

3.    Compression in Interest Rates and Volatility:  Volatility in the currency market also hit a record high in 2008 but in 2009 we expect the volatility to compress as interest rates around the world converge.  Much of the volatility this past year has been spurred by speculation about how much various central banks would cut interest rates.  As they run out of room to ease, we may stop seeing monetary policy surprises which can eventually lead to stabilization for carry trades. Don’t expect this to happen in the first quarter however as many central banks are still expected to cut interest rates.  The Fed’s rate cuts have long been a big driver of market volatility and now that risk is off the table.  When the monetary and fiscal stimulus start to impact the US economy, the market may actually start talking about a rate hike in the US.  Interest rates cannot remain at zero forever, especially if inflation starts creeping higher in the second half of the year.  

Is there a Risk of Deflation?  

Deflation is much more of a problem for the US economy than inflation.  Since oil prices are more than 75 percent off their highs. As a result, we have seen either flat or negative consumer price growth every month between August and November.  The December numbers have yet to be release, but there is no reason to expect CPI to turn positive.  Since the beginning of the year annualized consumer price growth has fallen from 2.1 to 1.1 percent.  The US economy has not officially hit deflationary conditions, but with commodity prices continuing to fall and consumer demand slumping, deflation will become a greater risk than inflation in the first half of 2009.  However this may change in the second half as Quantitative Easing, fiscal stimulus and hopefully a weaker currency boosts inflation.  

Time for Quantitative Easing

US interest rates have fallen 400bp from 4.25 percent to 0.25 percent in 2008.  For most people, interest rates at 0.25 percent are as unattractive as zero interest rates.  With US rates pretty much at zero, the Federal Reserve has informally adopted its own version of Quantitative Easing. Some people may even argue that the Fed has been pursuing this strategy for months now. In conjunction with the Treasury department, the Fed has doubled their balance sheet in the past 3 months to more than $2 trillion. They have done this by purchasing direct equity investments in banks, easing standards on commercial paper purchases, made efforts to relieve institutions of their toxic asset-backed securities and are now considering buying Treasury bonds and agency debt. By buying these assets, they are adding money into the financial system. Like the Yen, Quantitative Easing exposes the US dollar to significant downside risks because the Federal Reserve is basically printing money and using that money to flood the market with liquidity, eroding the value of the dollar in the process.  However it is a step that the central bank needs to take to stabilize the US economy and to prevent a deflationary spiral.  The central bank will not be worried about a weak currency and will in fact welcome one because they know that a weaker currency is like an interest rate cut in many ways because it helps to support and stimulate the economy.  

Technical Outlook for the Dollar Index

As indicated in the following chart, the US dollar rallied significantly in the second half of the year. Between June and November, the dollar index rose more than 25 percent.   However the rally hit a brick wall in the month of December, when it plunged 12 percent. Since then it has recovered modestly, but it is hovering below stiff resistance.   Not only is there the 38.2 percent Fibonacci retracement above current levels, but that also coincides with the 100-day Simple Moving Average.  If the dollar index breaks above 81.70, there is scope for a much sharper gain, but the combination of a head and shoulders pattern in formation, Fibonacci and Moving Average resistance suggests that the odds are skewed towards more losses than gains in the beginning of 2009.  


Euro 2009 Forecast

How Did the Euro Trade in 2008?

Exactly one year ago, the Euro was trading at approximately 1.47 against the US dollar, 5 percent higher than current levels.  In 2008, this type of move is considered mild especially when compared to the Euro’s 20 percent rally against the British pound and New Zealand dollar and 27 percent decline against the Japanese Yen.   However the mild year over year change in the EUR/USD masks a tremendous amount of volatility during the year.  In the first half of 2008, the EUR/USD soared to a record high above 1.60.  After that, it fell 22 percent to a 2 year low but recovered more than half of those losses in the month of December.

Eurozone’s to Underperform in 2009, Expect a Prolonged Recession

It is no secret that 2009 will be a tough year for many countries, but things will be particularly difficult in the Eurozone.  Every major central bank has cut interest aggressively, driving their currencies significantly lower in 2008.  The ECB on the other hand has been reluctant to follow suit, leaving the Euro only marginally lower for the year.  Although the Eurozone is in a recession, growth has not been nearly as weak as the US.  Annualized GDP growth in the Eurozone during the third quarter was +0.6 percent, compared to -0.5 percent in the US.  The Eurozone’s outperformance in 2008 however could be short-lived as the central bank forecasts a 1 percent contraction in growth next year. As an export dependent region, the strength of the Euro will make a recovery difficult. German companies have already scaled back production as global demand eases. Looking ahead, unemployment is expected to rise, slowing consumer spending and forcing the ECB to continue to cut interest rates.  If German unemployment hits 9 percent, we could easily see Eurozone rates hit 1 percent.

ECB Could Become One of the Most Aggressive Central Banks in 2009

Next to the Bank of Japan, the ECB has been the least aggressive central bank in 2008, having cut interest rates by only 150bp to 2.5 percent (counting the 25bp rate hike, their total easing is 175bp YTD).  Compared to the 400bp rate cut from the Federal Reserve and the 350bp rate cut from the Bank of England, the ECB’s nimble move singlehandedly prevented the Euro from collapsing alongside the British pound, New Zealand and Australian dollars.  However in face of slowing growth, it will be difficult for the ECB to hold onto their conservative monetary policy stance – they are expected to cut interest rates by 100bp in 2009.   The ECB was behind the curve in 2008 and the biggest risk for the Euro in 2009 is whether the central bank’s sluggish policies catch up to them.  In December, the EUR/USD soared on speculation that the ECB may refrain from cutting interest rates in January.  At a time when everyone who still has room to cut interest rates are cutting them, a pause by the ECB could spur a EUR/USD rally above 1.45.  However, with that in mind the ECB first hinted about pausing when the EUR/USD was trading at 1.25.  The 13 percent rally in the currency pair since then increases the chance of a rate cut because a stronger currency hurts the economy.  But a pause does not mean an end to the easing cycle.  Beyond January, we still believe that significantly slower growth will force the ECB to cut interest rates by another 100bp.  More importantly, the ECB will be cutting interest rates at a time when the Federal Reserve and the Bank of England are done easing.  If the Eurozone underperforms the US economy in the second half of the year and the ECB is still cutting interest rates, a prolonged recession and prolonged easing could lead to a major reversal in the EUR/USD in 2009.  Only if the economy proves to be resilient or if another major shock hits the US economy can we see a new high in the Euro.

Inflation Could Remain above ECB’s Target in 2009

One of the primary reasons why the ECB has been reluctant to ease rates aggressively in 2008 is inflation.  The central bank has a 2 percent inflation target and consumer prices remained above the target throughout the year.  In fact, the ECB became so alarmed in July when annualized CPI soared to a high of 4 percent that they raised interest rates by 25bp. Although the fall in oil prices has driven inflation lower by the largest amount in 20 years, CPI is still expected to remain above the ECB’s target in 2009.

Be Careful of a Run on the Dollar 

Another major risk next year is a run on the US dollar. The global slowdown has forced many central banks around the world to become internally focused.  This means that any excess money will be spent on spurring growth domestically instead of funding the US deficit.  With next to zero yield, a deteriorating balance sheet and the risk of a weaker dollar eroding the notional value of any US investments, there are almost no reasons for foreign investors to load up on US debt.  Having been burned badly by investments in Fannie and Freddie Mac, sovereign wealth funds like China have become skeptical of buying more US paper.  According to an editorial in the state owned newspaper, China Daily, "China's increased purchase of U.S. Treasury securities should not be interpreted as an endorsement of the assumption that the U.S. can borrow its way out of the current financial crisis."  If dollar demand continues to wane, it is another factor that could drive the dollar lower in the first half of 2009.

Political Risk

There will be 2 elections in Europe in next year– the election for the new Chancellor of Germany and elections for European Parliament.  In Germany, Chancellor Angela Merkel is expected to take on her foreign minister Frank Walter Steinmeier.  With an economy in turmoil, it is difficult to tell who will win but if it is another close election like one in 2005, we could see the Euro come under selling pressure.  When both Merkel and Schroeder declared a victory in September 2005, the EUR/USD plunged as political uncertainty hit the currency.  The European Parliament elections in June will be the largest transnational democratic election in history with over 700 members set to be voted in by 515 million EU citizens.  For the currency market, the only implication is the possibility of legislative activity coming to a standstill in the spring as the European Parliament prepares for the election.  

Technical Outlook for the EUR/USD

It is probably not a coincidence that the rally in the EUR/USD in December stopped right at the 50-week Simple Moving Average, which is hovering above the 61.8 percent Fibonacci retracement of the 1.60 to 1.23 bear wave.  According to our Bollinger Bands, the EUR/USD is now within the Range Trading Zone.  As long as it holds above 1.3760, the 38.2% Fibonacci support level, we could see a rally back towards 1.42.  However, a break of 1.4685 is needed for the currency pair to have any chance of retesting its record highs.  On the downside, a break of 1.30 would resurrect the downtrend.  


British Pound 2009 Forecast

How Did the British Pound Trade in 2008?

The British pound was one of the worst performing currencies in 2008.  It fell to a 6 year low against the US dollar and record low against the Euro in addition to selling off against every other G10 currency.  The overwhelming weakness in the currency is a direct reflection of the impact that the credit crisis had on the UK economy.  In the month of December, many currencies recovered against the US dollar, but unfortunately the British pound was not one of them.  Although the pound could continue to weaken in the first quarter, the government’s aggressive fiscal and monetary stimulus should help the country recover towards the end of 2009.

Official Recession in 2009

Without two consecutive quarters of negative GDP growth, the UK economy is not technically in a recession but that should change in the first quarter of 2009, when the 2008 Q4 GDP numbers are released.  Growth has been slowing materially and the weakness is reflected in the British pound. GDP growth fell by 0.6 percent in the third quarter, the largest decline in 18 years. The housing market and the financial sector have been the engine of growth in UK for the past few years and both blew up in 2008.  Unfortunately the worst is probably not over for the 2 key components of the UK economy, particularly following the Bernie Madoff’s Ponzi scheme.  In addition to losses suffered from the subprime mortgage crisis, many large hedge funds and European banks invested with Madoff’s.  In 2009, they will be forced to write down those losses and deal with what could be pretty severe consequences for the financial sector as a whole. With the financial and housing market sectors expected to remain weak in the first half of 2009 and layoffs predicted to rise, GDP growth could fall as much as 2 percent next year. Although we believe that the country could be one of the first to recovery from the global economic downturn, this will not before more pain is felt in the UK economy. The severity of the UK recession will be largely dependent upon how quickly the credit markets are restored in 2009.   

Inflation to Fall Back to 2%

Even though falling oil prices has driven inflation lower in the UK, the annualized pace of consumer price growth is still well above the central bank’s 2 percent target and even higher than their 3 percent upper limit.  The latest data is for the month of October and according to that report, consumer prices rose 4.1 percent yoy.  Despite the high level of inflation, the central bank has pretty much abandoned the inflation target and shifted their focus back to growth because they believe that the slowdown in the economy will naturally drive inflation lower.  They believe inflation could fall back to 2 percent as early as the first quarter.  

More Rate Cuts in First Half of 2009

Next to the Federal Reserve, the Bank of England has been the most aggressive central bank in 2008, having cut interest rates by 350bp to 2 percent, the lowest level in 57 years.  Despite the massive interest rate cuts, tax cuts and other fiscal stimulus, the Bank of England remains committed to doing all that it takes to prevent a recession from sparking deflation.  Central Bank Governor King believes that the economy will contract in 2009 and given his pledge UK interest rates could fall by another 100bp in the first half of the year.  Although zero interest rates are not expected in the UK, interest rates will fall below 2 percent and until the Bank of England is done easing, the British pound may remain weak.  

EUR/GBP at Parity

The sell-off of the British pound in the first few months of the year could drive EUR/GBP to parity.  If that happens, it would be the first time ever that one Euro would be worth more than one British pound.  This could not come at a better time than 2009, when the Euro celebrates its 10-year anniversary.  In this past decade, the currency has risen from ashes to become more valuable than the 2 primary reserve currencies in the world.  Although many Britons may be alarmed at the weakness of their exchange rate, the Bank of England will probably not step in to stop it from falling.  Instead, the BoE will revel in the stimulative effects of a weak currency.  There are already reports of Europeans from the Eurozone flocking to the UK for their holidays.  The weakness of the British pound against both the US dollar and the Euro are key ingredients for an economic recovery.  

Keep an Eye Out for a Recovery

Although the UK economy still faces many risks in 2009, there is hope.  Consumer spending has been pretty resilient with November retail sales rising for the first time in 3 months.  If the global economy begins to recover, we expect the UK economy to outperform its peers thanks to the Bank of England’s proactiveness. The currency has sold off significantly, providing additional stimulus for the battered economy.  Even if there is no full-blown recovery, the UK economy is much further long in their slowdown than the Eurozone.  Therefore if we see sharply weaker growth in the Eurozone economy in 2009, expectations for more aggressive ECB interest rate cuts may be all that the British pound needs to recover against the Euro.  As for the US dollar, the recovery could come sooner if the quantitative easing forces the greenback lower.  When the UK economy begins to recover, so will its currency.  

Technical Outlook for the GBP/USD

The British pound experienced a drastic sell-off throughout the year as the price tumbled to a level not seen since 2002. The pair lost roughly 5000 pips as the BOE reduced the interest rates far more aggressively than other central banks. Currently, the pair is well below the 200-week and 50-week SMA reflecting in the change of the trend from an upward to a downward bias. Nevertheless, the pair seems to be oversold for the time being, needing a major retracement if it will continue to depreciate further. The pair still remains in the sell zone that is established using the Bollinger Bands, and until the price closes above the 1st Standard Deviation we could experience a further downtrend. Although the pair is destined to retrace at some point during the following year, the price still remains within reach of breaking further establishing a prolonged downward trend.  Near term resistance is at 1.5723, the December high.  The currency pair could hold above 1.45, but if it breaks that level, the next meaningful support is not until 1.40, which served support from 2000 to 2001.  


Japanese Yen 2009 Forecast

How Did the Japanese Yen Trade in 2008?

The global economic turmoil and the subsequent unwinding of carry trades made the Japanese Yen, the best performing currency of 2008.  The Yen rose more than 35 percent against the British pound, Australian and New Zealand dollars and hit a 13-year high against the US dollar.  Unlike some of the other currencies, which may have seen wild swings throughout 2008, the Yen consistently strength throughout the year.  Unfortunately the remarkable rally in the Yen will also be a big reason why Japan could underperform, its peers next year.

Japan Could be the Worst Performing Country in 2009

Of all the countries in the developed world, Japan will probably have the toughest time in 2009 because of the strength of its currency.  As an export dependent nation, Japan typically runs a trade surplus but this year we have seen the country report trade deficits, which is extremely rare. Toyota, the world’s largest carmaker is the highest profile casualty of Yen strength.  The automaker reported their first lost in 70 years as sales plummeted and the Yen soared.  The toxic combination of a weak economy and a 16 percent rise in the yen against the US dollar has been disastrous for the automaker.  Although Toyota is probably the most high profile, they are certainly not the only major Japanese corporation to be hit by the double whammy of a slowing global economy and a strong currency.  Business sentiment across the country has already fallen to a 7 year low as exports decline by a record amount. Unless the Yen’s strength is suddenly reversed, we expect Japanese corporations to report more losses in the months to come.   As of the third quarter of 2008, Japan is in a recession with growth shrinking by an annualized pace of 1.8 percent. Next year, GDP growth is expected to fall by 2.5 to 4 percent as weak domestic and international demand hits the economy.  However it is important for currency traders to realize that the Japanese Yen does not always trade off economic fundamentals.  The outlook for Japan has been bleak for months now, yet the currency is rallying because risk appetite has been the dominant driver of the currency’s price action.  If the market is very nervous about the global economy, the Yen could still rise even if Japan’s economy continues to deteriorate.  

Inflation: Consumer Prices Could Turn Negative in 2009

Like the rest of the world, inflation is slowing in Japan, but consumer prices still remain in positive territory.  Nationwide, the latest data we have is from the month of November. During that month, annualized CPI growth slowed from 1.7 to 1.0 percent.  However the combination of a strong currency and the continual decline in commodity prices could drive consumer prices into negative territory next year.  A strong currency moderates inflationary pressures while a weak currency boosts it.

No More Room to Cut Interest Rates

With interest rates already at 0.5 percent in January 2008, we were surprised to see two obscurely sized rate cuts by the Bank of Japan that took interest rates down to 0.1 percent, within a whisker of zero.  Although the BoJ Governor denies it, the rate cuts combined with plans to buy commercial paper and increase purchases of government debt essentially returns the country to quantitative easing.  The only reason why the BoJ did not take interest rates to zero is because they do not want kill the repo market or give the public the perception that they have run out of ammunition.  Looking ahead, we have probably seen the last of BoJ rate cuts and the central bank will need to rely on fiscal policy and a further expansion of the balance sheet to stabilize the economy.

Will Carry Trades Recover?

Between 2001 and 2006, one of the most lucrative strategies in the currency market was carry trades.  However anyone long carry in 2008 was burned badly - GBP/JPY for example fell 41 percent to a 13 year low while NZD/JPY fell 39 percent to a 7 year low.  Record volatility, massive deleveraging and global interest rate cuts created a toxic combination for carry trades.  In order for carry trades to recover, central banks need to stop cutting interest rates, volatility needs to decline significantly and the global economy needs to recover enough for investors to be willing to start taking on risk.  This could happen in 2009 but not until the second half of the year at the earliest.  

Risk of BoJ Intervention

In the face of a deepening recession, a strong currency and little room to move on interest rates, everyone is wondering whether the Bank of Japan will physically intervene to weaken its currency. The problem is that the only type of intervention that has ever really worked is coordinated intervention and the BoJ will have a very tough time convincing the Americans and Europeans to take any steps that would strengthen their currencies.  Since the problem is not unique Japan and stems from the West, the Japanese needs to stand aside and allow the US and Eurozone governments to work on spurring their own growth.  If they weaken their currency and strengthen the dollar for their own short-term relief, it could actually be counterproductive. However with that in mind, as the economy worsens and the central bank runs out of options, intervention risk will grow.  

Technical Outlook for USD/JPY

As you can see from the weekly chart of USD/JPY, the sell-off in the currency pair has been severe. Currently, the price is well below the 200-week and 50-week SMA and at the level not experienced since 1995. This puts USD/JPY in the Bollinger Band sell zone and even though a retracement could imminent, it could be an opportunity to sell rallies than buy on dips. The closest level of support is at the 161.8% Fibonacci extension of a low established in late 2007 and the high for the 2008 at 86.50.  Resistance is at 94, the 10 week SMA.  

Canadian Dollar 2009 Forecast

How Did the Canadian Dollar Trade in 2008?

It is almost hard to believe that a little more than 1 year ago, one Canadian dollar was worth more than one US dollar.   The USD/CAD exchange fell to a record low of 90 cents in November 2007, prompting the Canadian edition of Time Magazine to name the Loonie the Newsmaker of the Year.  However since then, it has fallen hard.  In 2008, the Canadian dollar dropped to a 2 year low against the US dollar, a 9 year low against the Euro and an 8 year low against the Japanese Yen.  However CAD weakness was not universal.  Currencies that also lost value against the Loonie include the British pound, New Zealand and Australian dollars.  Looking ahead, the odds are still skewed towards further losses for the Canadian dollar.  

Canada: Recession Only Beginning

The recession in Canada is only beginning.  According to Statistics Canada, the Canadian economy slipped into recession in the beginning of the fourth quarter.  Contrast that with the US, which has been in a recession since December 2007.  It is not a surprise to see Canada trail behind the US because up until this summer, soaring oil prices kept part of the economy well supported.  However, a lot has changed since the Summer of ’08 and now Canada is faced with the double blow of slowing US growth and significantly lower oil prices.  In the third quarter, Canadian GDP rose 1.3 percent, but more recent data for October indicates that growth contracted by 0.1 percent, on slowing shipments of cars and lumber to the US.  We are only beginning to see the weakness manifested in consumer spending and the labor market.  In the month of October, retail sales contracted by 0.9 percent, the largest drop in 8 months and for the same period employment fell by the largest amount in 26 years.  Still, the Canadian economy is not expected to contract as much some of its international counterparts.  Finance Minister Flaherty predicts that GDP will shrink by 0.4 percent next year, which is nominal compared to a 1 percent decline expected for the US and the 2.5 to 4 percent decline expected in Japan.   

Slowdown in the East and West

The Canadian economy is heavily dependent upon energy production and manufacturing.  In the past, the slowdown in one sector could be masked by a boom in the other.  This was case for most of 2007 and the first half of 2008.  Soaring oil prices helped the 3 energy rich western provinces of Canada (British Columbia, Alberta, and Saskatchewan) carry the economy.  However in the second half of 2008, oil prices came crashing down, falling more than 75 percent in a matter of months.  This dealt a strong blow to the Western Part of Canada at a time when the central and eastern parts of the country were already floundering.  The automobile industry has been hit hard by the credit crisis and unfortunately for Canada, the auto sector is their largest manufacturing industry.  Ontario, houses plants for major American and Japanese automakers and they have been dragged down by their US counterparts.  The automobile industry is in such bad shape that Prime Minister Harper announced a CAD3.3 billion rescue plan for the US automakers in Ontario.  Seventy percent of Canada’s trade is with the US so as long as the US economy continues to slow and oil prices remain below $45 a barrel, the Canadian dollar will have a tough time recovering.  

Core Inflation is Actually Accelerating

Interestingly enough, Canada is one of the few countries to report higher inflation.  In the month of November, core prices rose 0.7 percent, pushing the annualized pace of growth from 1.7 to 2.4 percent.  Headline prices, which includes the impact of oil eased, but not by nearly as much as the market had expected.  The annualized growth of headline CPI is still above 2 percent.  The weakness of the Canadian dollar contributed to a sharp rise in food prices, which increased 7.4 percent yoy that month, the fastest pace of growth in 22 years.   From the beginning of October to the end of November, the Canadian dollar fell more than 20 percent against the US dollar.  Currency impacts can have a lagged effect on prices which may be a reason why we are only seeing the impact now.  Stronger inflationary pressures will make it more difficult for the Bank of Canada to cut interest rates aggressively.  

Bank of Canada Will Continue to Cut Interest Rates, But Not to US Levels

Since the beginning of 2008, the Bank of Canada has cut interest rates by 275bp to 1.5 percent, the lowest level since 1958.  Even though they have been fairly aggressive, more interest rate cuts will be needed to deal with what could be one of the worst years ever for the Canadian economy. The Canadian government has already pledged more monetary and fiscal stimulus therefore it should just be a matter of time before the BoC takes interest rates below 1 percent.  Although the idea of zero interest rates have been floated around, the weakness of the currency should continue to keep inflation around the central bank’s 2 percent target and for that reason we do not expect them to take rates down to US levels.  The Canadian economy is only beginning to slow and the prospect of more interest rate cuts will make the Canadian dollar vulnerable in the beginning of 2009.  

Things to Watch Out For:  Foreign Investment, Current Account Deficit and Political Risk

If falling oil prices and slower US growth aren’t enough of a burden on the Canadian economy, falling bond yields have made Canadian investments increasingly unattractive.  Over the past few years, soaring oil prices added to the allure of Canadian dollar investments, but now that 2 year bond yields are less than 50bp and oil prices are no longer supporting the economy, we could see foreign investment dwindle.  This in combination with lower weaker exports should lead to Canada’s first current account deficit in 10 years.  Prime Minister Harper has received a lot of criticism in 2008 and there is a strong chance that more political infighting could force his minority government could to fall.  Harper has already suspended Parliament until the end of January in order to avoid a no-confidence vote.  In the currency market, political risk can add downward pressure to the currency.   Although most arguments favor more weakness in the Canadian dollar next year, it would only take a recovery in the US economy or a sudden rally in oil prices to turn things around.  

Technical Outlook for USD/CAD  

After breaking parity for the first time ever late last year, USD/CAD experienced a rally throughout 2008.  Despite numerous tests, the pair failed to break the 1.3000 level and instead formed what could be a triple top.  This triggered a reversal in the currency pair that took it back below 1.20. USD/CAD is still trading well above the 50-week and 200-week SMA which means that the uptrend may still be intact. The price retraced 23.6% from a low established in 2007 and a high of 2008 and may be forming a cup-and-handle pattern. A break back above the first standard deviation Bollinger Band at 1.25 will be needed to officially reinstate the uptrend in the currency pair.  If it fails to break that level and instead falls below 1.20, then we could see a move to 1.15, which is the Fibonacci support of the same move that was mentioned earlier.    

Australian Dollar 2009 Forecast

How Did the Australian Dollar Trade in 2008?

Back in July 2008, everyone was talking about how the Australian dollar could reach parity with the US dollar.  At the time, the currency pair was trading at 0.9845 a 20 year high.  However what rises quickly can also fall quickly because when commodity prices peaked in July the Australian dollar came crashing down.  The currency fell close to 40 percent against the US dollar to a 5 year low before finding support above 60 cents.  The move was even more dramatic against the Japanese Yen.  AUD/JPY traded as high as 104 this year before it dropped close to 50 percent to a record low.  Despite the dramatic moves, the Australian dollar’s weakness was not universal. Since the beginning of the year, the currency actually strengthened marginally against the British pound and New Zealand dollars.  Looking ahead, the sharp weakness of the Aussie dollar could help the country recover in 2009.  

Will Australia Avoid Recession?Weak Australian Dollar Will Lead to Upward Revisions for Corporate Earnings

The global economy is slowing but there is a decent chance that we could see Australian corporations report an improvement in earnings.  Since the beginning of the year, the Australian dollar has fallen 25 percent against the US dollar, 35 percent against the Chinese Yuan and 50 percent against the Japanese Yen.  These currency fluctuations are particularly important because Japan, China and the US are the largest export destinations for Australia.  Since a weaker currency reduces the costs for exports, leading Australian companies like Qantas, Billabong and Fosters have revised up their earnings on the expectation that a weak currency will boost foreign demand for their products.  Stronger earnings will help to pull the country out of any recession and hopefully engineer the second half recovery that many economists are looking for.  

Slowdown in China Will HurtInflation to Ease, But Not By Much

The latest consumer prices for Australia are from the third quarter and in Q3, the annualized pace of consume price growth accelerated to 5 percent, the fastest since 2001.  According to the monthly TD Inflation index, price pressures have eased significantly since then.  However with that in mind, the RBA still expects inflation in the 12 months through June to be at 2.5 percent, which is well within the Reserve Bank’s 2 to 3 percent inflation target.

Dramatic Rate Cuts to Come to an End

The Reserve Bank of Australia has been extremely aggressive in 2008, cutting 300bp in just 4 months.  The last rate cut they made was in December when they slashed interest rates by a full percent.  According to the RBA, monetary policy is now “expansionary” which suggests that they are almost done with cutting interest rates.  The central bank has been extremely proactive and their efforts will be vital in helping to restore the Australian economy.  Like many of their international counterparts, Australia has combined monetary with fiscal stimulus.  At most, we expect another 100bp of easing from the RBA next year.  This will probably be in the first half of the year, which is when the economy could fall into recession.  After that, watch out for a quick recovery for Australia in the second half of the year.

Technical Outlook for the AUD/USD  

Although many countries across the globe have fallen into recessions, Australia has avoided one.  The economy has expanded every quarter since 2000 albeit at an increasingly sluggish pace.  In the third quarter of 2008, growth was a paltry 0.1 percent, the weakest in 8 years.  There is a decent chance that growth in the fourth quarter was negative and if so it would put Australia at risk of falling into a recession for the first time in 17 years.  It may be difficult for Australia to avoid a recession, but any recession in the country should be shallow.  Consumer spending has been neutral to positive every month this year thanks to a steady labor market as the unemployment rate has only ticked up marginally from 4.1 to 4.4 percent.  Domestic demand and Chinese demand has made the Australian economy much better equipped to deal with the global slowdown than its peers.   Many economists are looking for 2009 GDP growth to be in excess of 1 percent.  Although this would be the weakest growth since the recession in the 1990s, we are certain that Australians are grateful that their economy is growing at all.   The only significant risk for Australia is a major slowdown in China.  China has been the engine of global growth for the past 10 years and unfortunately for world and Australia in particular, that engine has begun to slow.  For the past few years, China has enjoyed double digit growth rates and in 2008, growth is expected to fall to 9.8 percent and in 2009, growth is expected to fall below 7 percent.  China has not been immune to the global financial and credit crisis and even though the government has deep pockets, the prospect of more weakness in the real estate market and the pain of sharp losses in the stock market could lead to a further slowdown in consumer spending.  Until the global recession is over, many people China could become more conservative with their spending which will undoubtedly have a negative impact on the Australian economy.  

In the first half of 2008, the Australian dollar soared within a whisker of parity with the US dollar.  However as the prices of commodities plunged, so did the AUD/USD.  Having hit a 5 year low of 0.60 in October, the currency pair has been quietly consolidating.  It December, it rose out of the Bollinger Band sell zone.  Prices are also in the process of breaking the 23.6 percent Fibonacci retracement of the 0.9850-0.60 sell-off.  The next level of resistance is at 0.7200, the 20 week SMA and the October / December high.  The turn in AUD/USD remains intact as long as the currency pair remains above 65 cents.   


New Zealand Dollar 2009 Forecast

How Did the New Zealand Dollar Trade in 2008?

In 2008, the New Zealand dollar lost value against every single major currency except for the British pound.  Although the most pronounced weakness for the currency was against the Japanese Yen, the kiwi also fell to a 5 year low against the US dollar and a 7 year low against the Australian dollar. The collapse of the carry trade weighed heavily on all of the major currencies but the New Zealand dollar was one of the first to peak in 2008 and the downtrend that ensued lasted for most of the year.  The early weakness in the currency stemmed from the fact New Zealand was one of the first countries to fall into recession. However looking ahead, the strong sell-off in the New Zealand dollar will also be the key ingredient to stabilizing the economy in 2009.  

Will the Recession Come to an End in 2009?

New Zealand is a tiny country that is particularly sensitive to the ebbs and tides of the global economy.  In 2008, growth contracted every quarter as the recession deepened. New Zealand has been hit hard by rising credit costs, slowing exports and a drought that crimped production. In the third quarter, GDP growth contracted by 0.4 percent and growth is likely to have fallen in the fourth quarter as well. The recession has forced companies to cut production and fire workers, driving the unemployment rate to a 5 year high in Q3.  This triggered a sharp contraction in consumer spending - retail sales fell 1.3 percent in the month of October, the largest decline since 2004. The jury is still out on whether the recession in New Zealand will come to an end in 2009.  Central Bank Governor Bollard is optimistic – he thinks the recession may already be over and believes fourth quarter growth could be positive.  However economists beg to differ – they expect GDP growth be negative in 2009.  We think that any further contraction in the New Zealand economy will be concentrated in the first half of the year.  The Reserve Bank has cut interest rates significantly, increased spending and lowered the income tax rate.  Combined with the weakness of the currency, this stimulus will contribute to a second half recovery.  

Inflation to Ease but Off Very High Levels

Like Australia, the latest consumer prices are from the third quarter and in Q3, the annualized pace of consumer price growth accelerated 5.1 percent, the largest increase in 18 years.  The weakness of the New Zealand dollar has played a large role in contributing to higher inflation pressures.  Therefore even though inflation will ease in 2009, it may not ease much because the New Zealand dollar is still weak and inflation is coming off of very elevated levels. With that in mind, the Reserve Bank of New Zealand may not care about the elevated level of inflation, as they remain committed to using monetary policy to stimulate the economy.

Dramatic Rate Cuts to Come to an End

The Reserve Bank of New Zealand has also been very aggressive with easing monetary policy this year, having cut interest rates by 325bp since July.  The last rate cut of 150bp was the largest ever for the Reserve Bank.  Such aggressive measures would lead one to believe that the RBNZ is looking to draw an end to their easing cycle as soon as possible.  This is true but not before interest rates is cut by another 100 to 150bp.  After the last rate cut in December, Bollard said that he believes rate cuts will come to an end in the middle of next year.  When the RBNZ signals that they are done cutting interest rates, we could see a sharp recovery in the New Zealand dollar as the fiscal and monetary stimulus hits the economy.  The drought that hung over the country in the first half of the year is finally over, offering some additional relief for New Zealand’s agriculture, dairy and beef industries.  

New Zealand Needs Australia to Recovery

In 2009, New Zealand dollar traders also need to keep an eye on Australia, the country’s largest trading partner.  If New Zealand wants to have any chance of recovering, we need to see the Australian economy stabilize first. Demand has not been increasing, while the weakness of the New Zealand dollar has been boosting the cost of exports.  The end result is a widening current account deficit.  For any country, a wider current account deficit is bearish for the currency.  Therefore if the Australian economy stabilizes and exports increase, then the deficit may narrow, helping to reverse the downtrend in the New Zealand dollar.  Thankfully this turn of events may actually happen in 2009 as the downturn in Australia is expected to be shallow.

Technical Outlook for the NZD/USD

The downtrend in the NZD/USD has lasted for most of the year.  According to the following chart, the currency pair remained within our Bollinger Band sell zone from June to the end of November.  However the trend began to change in December, after the currency hit a 5 year low against the US dollar.  It is now trading out of the Bollinger Band sell zone which suggests that a turn may be in place.  The closest level of resistance for the currency pair is 0.6085, which is December high and the 20-week Simple Moving Average. If it manages to clear that level, we could see a move up to 0.6345, the 38.2 percent Fibonacci retracement of this year’s entire sell-off.   On the flip side, if the NZD/USD breaks the first standard deviation Bollinger Band on the downside at 0.55, we could see a resumption of the year long downtrend.    

Swiss Franc 2009 Forecast

How Did the Swiss Franc Trade in 2008?

2008 was the revenge of the low yielders.  The Swiss Franc and the Japanese Yen were the best performing currencies of the year, followed by the US dollar, which only became the second lowest yielding currency in March.  The fact that the Japanese Yen was the only currency to appreciate against the Swiss Franc indicates how much of an impact interest rates had on the currency’s performance.  When the markets were nervous and economic climate is as uncertain as it was last year, investors rush out of high yielding currencies, which typically have more risk into lower yielding ones, which typically have less risk.  This helps to explain the Franc’s 25 percent appreciation against the British pound, New Zealand and Australian dollars.   Looking ahead, we could see more gains in the Swiss Franc, but that will be largely dependent upon the market’s risk appetite.  

Recession Expected in 2009

Like Australia, the global recession has yet to hit Switzerland, but in 2009, it may be difficult for the country to avoid one.   GDP growth in the third quarter was flat and it may be only a matter of time before we start seeing a contraction.  The annualized pace of GDP growth has already fallen materially from more than 3 percent in Q1 to 1.6 percent in the Q3.  Although Switzerland has proven to be more economically resilient than its Eurozone counterparts, they are not immune to the global economic crisis. The country is heavily dependent upon its financial services industry or foreign investment and unfortunately the sector has been hit hard by the credit crisis.  UBS, Switzerland’s largest bank has already report billions in write-downs and is planning to split its investment banking and wealth management businesses.  After cutting interest rates in December, Swiss National Bank President Roth predicted that 2009 will be a year of recession.  They expect GDP to growth to contract between 0.5 to 1 percent in 2009.  The UBS Consumption hit a 3.5 year low in the month of November while the KoF leading indicators report fell to a 5 year low in December.  This confirms that more weakness is ahead for the retail sector and the economy as a whole.  However with that in mind, like the Japanese Yen, the Franc does not always move on Swiss fundamentals.  Instead, it usually moves on the market’s risk appetite.  

Inflation: Big Nose Dive Expected to Continue

Inflation is declining rapidly in Switzerland.  The latest consumer price figures were for the month of November and based upon the report, inflation dropped the most in 15 years.  On a monthly basis, CPI declined by 0.7 percent.  This dragged the annualized pace of CPI growth down from 2.6 to 1.5 percent.  Although the franc rose against the Euro for most of the year, its early sell off against the US dollar limited the impact of foreign exchange fluctuation on price pressures.  Falling oil prices therefore drove inflation lower.  Price pressures are expected to slow further in the 2009.  The Swiss government expects inflation to average 0.7 percent next year which is next to nothing.  Softer inflation pressures increases the central bank’s flexibility to leave monetary policy easy.  

Zero Interest Rates for Switzerland?

The Swiss National Bank has been full of surprises this year.  They delivered a series of intermeeting rate cuts that took interest rates to the lowest level in 4 years.  Over the course of 2 months the SNB cut interest rates by 225bp to 0.5 percent and even though interest rates are very low, after their December rate cut, the SNB suggested that they are open to taking interest rates to zero.  The slowdown in the global economy has taken a big toll on Swiss economy and if economic conditions worsen, the central bank is ready to take further action if needed.  With interest rates at ultra low levels, the Swiss central bank may need to start thinking about unconventional options like Quantitative Easing.  Of course they would not be alone because it is a road that the Federal Reserve and the Bank of Japan have already taken.  There is also talk of currency intervention, but we do not think that it is likely. The SNB has been very proactive this year and they will continue to do all that they can to support the economy in 2009.  However as the third lowest yielding currency developed, as long there is uncertainty in the financial markets and the global recession deepens in the first few months of year, the Swiss Franc may still appreciate despite the dismal outlook for the economy.  

Technical Outlook for EUR/CHF

It has been a rollercoaster ride for EUR/CHF this year.  After retracing 61.8 percent of the October 2007 to October 2008 sell-off, the currency pair reversed violently.  It is now trading back within our Bollinger Band sell zone and as a result the downtrend has resumed.  As long as the currency pair holds below 1.51, the 50 percent Fibonacci retracement of the latest rally, we could see a further move back towards 1.4725, the October low.  If the currency pair breaks above 1.50, which is a psychological and Fibonacci resistance level, the downtrend will be broken.  

About The Author

Lien has extensive knowledge within the interbank market, particularly in trading spot FX and options. She has written for numerous publications, is frequently quoted on financial media outlets, and is the author of several books, including Millionaire Traders. Read more >>

DISCLAIMER: This forum and the information provided here should not be relied upon as a substitute for extensive independent research before making your investment decisions. Global Forex Trading is merely providing this column for your general information. This forum and its information does not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision based upon this forum or any information contained within. In addition, any projections or views of the market provided by the author may not prove to be accurate. Global Forex Trading and Kathy Lien will not be responsible for any losses incurred on investments made by readers and clients as a result of any information contained in this column. Global Forex Trading and Kathy Lien do not render investment, legal, accounting, tax or other professional advice. If such advice is sought, or other expert assistance is required, the services of a competent professional should be sought.




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