Friday January 6, 2006 - 15:51:19 GMT
Share This Story
BHF-Bank - www.bhf-bank.com
FX BriefingFX Briefing 6 January 2006
• A good start to the year does not mean things will continue to go well for the euro
• US yield curve shaped by exaggerated growth pessimism
• Interest rate advantage will continue to be a pillar of support for the dollar
Dollar remains attractive
At the beginning of 2005, there was a turnaround on the forex market. Just as the world’s leading currency seemed to be collapsing under its growing current account deficit, the Fed’s regular interest rate hikes began to take effect. During the course of January alone, the dollar recovered from USD1.36 to 1.30 per euro, and in spite of the high energy prices in late summer, bounced back to 1.18 towards the end of the year. However, the US currency started this year with significant losses. The euro rose by 2.2% to around USD1.21. The Scandinavian currencies, the Swiss franc and the Polish zloty gained even more. The yen, which had already adjusted strongly upwards in the previous weeks, gained a more modest 1.5% to just under 116.
Is the way the year starts an omen for how it will continue? Judging by the historical performance of EUR-USD (and before 1999, USD-DEM), the exchange rate trend in January really seems to have a certain significance. In 20 of the last 32 years, i.e. in 63% of cases, the trend of the exchange rate in January corresponded with that of the rest of the year. But for those who feel tempted to take advantage of this, a word of warning: Firstly, January has just begun: the situation could turn around again by the end of the month. Secondly, it would probably be necessary to invest a great deal of time and money in order to reap any benefit from the 63% chance.
We do not share the sceptical view of the US currency. There are currently two main arguments against the dollar. The first is the expectation that the Fed will phase out its rate hikes and the US interest rate advantage will dwindle when the central banks in the other major currency areas, particularly the ECB and the BoJ, begin to tighten their monetary policies. The other argument, just like last year, is the structural widening of the US current account. In our opinion, neither argument is convincing. However, here we will concentrate on the monetary policy considerations.
At present, the market is expecting one more rate increase from the Fed in January and sees about a 50:50 chance of another one in the second quarter. At the same time the yield curve is extremely flat. Thus in our view, the market has put itself in an extreme position: it is speculating on an imminent weakening of the US economy. However, it is by no means clear whether the tightening cycle in the US has in fact come to an end. The Fed is of the opinion that monetary policy is now no longer accommodative, but still thinks that some further policy firming is needed. Nor do the minutes of the December meeting give any clear indication as to whether one, two, three or even more rate hikes are under consideration. All they say is that the number of steps will probably “not be large”.
But even if the Fed believes an interest rate of, e.g. 4.75% to be adequate at the moment, this does not mean it is committing itself to a medium or long-term interest rate policy. On the contrary, the Fed considers the risks to be balanced. It depends on the further economic development as to where the journey will take us in the end.
Some think that the US economy is in for a slowdown, the main argument for this being the presumed weakness of the US housing market. But obviously the US central bank considers the situation to be less critical – otherwise it would presumably not be thinking about raising interest
It is true that the housing market has sent mixed signals over the past months. Sales figures are growing less buoyantly, the number of unsold units has increased and less households can afford to buy houses. But on the other hand, sales are still at a very high level, house prices are more than 12% higher than last year and almost 70% of private households now own their homes, which is about 5 percentage points more than 10 years ago.
You cannot make an omelette without breaking eggs. Nor can you contain the risk of a housing market bubble without dampening demand and thus price increases. Even if the US real estate market is really calming down, this is still no reason for the central bank to contemplate interest rate cuts. Moreover, given the volatile nature of the market, it is by no means a sure thing that the development is actually slowing. Speaking against this, for instance, is that American REITs (compared to broad indices such as the Dow Jones and S&P) are approaching new highs precisely at a time when the risks of the housing market development are being increasingly discussed.
Up to now the US economy has proved surprisingly robust again and again. Employment growth is consistently strong and consumer sentiment has improved considerably as gasoline prices have come down. Therefore private consumption is likely to continue providing substantial growth impetus. Moreover, companies are planning to step up investment given the favourable earnings situation. Additionally, the reconstruction activities in the Gulf of Mexico will support growth for some time. And finally, the economic recovery in Japan and Europe will also help to boost exports.
We therefore think that the pessimistic view reflected in the current shape of the yield curve is exaggerated. The risks might be somewhere else entirely: with a tighter labour supply, wages and unit labour costs might rise, higher costs might be passed on to a greater extent, or the increase in house prices could spill over into rents and thus find its way into consumer prices.
If we keep in mind the possible risks for price stability, it is quite conceivable that the fed funds rate might reach 5% in the course of 2006. And, judging by the real money market rate for instance, even at that level monetary policy would not be exactly restrictive. But this would put paid to the notion that the interest rate spread versus the euro will narrow. Even if the money-market spread peaks some time in 2006, a difference of perhaps only 175 basis points (compared to around 200 at present) would still be a strong argument for the dollar. And this is all the more true for the yen.
Stephan Rieke +49 69 718-4114
+49 69 718-3642
Foreign Exchange Trading
+49 69 718-2695
Matthias Grabbe / Klaus Näfken
+49 69 718-2688
This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHF-BANK Group") solely for the information of its clients. The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results. This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it. BHF-BANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities. This publication must not be distributed in the United States.
© 2005 BHF-BANK Aktiengesellschaft
All rights reserved. Please mention source when quoting from it.
Forex Trading News
Daily Forex Market News
Forex news reports can be found on the forex research
headlines page below. Here you will find real-time forex market news reports
provided by respected contributors of currency trading information. Daily forex
market news, weekly forex research and monthly forex news features can be found
Real-time forex market news reports and features providing
other currency trading information can be accessed by clicking on any of the
headlines below. At the top of the forex blog page you will find the latest
forex trading information. Scroll down the page if you are looking for less
recent currency trading information. Scroll to the bottom of fx blog headlines
and click on the link for past reports on forex. Currency world news reports
from previous years can be found on the left sidebar under "FX Archives."