Tuesday September 4, 2007 - 12:15:38 GMT
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FOREX: GVI Month Ahead Forex Outlook
Forex Forecast of Major Currency Pairs
Credit concerns in the inter-bank market are not diminishing as expected. With each passing session it seems that credit premiums for inter-bank funding are rising. As the effective cost of money between banks rises, the cost of credit throughout the system rises. This amounts to a TIGHTENING of monetary policy just as central banks have been attempting to grease the wheels of the system. Presumably the Fed will perceive this and will be forced to react with an interest rate reduction of 25 to 50 bps on September 18 to maintain policy neutrality. Odds are that many commercial banks will be under instructions to shrink their footings and thus keep their trading activities on a reduced scale. This suggests that for the balance of the year that markets could remain thin and potentially volatile. Forex markets are not at the point yet where the traditional drivers of forex trade can come back to the fore. The USD three-month libor has steadily risen to 5.70% after holding at about 5.35% the entire year up until August. At the same time, Fed Funds traded at an effective 5.02% in August while the official target remained at 5.25%. The difference between the effective fed funds rate and three month libor (70bps) is mostly a credit risk premium.
Other than in the U.S., policy decisions by most key central banks have been put on hold while the financial markets work their way through the current credit crisis. That suggests at some point when conditions start to normalize again that some catch up policy decisions will have to be taken. The ECB and U.K. are likely to keep policy on hold decision Thursday, although both banks have kept all options open. This current period of market uncertainty has tended to favor the USD. Presumably, when markets start to normalize again, the USD should fall.
Major Currency Pairs - Currency Forecasts- Monthly Perspective
The European economy, led by Germany, is still in an expansionary phase. Concern is that the economy may be slowing seem not to be shared by the ECB, who on August 2 signaled a September interest rate hike. Since then, ECB President Trichet has indicated that the central bank will make its next decision at the upcoming policy meeting on September 6. The EUR stands to benefit from a return to normalcy in the financial markets.
The Bank of Japan would love to have a normalization of interest rates and a normalization of monetary policy. Nevertheless, the economy simply has not cooperated. The low level of inflation remains a concern. Odds now favor a 4Q07 rate hike of +25bps. A return to JPY carry trades would be an indicator that financial markets have resumed business as usual. When the BOJ does hike by +25bp, the low level of Japanese interest rates afterwards should not be a major deterrent to the carry trade.
The U.K. economy is seeing some price pressures. The Bank of England raised its repo target by +25bps to 5.75% on July 5. Another rate hike is possible later in the year.
The Swiss National Bank has been unhappy with the relative weakness of the CHF against the EUR. Additional quarterly hikes are in the pipeline with the next possible +25bp tightening set for September 13.
The Australian economy has been improving. A key focus for the RBA remains inflation, employment and commodity demand. Latest (2Q07) inflation data suggest that a future rate hike is possible, depending on the state of the financial markets.
The CAD is underpinned by M&A flows, a steady economy and commodity prices. The Bank of Canada hiked rates at its July 10 policy meeting. Another hike of +25bps is seen possible late in the year.
John M. Bland is a co-founder and partner of Global-View.com. Prior to Global-View.com, he was a Vice-President and senior dealer in a forex inter-bank and futures trading arm of a subsidiary (ContiCurrency) of the Continental Grain Company in NYC. Previous to that, he was one of the early members of the Chemical Bank corporate advisory service in NYC, and also worked in international liability management for that bank. John holds an MBA from the Hass School at the University of California at Berkeley and a bachelor?s degree in International Economics from Berkeley.
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