Forecast Summary... 2 Currencies Strategy... 3 East Asia The Subcontinent...6 The Americas..7 Europe/Africa

Transcription

1 C O N T E N T S Forecast Summary... 2 Currencies Strategy... 3 East Asia The Subcontinent...6 The Americas..7 Europe/Africa FEBRUARY 2006 We expect the dollar to resume a downtrend soon, as a housinginduced US economic slowdown becomes more apparent, and as the Fed approaches a pause in its tightening cycle. We now expect that most of the dollar s decline will be front-loaded: our 3 month forecasts are USD1.28/EUR and JPY110. Ben Bernanke s testimony confirmed that a March Fed rate hike is highly likely, but we expect the Fed to move to the sidelines after that. Markets are now pricing in further rate hikes in May or June, but, while there are risks to the upside, we believe that slower growth will allow the Fed to pause at 4.75%. Bernanke reiterated Fed concerns that the economy is running near to capacity, but also expressed comfort with underlying inflation pressures. A slowing US housing market, higher energy costs and only moderate employment gains, we think, will dampen consumer activity, taking growth back to a trend pace and keeping core inflation within the Fed s target. The Fed pausing while the ECB and BOJ signal tighter policy should take the dollar weaker for a while. A continued economic upswing should see rates moving higher in the Euro-zone from next month, while Japan should start to hike rates from the second half of The US s external deficit is also likely to become higher profile once US growth slows, contributing to near-term dollar weakness. Over the long run we see the dollar rallying again, but the yen should hold on to most of its 2006 gains. The US economy should be picking up again from late 2006 or during 2007 as energy prices ease, housing stabilises rather than crashing and lower bond yields stimulate demand. At that point the Fed may well be signalling tighter policy once again. From late-2006 we would expect to see the dollar rallying again, particularly against the euro, sterling and Swiss franc. The yen is relatively undervalued, and should continue to benefit from strong capital inflows into equities and from further Chinese renminbi appreciation. Dollar-bloc currencies should move weaker over 12 months as their interest rates peak, though volatile commodity prices will keep the Aussie dollar whippy. See page 3 for an AUD/GBP cross play. This Currencies report appears every month and is distributed by . Also published by is Economics for Investment - Weekly. The hard copy Economics for Investment is printed and distributed every two months. Please ask your Relationship Manager if you would like to receive them. All of the Economics for Investment publications can now be accessed on This publication is for information only and is not to be construed as an offer to buy or sell investments. American Express Bank Ltd., whilst considering the contents to be reliable, takes no responsibility for any individual investment decisions based thereon. These represent the views of American Express Bank as of the date of this publication; these views may change over time and without notice. GLOBAL ECONOMICS UNIT John Calverley, Kevin Grice, Sarah Hewin, Giriraj Singh. Distribution: Giriraj Singh address: aeb.economics@aexp.com AMERICAN EXPRESS BANK LTD. 60 Buckingham Palace Road, London, SW1W 0RR (No. FC1863, BR301). Incorporated with Limited Liability in the State of Connecticut, USA and registered with the Secretary of State, Hartford, Connecticut, USA with its head office in New York, USA. American Express Bank Ltd.("the Bank") is authorised and regulated by the Financial Services Authority ("FSA"). The Bank is entered in the FSA's Register and its Register number is The FSA's Register can be accessed at The Bank's registered VAT number is GB February 16, 2006

2 Economics for Investment Currencies EAST ASIA Spot per US$ 18/01/06 CURRENCY FORECAST SUMMARY 3 month forecast per US$ % Change* 3 month interest rate, % Implied return, 3 months, %** Large devaluation risk, %*** 12 month forecast per US$ % Change* Japanese Yen/US$ Japanese Yen/Euro Australian Dollar Chinese Renminbi Hong Kong Dollar Indonesia Rupiah Korean Won Korean Won/JPY New Zealand Dollar AUD/New Zealand dollar Philippine Peso Singapore Dollar Taiwan Dollar Thai Baht THE SUBCONTINENT Indian Rupee THE AMERICAS Canadian Dollar Argentine Peso Brazilian Real Mexican Peso EUROPE/MIDDLE EAST/AFRICA Euro UK Pound/US$ UK Pound/Euro Swiss Franc/US$ Swiss Franc/Euro Hungarian Forint Hungarian Forint/Euro Polish Zloty Polish Zloty/Euro Russian Rouble Turkish Lira Turkish Lira/Euro South African Rand South African Rand/Euro * -ve = depreciation, +ve = appreciation, ** return on USD investment in currency over 3 months, *** defined as a 10% or more devaluation against the US$ over three months. American Express Bank Ltd. 2 EFI Currencies February 2006

3 FMS Currencies Strategy AUD/GBP With the outlook for the AUD still bearish investors may want to take advantage of a potential rally on the AUD/GBP cross rate. The cross becomes exciting if the GBP can push above 2.38 and then The commodity currencies were looked at last month, and our underlying view remains the same USD strength should be seen against the AUD, NZD, ZAR and CAD to varying extents. The recent tumble in gold prices should focus attention on these currencies over the coming weeks, with the bias on gold turning below $520 per oz. The key will be whether or not the yellow metal can turn below $500 to $470 per oz., a major turning point from a trend perspective if seen. USD/AUD AUD/GBP USD/AUD Source: DATASTREAM AUD/GBP Looking at the AUD specifically, though, and the peak vs. the USD came in February 2004 some time ago! Since then the RBA rate hikes and underlying commodity trend flows kept the AUD firm, but not firm enough to make new highs. A slide towards and then back to the 2004 pullback lows near would be in line with a consolidative trading phase. Bearish? Think 0.60, last seen in Spring While a straight AUD bear play is easy enough to consider against the AUD, bets on the USD rallying do not sit well with some who may consider the USD story a little too long in the tooth. But the GBP/AUD cross rate may be worth a look on a basing pattern play. The cross formed a spike low at /80 in July 2005 and has consolidated in a sideways manner since then. The BoE risk is on a rate cut this year, the RBA is expected to keep rates flat for a while but rate cut risk has increased further out as the labour data seems to have come off the boil and softened a touch. From a chart perspective, the cross becomes exciting if the GBP can push above 2.38 (250-day moving average near ) and then the August 2004 pullback high near /20. If this is seen then a technical case for a rally towards the 2.56 highs from December 2004 can be made, with chart resistance at 2.46 and 2.50/2.51 along the way. Support is at and just now, with 2.30 marking the major turning point ahead of the /80 low from last year. There are many different ways of trying to take advantage of a potential rally in the cross. A long GBP/short AUD spot or forward position has the negative carry to fight against, but hopefully a spot move in the right direction would make up for it. Risk would be potentially unlimited on an adverse spot move though. Options can give different ways of taking advantage of a rally, for instance purchasing a 2.50 strike GBP call, AUD put with an expiry of 18 December, 2006 and simultaneously writing a 2.29 strike GBP put, AUD call (spot ref ) would give a zero cost play on the upside Analysis from: Gerry Celaya, Redtower Research Sourc e: DATASTREAM For those wishing to earn premium, using the same spot ref. and expiry and buying the same 2.50 GBP call but selling a GBP put, AUD call would earn 0.3% GBP. Both would have potentially unlimited losses if spot were below 2.29 or , respectively. Options pricing from: Colm O Neill AEB Global Financial Markets American Express Bank Ltd. 3 EFI Currencies February 2006

4 EAST ASIA CURRENCIES JAPANESE YEN Spot Month Forecast 110 The yen is down because carry trades funded in JPY have stayed popular. Nevertheless we still expect sustained yen appreciation, although not to the levels that we thought likely in late Japan s upswing should stay in good shape and local investors should increasingly channel funds into Japanese markets, especially equities, reducing capital outflow. Continued good exports growth and rising income from foreign investments should also keep the external surplus on an improving trend. Finally, the BOJ should start tightening policy from Q The carry trade will not disappear as rates will stay very low, but the increased risk of a stronger yen should at least curb its current popularity. Large devaluation risk*: 5% AUSTRALIAN DOLLAR Spot Month Forecast 0.74 We expect the Aussie dollar to weaker further as its yield premium narrows, but the AUD is also likely to be whippy, as commodity prices could well be volatile for a time. Australian consumer demand has eased, and GDP growth is likely to stay on a slow track in Retail sales slowed in Q4 2005, the labour market has weakened, and Q4 inflation came in less than expected at 2.8% pa. But a strong pick up in December home finance approvals rules out a rate cut anytime soon. In addition, inflation is still near the top of the target range and the RBA will stay concerned for a while about wage pressures. We expect Australian policy rates to stay at 5.5% going into 2007, whilst US rates should move up further. Large devaluation risk*: 10% CHINESE RENMINBI Spot Month Forecast 7.89 Chinese officials have revealed that the USD is less than 50% of its new currency basket, leading to speculation that it will soon sanction much greater fluctuation in the CNY/USD rate. We would be surprised if this happens and continue to expect only a small pick up in the appreciation rate to around 4% pa over the next 12 months, from 3% in Furthermore, 4% is slightly less than the 5% gain the 12-month NDFs have currently priced in. Maintaining employment growth should remain Beijing s top priority in Slow China moves on the CNY will likely keep trade tensions high profile in 2006 and there is a good chance that April s US Treasury report will cite China for fx rate manipulation. Large devaluation risk*: 5% HONG KONG DOLLAR Spot Month Forecast 7.76 Recent data show that the economy continues to have good forward momentum. The December unemployment rate held steady at 5.3% for a third consecutive month and December retail sales growth accelerated to 6.9% pa, in part on a pick-up in tourist arrivals. Total arrivals in 2005 reached 23.4mn, a new record, and up 7% on Home sales rose 10.7% in January in the first month-on-month increase in 9 months, and high-end property prices should also start to pick up again soon, after falling in late Affordability is still good, new supply will stay tight for a while, and Hong Kong interest rates are expected to peak out soon, in line with the Fed. The HKD peg should remain unchanged even though at some point in 2006 the CNY/USD will likely move through the USD/HKD rate. Large devaluation risk*: 5% American Express Bank Ltd. 4 EFI Currencies February 2006

5 EAST ASIA CURRENCIES INDONESIA RUPIAH Spot Month Forecast 8800 Favourable interest rate differentials have continued to lift the rupiah. We expect more appreciation but export competitiveness concerns are likely to kick in soon, and we think that the rally will top out in the area. January inflation came in ahead of expectations at 17% pa and may accelerate in February as electricity tariffs move up, and on a minimum wage hike and civil servant salary gains. BI rates have probably peaked (at 12.75%), although there is a chance they may rise one last time in March. With inflation likely to slow to around 8% pa by end 2006, rates should be coming down from September we think to around 10% by year end. The main devaluation risk is premature BI easing. Large devaluation risk*: 15% SOUTH KOREAN WON Spot Month Forecast 960 The won will probably move stronger over the next few months, but the majority of its appreciation move now looks over. Economic growth remains strong, but the upswing is probably topping out and exports have been disappointing. GDP growth should still come in around 5% pa in 2006, up from 4% last year. But the first half of 2006 is likely to be stronger than the second half. Core inflation, now 1.7% pa is still expected to accelerate, but to probably no higher than the mid-point of the central bank s % pa target range. Interest rates were hiked to 4% in early February but the tightening cycle looks close to an end. We now only expect one more rate hike, in March or April. Large devaluation risk*: 10% NEW ZEALAND DOLLAR Spot Month Forecast 0.66 The impact of high rates and the strong NZD keeps coming through. Business confidence is depressed, and consistent on historical trends with GDP contracting in both Q and Q Employment also dropped in Q4, the first quarterly decline since House prices and retail sales are holding up for now, but inflation has probably peaked. As expected, the RBNZ kept rates on hold in January (at 7.25%) and the issue now is when will they start to cut we think from Q3. Lower local rates, a large external deficit mainly financed by short term capital inflows chasing yield, as well as the likely undermining of the carry trade as yen rates move up, all point to further, possibly sharp, NZD slippage. Large devaluation risk*: 25% PHILIPPINE PESO Spot Month Forecast 50.0 We expect further appreciation over the next few months. Worker remittance inflows should stay strong and merchandise exports rebounded sharply in December. In addition, capital inflows into the local equities market should also stay strong for a while, due to IPOs and the CALPERS (California s public employees pension fund) Philippines upgrade, which should trigger buying by other investors who use the CALPERS list as a benchmark. Finally, S&P has, as expected, moved up the debt outlook from negative to stable, on the much improved fiscal performance. The improvement should continue as VAT was increased in February. Higher VAT will boost inflation and, despite the strong PHP, a further 50bps in rate hikes looks likely this year, taking policy rates to 8.0% (now 7.5%). Large devaluation risk*: 20% American Express Bank Ltd. 5 EFI Currencies February 2006

6 EAST ASIA / SUBCONTINENT CURRENCIES SINGAPORE DOLLAR Spot Month Forecast 1.58 Economic growth remains very strong, with faster-than-expected Q4 activity taking 2005 GDP growth to 6% and official growth forecasts for 2006 being revised up to 4-6% from 3-5%. Services and manufacturing are leading the way and should hold strong in 2006 on foreign demand, whilst construction has emerged from its slump employment growth was a record 111K (71K in 2004) and Q4 unemployment dipped to 2.5%, below Singapore s full employment rate which is around 3.0%. Therefore, the MAS will be comfortable with further SGD appreciation even though the Singapore dollar is probably already at the strong end of the (unknown) trading band. Large devaluation risk*: 5% TAIWAN DOLLAR Spot Month Forecast 31.0 The TWD should appreciate further, as local stocks still look undervalued and should generate capital inflow. But the TWD will likely under-perform the region given its low yield. Economic growth has good momentum, with Q GDP growth up 5.3% pa and December industrial production up 10% pa. But exports have slowed recently and leading indicators such as the business climate index are pointing to economic growth peaking out soon. Core inflation picked up sharply in January but to only 1.4% pa. Rates are low as well and should rise in late March (to 2.37%). But the central bank should then go on hold. The main devaluation risk is an escalation of the consumer debt problem. Large devaluation risk*: 15% THAI BAHT Spot Month Forecast 38.0 GDP growth is now likely to accelerate to 5-6% pa in 2006, up from around 4.7% in 2005, but inflation (5.9% pa in January) still looks set to slow - we think to 4.5% by mid-year. The BoT hiked rates again in February (to 4.25%) but inflation peaking out probably means that the BoT won t need to hike much more. We expect 25bps hikes at the next two meetings (March 8 th, April 24 th ) but the BoT should then go on hold into The THB rally probably still has further upside but it will likely be limited with rates close to peaking out. In addition, a move back to monthly external deficits is likely soon as tourism receipts ease off. The baht is also vulnerable due to increased domestic political uncertainties. Large devaluation risk*: 10% INDIAN RUPEE Spot Month Forecast 42.8 The rupee has range-traded in the past few weeks, with continued strong equity market capital inflows being offset to some extent by the widening of the external deficit and the RBI s preference for broad currency stability. Nevertheless, we expect further appreciation, in line with Asian currencies more generally. Economic growth remains very strong and the government now expects GDP in FY05/06 (April-March) to climb around 8% pa, at the top end of India s sustainable growth rate for now, and up from FY04/05 s revised growth of 7.5% pa. Rates moved up as expected in January and look likely to climb at least another 50bps over the next 12 months to help keep inflation (currently 4.5%) under control. Large devaluation risk*: 10% American Express Bank Ltd. 6 EFI Currencies February 2006

7 AMERICAS CURRENCIES CANADIAN DOLLAR Spot Month Forecast 1.18 The CAD has stayed strong despite lower natural gas prices. We still believe that the CAD is peaking out and expect some slippage as the BoC stops hiking rates from mid-year and natural gas prices, probably, move lower still. Business sentiment rebounded in January, employment as well, and the government now expects GDP growth of 3.1% pa in 2006, above trend for Canada. This means that the BoC will likely hike rates 25bps a time at each of its next two meetings (March 7 th, April 25 th ) to 4% from 3.5% now. But this is already what markets expect and, we think, the BoC will then pause. For the CAD to rise further, markets need to price-in a more aggressive BoC this is possible but in our view unlikely. Large devaluation risk*: 15% ARGENTINE PESO Spot Month Forecast 3.10 We expect ARS depreciation as we doubt that the government s current strategy for controlling inflation through price controls will be successful. January inflation held at a high 12.1% pa despite agreements with major supermarkets to hold down the price of around 200 key items in the basket of goods used to calculate the consumer price index. Interest rates are drifting up, but are negative in real terms and, with the government focused on keeping GDP growth as high as possible, are likely to remain negative. But a sharp ARS depreciation looks unlikely. The external accounts should stay in surplus in 2006, IMF debt has been paid off, and Venezuela is helping to cover domestic financing needs. Large devaluation risk*: 15% BRAZILIAN REAL Spot Month Forecast 2.18 The BRL has climbed further, embarrassing our forecasts, with its recent surge coming on the back of a foreign currency debt buyback. The BRL should remain attractive as a yield play for a while, but we expect the currency to range-trade or slip a little rather than rise further towards Industrial output picked up in December, whilst January data brought continued strong exports and a pick-up in inflation. But export competitiveness is becoming a major issue, and SELIC rates still look set to fall 75bps at the next COPOM meeting (in March). We also remain more aggressive than the market in expecting rates to fall to 14% by end-2006 from 17.25% now (the market is at 15-16%). Large devaluation risk*: 10% MEXICAN PESO Spot Month Forecast The key issue for investors is gauging the level at which the yield pick-up is too low to compensate for the depreciation risk. We think the yield pick-up will narrow enough over the next 3 months for investors to become more cautious on the MXN, and expect sustained slippage. Inflation should stay under control, whilst GDP growth has been sluggish recently. Part of this results from hurricane Wilma disruption, but retail sales have been disappointing as well. The central bank cut rates by 50bps in January (to 7.75%) and rates should fall at least another 75bps over the next few months, with the next cut coming at their February 24 th meeting. In 3 months time, the MXN short end yield pick-up against the USD should have narrowed to around 225bps, from 325bps now. Large devaluation risk*: 5% American Express Bank Ltd. 7 EFI Currencies February 2006

8 EUROPE/AFRICA CURRENCIES per euro EURO Spot Month Forecast 1.28 Euro-zone Q GDP growth fell back to a lacklustre 1.2% pa but upbeat sentiment indicators point to a bounce-back in growth in Q Inflation picked up to 2.4% in January, partly energy-driven, but also due to temporary base effects, and should move back towards the 2% target; meanwhile core inflation has stayed low despite the rise in energy prices. But the ECB remains concerned about strong credit growth, especially into housing. With the economy growing broadly at trend and rates still below a neutral level the ECB will continue to tighten, taking rates up 25bps on 9 th March and, we expect, to 3% in 12 months. The euro should benefit, especially as US rates approach a near-term term peak. Large devaluation risk*: 10% UK POUND Spot Month Forecast 1.80 The economy has recovered from last summer s downturn, and the Bank of England s upward revision to its growth outlook for 2006 suggests that no rate cuts are likely over the next few months. But inflation is below-target, earnings growth is benign and retail sales are still weak so we still think another cut in rates is possible in the summer. Flat-to-lower UK interest rates while Euro-zone interest rates move higher should take sterling weaker vs the euro over the next 3-12 months. Sterling is likely to benefit from dollar weakness in coming months, but for most of H we expect sterling also to be weaker than current levels against the USD, as US rates move above UK rates. Large devaluation risk*: 10% SWISS FRANC Spot Month Forecast 1.20 Leading indicators point to the economy experiencing a broad-based recovery, with consumption, industry and services contributing to GDP growth picking up, probably to 2.1% this year after 1.9% in Consumer sentiment, which has lagged the export sector, has finally swung positive. Inflation of 1.3% in January is likely to rise further in February because of higher oil prices, though should fall back below 1% later in 2006 on base effects, assuming no further sharp rise in energy prices. But the SNB is aiming at restoring rates to a more normal level (next hike likely in March) and, we think, will tighten more than the ECB, taking the Swiss franc stronger against the euro and, near-term, also against the dollar. Large devaluation risk*: 10% HUNGARIAN FORINT Spot Month Forecast 197 Q4 GDP growth of 4.1% was below expectations but a bounce-back is expected in Q The central bank s Monetary Council is divided on whether there is room for further rate cuts. Recent inflation developments (inflation down to 2.7%, core inflation at 0.5%, its lowest ever level) favour lower interest rates. But the forint is still vulnerable to volatile market sentiment on the twin deficits, and we expect the NBH to stay on hold at its next meeting (27 th February) and in coming months. The external deficit is improving, but the fiscal deficit looks set to overshoot this year s target again, and could reach over 9% of GDP if new EU spending classifications are adopted. April s election is another uncertainty. But NBH caution on interest rates should prevent a sharp forint sell-off against the euro in coming months. Large devaluation risk*: 25% American Express Bank Ltd. 8 EFI Currencies February 2006

9 EUROPE CURRENCIES per euro POLISH ZLOTY Spot Month Forecast 2.93 Inflation of 0.7% is the lowest in the EU, and is expected to stay below the central bank s % target band until early This should allow rates to fall further, possibly as early as the February th meeting. But the NBP will act cautiously and rates should stay attractive relative to Euro-zone rates. The economy is strong (industrial production up over 9%), public spending is set to rise and, while wages are well-behaved for the moment, the NBP is on the alert for rising pressures over the medium term. Political tensions have calmed now that new elections look less likely, and the outlook for the economy should stay good, supporting a stronger zloty vs the euro over the next 3-12 months. Large devaluation risk*: 10% RUSSIAN ROUBLE Spot Month Forecast The authorities are targeting a gradual appreciation of the rouble in order to keep inflation under control in the face of high oil-revenuegenerated liquidity. The official inflation target for 2006 has already been revised up to 8-9% after a sharp rise in prices in January and early-february. The higher cut-off price for the oil stabilisation fund (raised from $20/barrel to $27/barrel at the beginning of the year) may also feed inflation. Official GDP growth forecasts have also been raised, to 6% (previously forecast to be 5.8%) on the back of higher oil prices. Barring an unexpected drop in oil prices the rouble should continue to strengthen in 2006, helped by the stronger euro that we expect against the US dollar. Large devaluation risk*: 10% TURKISH LIRA Spot Month Forecast 1.25 The central bank has intervened for the first time since November to push the lira weaker, but any further action looks likely to smooth rather than reverse the lira s ascent in coming months. Interest rates should fall again from the spring, but the yield carry will stay very attractive and the economy should continue to do well. Lira strength is a worry for exporters, and the current account deficit is too high. But a strong lira will help to keep inflation within the central bank s target (CPI reversed higher recently on buoyant growth, rising oil prices and unusually cold winter weather). The key risks remain a drop in global appetite for risk, policy/political concerns and/or a bird flu catastrophe. Large devaluation risk*: 25% SOUTH AFRICAN RAND Spot Month Forecast 5.70 There are concerns that the strong rand is hurting manufacturing competitiveness (PMI now down below the 50-expansion mark) and may jeopardise efforts to boost GDP growth to 6% pa over the medium term. But business and consumer confidence is upbeat, and the authorities recognise the benefits to inflation of a strong rand, so interest rates are unlikely to be cut sharply over the coming year. The peaking out of house prices may dampen the consumption boom, but income tax cuts announced in the budget should be supportive. The rand will stay volatile, with the key risks being a change in sentiment on emerging markets and on gold. But on balance we still expect the ZAR to trade firmer in coming months, with rates staying attractive, commodity prices holding up and on anticipated euro appreciation against the US dollar. Large devaluation risk*: 20% American Express Bank Ltd. 9 EFI Currencies February 2006