Saturday, November 27, 2010

USDJPY follows yields

US dollar: Macro data and Ireland crisis support dollar

EURCHF: Ireland, Portugal, etc.

USDJPY follows yields

US Dollar
From our point of view two drivers have been causing the US dollar to appreciate in the past weeks. Firstly, a number or relatively good economic indicators for October created some uncertainty with regard to the extent of the monetary easing in the future. After all, the slump of the US dollar that had started in mid-September was due to the anticipation of the additional monetary expansion. And the second reason for the appreciation of the dollar was the crisis relating to the Irish government debt as well as the costs involved in restructuring various Irish banks. Ireland has recently taken the decision to apply for support at the EU and the IMF. The volume and the details are currently subject to negotiations. On the political front, the situation in Ireland has been growing more acute and has come to constitute a factor of uncertainty.

But the euro is not likely to benefit much even from a successful outcome of the negotiations. In fact, the uncertainty might spill over to other weak debtors of the Eurozone. A sell-off of Portuguese bonds would push up the financing costs of the country even further; Portugal is already grappling with a budget deficit of 7% in terms of GDP. Should the European crisis be sorted out, the development of the US economy would still prevent the US dollar from sliding. The data should be good enough to keep the speculations about a trend reversal of the extremely expansive monetary policy alive. We stick to our forecast for next year and expect the euro to fall to USD 1.25. In view of the recent events, we have to revise our forecast for December of this year from EURUSD 1.43 to 1.36.

Swiss Franc
The EURCHF exchange rate is still under the spell of worries surrounding state finances of peripheral Eurozone countries. Even though a temporary relief set in when it was announced that Ireland could get international support (EFSF, IMF, UK, Sweden), the problems remain in focus. Markets are currently speculating about the extent of the support, if the package will include preventive financing for Ireland beyond support for the banking sector, and finally if Portugal will be the ‘next in line’. Overall, we think that government debt woes might not stay permanently in the spotlight, but that the theme will come up every now and then, undermining the confidence in the euro and thus leading to safe haven flows to the franc. Beyond the possibility of substantial departures of the exchange rate in both directions, we also think that renewed strengthening of the franc seems likely, in particular given the fact that, so far, the strengthening has been quite limited, given the news.

Japanese Yen
The rapid Treasury yield increase seen in the last two weeks has also lent support to the dollar vs. the yen, so that the USDJPY has almost reached 84 by now. In our opinion, US yields will be decisive in the future, too. In this respect, the release of the minutes of the November FOMC meeting – to be released today – that will include the Fed’s assessment of the future path of the economy (in particular, unemployment and inflation) will be of great interest, as the future path of interest rates (and thus yields) is strongly dependent on that. The upcoming labor market data as well might give a hint to what extent the Fed’s policy could be expansive in the future. In the case of a renewed decrease of US yields, yen strengthening seems likely.
Full report: USDJPY follows yields

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