It’s been an exceptionally active year in the foreign exchange market as currency volatilities hit record highs. In the first half of the year, many traders 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 U.S. dollar actually surged to a two-year high. From trough to peak, the dollar index rose more than 23 percent in 2008.
3 Themes for 2009
The U.S. economy and the dollar’s fate in the years ahead could be determined by what happens in 2009. We are focusing on three big themes that may affect the U.S. dollar and each of these themes encompasses a lot.
1. Will there be a U or L Shaped Recovery?
The U.S. is in recession and most economists expect the slowdown 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 U.S. corporations forced to tighten their belts, the unemployment rate could reach 8 percent in 2009. 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, that would put the unemployment rate at least 7.8 percent by the end of 2009.
There’s also the possibility that non-farm payrolls could double dip, 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 and spending, typically leading to more layoffs. This toxic cycle must end before we can see a recovery.
Consumer spending has already been weak and, as the dollar strengthens, the trade deficit is widening. Because consumer spending and the trade deficit are the two primary drivers for the gross domestic product (GDP), we expect fourth quarter growth to be very weak. The dollar’s strength in Q3 and for most of Q4 will also take a big bite out of corporate earnings, likely leading to more stock declines. Given all these factors, we can probably expect more weakness in the U.S. dollar and the U.S. economy in the first quarter of 2009.
Towards the middle of the second quarter, however, we may begin to see the U.S. economy stabilize as it begins to reap the benefits of quantitative easing and President Barack Obama’s proposed fiscal stimulus plan. New administrations typically hit the ground running and, as such, we fully expect the rest of the Troubled Asset Relief Program (TARP) funds to be tapped shortly after his inauguration. The shape of the U.S. recovery will have a big impact on the price action of the U.S. dollar but there is little 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 U.S. economy to start its slow recovery in the second half of 2009, we’ll likely still see negative GDP growth. 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 an 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 safety flight into U.S. dollars and government bonds has kept the greenback from collapsing against other currencies like the British pound and 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 U.S. 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 U.S. dollar. Its performance against other currencies would be contingent upon growth in the rest of the world. For example, if the U.K. economy is in the process of recovering, demand for yield and the prospect of larger returns could send the GBP/USD higher, but a prolonged recession in the Eurozone could signal a drop in the EUR/USD.
3. Compression in Interest Rates and Volatility:
Volatility in the currency market also hit a record high in 2008, but we expect the volatility to compress as interest rates around the world converge in 2009. 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 see fewer 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 driver of market volatility and now that risk is off the table. When the monetary and fiscal stimulus start to affect the U.S. economy, the market may actually start talking about a rate hike in the U.S. 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?
With oil prices more than 75 percent off their highs, deflation is much more of a problem for the U.S. economy than inflation. We have seen either flat or negative consumer price growth every month between August and November. The December numbers have yet to be released, 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 U.S. 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
U.S. interest rates were slashed 400bp in 2008 from 4.25 percent to 0.25 percent. For most people, interest rates at 0.25 percent are as unattractive as zero interest rates. With U.S. 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 three 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 with the yen in 2001, quantitative easing exposes the U.S. dollar to significant downside risks because essentially the Fed is printing money to flood the market with liquidity, eroding the dollar’s value in the process. However, it’s likely a step that the central bank needs to take to stabilize the U.S. 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 as 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 U.S. dollar rallied significantly in the second half of 2008. Between June and November, the dollar index rose more than 25 percent. However, that rally hit a brick wall in the month of December, plunging 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 U.S. 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 U.S. Annualized GDP growth in the Eurozone during the third quarter was +0.6 percent, compared to -0.5 percent in the U.S.
However, the Eurozone’s outperformance in 2008 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, cutting 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 nations that still have 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 likelihood 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 cut interest rates at a time when the Fed and the Bank of England are done easing. If the Eurozone underperforms the U.S. 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 U.S. economy will 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 aggressively ease rates 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
A run on the U.S. dollar could also pose a major risk in 2009. The global slowdown has forced many central banks around the world to become internally focused, so that any excess money is spent on spurring domestic growth instead of funding the U.S. deficit. With next to zero yield, a deteriorating balance sheet and the risk of a weaker dollar eroding the notional value of any U.S. investments, foreign investors may have little incentive to load up on U.S. debt. Having been burned badly by investments in Fannie and Freddie Mac, sovereign wealth funds like China have become skeptical of buying more U.S. 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 two elections in Europe in next year — one for a new German chancellor 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, predicting an outcome is difficult. If it’s 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 elected 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 polls.
Technical Outlook for the EUR/USD
It’s likely no 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, falling to six-year low against the U.S. dollar and a record low against the Euro in addition to selling off against every other G10 currency. The pound’s overwhelming weakness directly reflects the impact of the credit crisis on the U.K. economy.
In December, while many currencies enjoyed a recovery against the U.S. dollar, the pound was left behind. Although this weakness could continue 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 U.K. economy is not technically in a recession. That should change in the first quarter of 2009, however, 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 U.K. for the past few years and both blew up in 2008.
Unfortunately the worst is probably not over, 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 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 forecasted 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, it won’t be before we see more pain in the U.K.’s economy. The U.K. recession’s severity 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 U.K., the annualized pace of consumer price growth is still well above the central bank’s 2 percent target and higher even than their 3 percent upper limit. According to the latest data (October 2008), consumer prices rose 4.1 percent year over year. Despite the high inflation, the central bank has seemingly abandoned their inflation target and shifted their focus back to growth. They believe that the slowdown in the economy will naturally drive inflation lower, perhaps falling back to 2 percent as early as the first quarter.
More Rate Cuts in First Half of 2009
Next to the Fed, the BOE has been the most aggressive central bank in 2008, cutting 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 BOE remains committed to doing all it can to prevent a recession from sparking deflation. BOE Governor Mervyn King believes that the economy will contract in 2009 and, given his pledge, U.K. interest rates could fall by another 100bp in the first half of the year. Although zero interest rates are not expected, rates will likely fall below 2 percent and, until the BOE is done easing, the pound may remain weak.
EUR/GBP at Parity
The pound’s sell-off in the first few months of the year could drive EUR/GBP to parity. It would be the first time that one euro would be worth the same or more than one pound and it couldn’t come at a better time than 2009 — when the Euro celebrates its 10-year anniversary. Over the past decade, the currency has risen from ashes to become more valuable than the world’s two primary reserve currencies. Although many Britons may be alarmed at the weakness of their exchange rate, the BOE will probably not step in to halt the fall. Instead, the BOE will revel in the stimulative effects of a weak currency. There already are reports of Eurozone citizens flocking to the U.K. for their holidays. The weakness of the pound against both the U.S. dollar and the euro are key ingredients for an economic recovery.
Keep an Eye Out for a Recovery
While the U.K. economy still faces many risks in 2009, there is hope. Consumer spending has been relatively resilient, with November retail sales rising for the first time in three months. If the global economy begins to recover, we expect the U.K. economy to outperform its peers thanks to the BOE’s proactive approach. The currency has sold off significantly, providing additional stimulus for the battered economy.
Even if there is no full-blown recovery, the U.K. 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 pound needs to recover against the euro. As for the U.S. dollar, the recovery could come sooner if the quantitative easing forces the greenback lower. When the U.K. 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, tumbling to a level not seen since 2002. The pair lost roughly 5,000 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 Simple Moving Average, 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 first standard deviation, it could experience a further downtrend. Although the pair is destined to retrace at some point this 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 as 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 and Australian and New Zealand dollars and hit a 13-year high against the U.S. dollar. Unlike other currencies, which may have seen wild swings throughout 2008, the yen showed consistent 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 nations 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 the country has reported trade deficits — an extremely rare occurrence. Toyota, the world’s largest carmaker, is the highest profile casualty of yen strength. The automaker reported their first loss 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 U.S. dollar has been disastrous for the automaker.
Toyota is 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 seven-year low as exports declined 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 on economic fundamentals. The outlook for Japan has been bleak for months now, yet risk appetite has driven the currency’s rally. If traders remain cautious about the global economy, the yen could still rise regardless of the state of the Japanese economy.
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. In November (the latest available data), 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 (BOJ) 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 BOJ didn’t take interest rates to zero to avoid killing the repo market or giving the public the perception that they have run out of ammunition. Looking ahead, we have probably seen the last of BOJ rate cuts. 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, carry trades were one of the most lucrative strategies in the currency market. However anyone long carry in 2008 was burned badly. For example, GBP/JPY fell 41 percent to a 13-year low, while NZD/JPY fell 39 percent to a seven-year low. Record volatility, massive deleveraging and global interest rate cuts created a toxic combination for carry trades. For carry trades to recover, central banks need to stop cutting interest rates, volatility must decline significantly and the global economy will have 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, many traders wonder whether the BOJ will physically intervene to weaken its currency. Unfortunately, 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 own currencies. Since the problem is not unique to Japan and stems from the West, the Japanese need to stand aside and allow the U.S. and Eurozone governments to work on spurring their own growth. Weakening their currency and strengthening the U.S. dollar for their own short-term relief could actually be counterproductive. However, 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 following USD/JPY weekly chart, the pair’s sell-off has been severe. Currently, the price is well below the 200-week and 50-week simple moving average and at a level not seen since 1995. This puts USD/JPY in the Bollinger Band sell zone and, even though a retracement could be imminent, it could be an opportunity to sell rallies then buy on dips. The closest level of support is at the 161.8% Fibonacci extension of a low established in late 2007 and the 2008 high at 86.50. Resistance is at 94, the 10-week simple moving average.
Canadian Dollar 2009 Forecast
How Did the Canadian Dollar Trade in 2008?
It is almost hard to believe that a little more than a year ago, one Canadian dollar was worth more than one U.S. 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 two-year low against the U.S. dollar, a nine-year low against the euro and an eight-year low against the Japanese yen. However CAD weakness was not universal. The British pound and New Zealand and Australian dollars all lost ground against the Loonie. Looking ahead, the odds are still skewed towards further losses for the Canadian dollar.
Canada: Recession Only Beginning
According to Statistics Canada, the Canadian economy slipped into recession in the beginning of the fourth quarter, compared to the U.S., which has been in a recession since December 2007. Canada’s lag behind the U.S. isn’t surprising because, up until this summer, soaring oil prices kept part of the Canadian economy well supported. However, much has changed since then, and now Canada is faced with the double-blow of slowing U.S. 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 U.S. We are only beginning to see the weakness manifested in consumer spending and the labor market. In October, retail sales contracted by 0.9 percent, the largest drop in eight months. 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 Jim Flaherty predicts that GDP will shrink by 0.4 percent next year, which is nominal compared to a 1 percent decline expected for the U.S. 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 three 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 western 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 U.S. counterparts. The automobile industry is in such bad shape that Prime Minister Stephen Harper recently announced a CAD$3.3 billion rescue plan for the U.S. automakers in Ontario. Roughly 70 percent of Canada’s trade is with the U.S., so as long as the U.S. 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, Canada is one of the few countries to report higher inflation. In November, core prices rose 0.7 percent, pushing the annualized pace of growth from 1.7 to 2.4 percent. Headline prices, which include 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 Loonie’s weakness contributed to a sharp rise in food prices, which rose 7.4 percent year over year, the fastest pace of growth in 22 years. From the October 1 to November 30, the Canadian dollar fell more than 20 percent against the U.S. 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 (BOC) has cut interest rates by 275bp to 1.5 percent, the lowest level since 1958. While they have been fairly aggressive, more cuts are 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, so 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 U.S. 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 U.S. growth aren’t enough of a burden, 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 two-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 received a lot of criticism in 2008 and there is a strong chance that more political infighting could force his minority government to fall. Harper has already suspended Parliament until the end of January 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 U.S. 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, triggering a reversal in the currency pair that took it back below 1.20. The pair is still trading well above the 50-week and 200-week simple moving averages 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. If it fails to break that level and instead falls below 1.20, then we could see a move to the Fibonacci support at 1.15.
Australian Dollar 2009 Forecast
How Did the Australian Dollar Trade in 2008?
In July of last year, the big story was whether the Australian dollar would reach parity with the U.S. dollar. At the time, the currency pair was trading at 0.9845 – a 20-year high. However, when commodity prices peaked in July the Australian dollar came crashing down. The currency fell nearly 40 percent against the U.S. dollar to a five-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 dropping close to 50 percent to a record low.
Will Australia Avoid Recession?
Unlike many other nations, Australia has —so far — avoided recession. 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 eight years. If fourth-quarter growth was negative, Australia may be at risk of falling into a recession for the first time in 17 years.
Avoiding an Australia recession may be difficult, 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 and Chinese demand have 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.
Weak Australian Dollar Will Lead to Upward Revisions for Corporate Earnings
The global economy is slowing but we still could see Australian corporations report improved earnings. Since the beginning of the year, the Australian dollar has fallen 25 percent against the U.S. 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 U.S. 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 increased their earnings expectations on the idea that a weak currency will boost foreign demand for their products. Stronger earnings will help to pull the country out of any recession and perhaps engineer the second half recovery that many economists are looking for.
Slowdown in China Will Hurt
A major slowdown in China could be bad news for Australia. China has been the engine of global growth for the past 10 years and that engine has begun to slow. For the past few years, China has enjoyed double-digit growth rates.In 2008, however, growth is expected to fall to 9.8 percent, while forecasts for 2009 put growth below 7 percent. China has not been immune to the global financial and credit crises 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 Chinese could become more conservative with their spending, which will undoubtedly have a negative impact on the Australian economy.
Inflation to Ease, But Not By Much
The third quarter of 2008 (the latest available data), reveals that the annualized pace of consumer 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 Reserve Bank of Australia (RBA) still expects inflation in the 12 months through June to be at 2.5 percent, which is well within the bank’s 2 to 3 percent inflation target.
Dramatic Rate Cuts to Come to an End
The RBA has been extremely aggressive in 2008, cutting 300bp in just four months. The last cut in December slashed interest rates by a full percent. According to the RBA, monetary policy is now “expansionary,” which suggests that they are almost done 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 in the second half of the year.
Technical Outlook for the AUD/USD
In the first half of 2008, the Australian dollar soared within a whisker of parity with the U.S. dollar. However as the prices of commodities plunged, so did the AUD/USD. After hitting a five-year low of 0.60 in October, the currency pair has quietly consolidated, finally rising out of the Bollinger Band sell zone in December. 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 simple moving average and the October/December high. The turn in AUD/USD remains intact as long as the pair remains above 65 cents.
New Zealand Dollar 2009 Forecast
How Did the New Zealand Dollar Trade in 2008?
In the first half of 2008, the Australian dollar soared within a whisker of parity with the U.S. dollar. However as the prices of commodities plunged, so did the AUD/USD. After hitting a five-year low of 0.60 in October, the currency pair has quietly consolidated, finally rising out of the Bollinger Band sell zone in December. 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 simple moving average and the October/December high. The turn in AUD/USD remains intact as long as the pair remains above 65 cents.
Will the Recession Come to an End in 2009?
New Zealand is a small 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 five-year high in Q3. This triggered a sharp contraction in consumer spending, with retail sales falling 1.3 percent in 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. Reserve Bank of New Zealand (RBNZ) Governor Dr. Alan Bollard is optimistic, believing the recession may already be over and fourth quarter growth could be positive. However, economists beg to differinstead expecting 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 central 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
In the third quarter (the latest available data), 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 central bank 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 RBNZ was very aggressive with easing monetary policy in 2008, cutting interest rates by 325bp since July. In fact, the last rate cut of 150bp was the largest ever. 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 may be true, but not before another 100 to 150bp cut. After the last cut in December, Bollard said that he believes rate cuts will end in the middle of next year. When the RBNZ signals that they‘re 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. The Australian economy must stabilize before we see any recovery in New Zealand. Demand has not increased, and the kiwi’s weakness has been boosting the cost of exports. The end result is a widening current account deficit. For any country, such a 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 five-year low against the U.S. dollar. It is now trading out of the sell zone which suggests that a turn may be in place. The pair will find it’s closest resistance at 0.6085 — the 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 sell-off. On the flip side, if the pair breaks the first standard deviation Bollinger Band on the downside at 0.5500, 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 U.S. dollar, which became the second-lowest yielding currency in March. The fact that the yen was the only currency to appreciate against the 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 higher-yield, higher-risk currencies into lower-yielding ones, which typically have less risk. This helps to explain the franc’s 25 percent appreciation against the British pound and 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 the coming year, 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 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, those sectors have been hit hard by the credit crisis. UBS, Switzerland’s largest bank has already reported 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 (SNB) President Jean-Pierre Roth predicted that 2009 will be a year of recession. The bank expects GDP growth to contract between 0.5 to 1 percent in 2009. The UBS Consumption indicator hit a three-and-a-half-year low in November while the KOF leading indicators report fell to a five-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, often moving instead on the market’s risk appetite.
Inflation: Big Nose Dive Expected to Continue
Inflation is declining rapidly in Switzerland. November’s CPI figures (the latest available data) showed that inflation recorded the largest drop in 15 years. On a monthly basis, CPI declined by 0.7 percent, dragging the annualized pace of CPI growth 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 U.S. dollar limited the impact of foreign exchange fluctuation on price pressures. Falling oil prices therefore drove inflation lower, but such 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 increase the SNB’s flexibility to leave monetary policy easy.
Zero Interest Rates for Switzerland?
The SNB has been full of surprises this year, delivering a series of intermeeting rate cuts that took interest rates to the lowest level in four years. In just two months, the SNB cut interest rates by 225bp to 0.5 percent and, after their December rate cut, the bank suggested that they are open to taking interest rates to zero. The global economic slowdown has taken a big toll on Swiss economy and if economic conditions worsen, the SNB is ready to take further action if needed.
With interest rates at ultra low levels, the SNB may need to consider unconventional options like quantitative easing. Of course they would not be alone, as it is a road that the Fed and the BOJ have already taken. There is also talk of currency intervention, but we do not think that it is likely. The SNB has been highly 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, 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 economic outlook.
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 pair reversed violently, trading back within our Bollinger Band sell zone and resuming its downtrend. As long as the pair holds below 1.51 (the latest rally’s 50 percent Fibonacci retracement), we could see a further move back toward the October low — 1.4725. If the 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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2009 Currency Market Outlook
Last Updated 1/12/2009 2:08:32 PM EST (GMT +5)
US Dollar 2009 Forecast
How Did the Dollar Trade in 2008?
It’s been an exceptionally active year in the foreign exchange market as currency volatilities hit record highs. In the first half of the year, many traders 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 U.S. dollar actually surged to a two-year high. From trough to peak, the dollar index rose more than 23 percent in 2008.
3 Themes for 2009
The U.S. economy and the dollar’s fate in the years ahead could be determined by what happens in 2009. We are focusing on three big themes that may affect the U.S. dollar and each of these themes encompasses a lot.
1. Will there be a U or L Shaped Recovery?
The U.S. is in recession and most economists expect the slowdown 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 U.S. corporations forced to tighten their belts, the unemployment rate could reach 8 percent in 2009. 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, that would put the unemployment rate at least 7.8 percent by the end of 2009.
There’s also the possibility that non-farm payrolls could double dip, 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 and spending, typically leading to more layoffs. This toxic cycle must end before we can see a recovery.
Consumer spending has already been weak and, as the dollar strengthens, the trade deficit is widening. Because consumer spending and the trade deficit are the two primary drivers for the gross domestic product (GDP), we expect fourth quarter growth to be very weak. The dollar’s strength in Q3 and for most of Q4 will also take a big bite out of corporate earnings, likely leading to more stock declines. Given all these factors, we can probably expect more weakness in the U.S. dollar and the U.S. economy in the first quarter of 2009.
Towards the middle of the second quarter, however, we may begin to see the U.S. economy stabilize as it begins to reap the benefits of quantitative easing and President Barack Obama’s proposed fiscal stimulus plan. New administrations typically hit the ground running and, as such, we fully expect the rest of the Troubled Asset Relief Program (TARP) funds to be tapped shortly after his inauguration. The shape of the U.S. recovery will have a big impact on the price action of the U.S. dollar but there is little 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 U.S. economy to start its slow recovery in the second half of 2009, we’ll likely still see negative GDP growth. 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 an 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 safety flight into U.S. dollars and government bonds has kept the greenback from collapsing against other currencies like the British pound and 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 U.S. 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 U.S. dollar. Its performance against other currencies would be contingent upon growth in the rest of the world. For example, if the U.K. economy is in the process of recovering, demand for yield and the prospect of larger returns could send the GBP/USD higher, but a prolonged recession in the Eurozone could signal a drop in the EUR/USD.
3. Compression in Interest Rates and Volatility:
Volatility in the currency market also hit a record high in 2008, but we expect the volatility to compress as interest rates around the world converge in 2009. 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 see fewer 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 driver of market volatility and now that risk is off the table. When the monetary and fiscal stimulus start to affect the U.S. economy, the market may actually start talking about a rate hike in the U.S. 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?
With oil prices more than 75 percent off their highs, deflation is much more of a problem for the U.S. economy than inflation. We have seen either flat or negative consumer price growth every month between August and November. The December numbers have yet to be released, 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 U.S. 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
U.S. interest rates were slashed 400bp in 2008 from 4.25 percent to 0.25 percent. For most people, interest rates at 0.25 percent are as unattractive as zero interest rates. With U.S. 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 three 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 with the yen in 2001, quantitative easing exposes the U.S. dollar to significant downside risks because essentially the Fed is printing money to flood the market with liquidity, eroding the dollar’s value in the process. However, it’s likely a step that the central bank needs to take to stabilize the U.S. 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 as 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 U.S. dollar rallied significantly in the second half of 2008. Between June and November, the dollar index rose more than 25 percent. However, that rally hit a brick wall in the month of December, plunging 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 U.S. 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 U.S. Annualized GDP growth in the Eurozone during the third quarter was +0.6 percent, compared to -0.5 percent in the U.S.
However, the Eurozone’s outperformance in 2008 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, cutting 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 nations that still have 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 likelihood 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 cut interest rates at a time when the Fed and the Bank of England are done easing. If the Eurozone underperforms the U.S. 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 U.S. economy will 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 aggressively ease rates 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
A run on the U.S. dollar could also pose a major risk in 2009. The global slowdown has forced many central banks around the world to become internally focused, so that any excess money is spent on spurring domestic growth instead of funding the U.S. deficit. With next to zero yield, a deteriorating balance sheet and the risk of a weaker dollar eroding the notional value of any U.S. investments, foreign investors may have little incentive to load up on U.S. debt. Having been burned badly by investments in Fannie and Freddie Mac, sovereign wealth funds like China have become skeptical of buying more U.S. 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 two elections in Europe in next year — one for a new German chancellor 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, predicting an outcome is difficult. If it’s 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 elected 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 polls.
Technical Outlook for the EUR/USD
It’s likely no 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, falling to six-year low against the U.S. dollar and a record low against the Euro in addition to selling off against every other G10 currency. The pound’s overwhelming weakness directly reflects the impact of the credit crisis on the U.K. economy.
In December, while many currencies enjoyed a recovery against the U.S. dollar, the pound was left behind. Although this weakness could continue 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 U.K. economy is not technically in a recession. That should change in the first quarter of 2009, however, 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 U.K. for the past few years and both blew up in 2008.
Unfortunately the worst is probably not over, 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 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 forecasted 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, it won’t be before we see more pain in the U.K.’s economy. The U.K. recession’s severity 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 U.K., the annualized pace of consumer price growth is still well above the central bank’s 2 percent target and higher even than their 3 percent upper limit. According to the latest data (October 2008), consumer prices rose 4.1 percent year over year. Despite the high inflation, the central bank has seemingly abandoned their inflation target and shifted their focus back to growth. They believe that the slowdown in the economy will naturally drive inflation lower, perhaps falling back to 2 percent as early as the first quarter.
More Rate Cuts in First Half of 2009
Next to the Fed, the BOE has been the most aggressive central bank in 2008, cutting 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 BOE remains committed to doing all it can to prevent a recession from sparking deflation. BOE Governor Mervyn King believes that the economy will contract in 2009 and, given his pledge, U.K. interest rates could fall by another 100bp in the first half of the year. Although zero interest rates are not expected, rates will likely fall below 2 percent and, until the BOE is done easing, the pound may remain weak.
EUR/GBP at Parity
The pound’s sell-off in the first few months of the year could drive EUR/GBP to parity. It would be the first time that one euro would be worth the same or more than one pound and it couldn’t come at a better time than 2009 — when the Euro celebrates its 10-year anniversary. Over the past decade, the currency has risen from ashes to become more valuable than the world’s two primary reserve currencies. Although many Britons may be alarmed at the weakness of their exchange rate, the BOE will probably not step in to halt the fall. Instead, the BOE will revel in the stimulative effects of a weak currency. There already are reports of Eurozone citizens flocking to the U.K. for their holidays. The weakness of the pound against both the U.S. dollar and the euro are key ingredients for an economic recovery.
Keep an Eye Out for a Recovery
While the U.K. economy still faces many risks in 2009, there is hope. Consumer spending has been relatively resilient, with November retail sales rising for the first time in three months. If the global economy begins to recover, we expect the U.K. economy to outperform its peers thanks to the BOE’s proactive approach. The currency has sold off significantly, providing additional stimulus for the battered economy.
Even if there is no full-blown recovery, the U.K. 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 pound needs to recover against the euro. As for the U.S. dollar, the recovery could come sooner if the quantitative easing forces the greenback lower. When the U.K. 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, tumbling to a level not seen since 2002. The pair lost roughly 5,000 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 Simple Moving Average, 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 first standard deviation, it could experience a further downtrend. Although the pair is destined to retrace at some point this 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 as 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 and Australian and New Zealand dollars and hit a 13-year high against the U.S. dollar. Unlike other currencies, which may have seen wild swings throughout 2008, the yen showed consistent 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 nations 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 the country has reported trade deficits — an extremely rare occurrence. Toyota, the world’s largest carmaker, is the highest profile casualty of yen strength. The automaker reported their first loss 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 U.S. dollar has been disastrous for the automaker.
Toyota is 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 seven-year low as exports declined 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 on economic fundamentals. The outlook for Japan has been bleak for months now, yet risk appetite has driven the currency’s rally. If traders remain cautious about the global economy, the yen could still rise regardless of the state of the Japanese economy.
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. In November (the latest available data), 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 (BOJ) 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 BOJ didn’t take interest rates to zero to avoid killing the repo market or giving the public the perception that they have run out of ammunition. Looking ahead, we have probably seen the last of BOJ rate cuts. 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, carry trades were one of the most lucrative strategies in the currency market. However anyone long carry in 2008 was burned badly. For example, GBP/JPY fell 41 percent to a 13-year low, while NZD/JPY fell 39 percent to a seven-year low. Record volatility, massive deleveraging and global interest rate cuts created a toxic combination for carry trades. For carry trades to recover, central banks need to stop cutting interest rates, volatility must decline significantly and the global economy will have 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, many traders wonder whether the BOJ will physically intervene to weaken its currency. Unfortunately, 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 own currencies. Since the problem is not unique to Japan and stems from the West, the Japanese need to stand aside and allow the U.S. and Eurozone governments to work on spurring their own growth. Weakening their currency and strengthening the U.S. dollar for their own short-term relief could actually be counterproductive. However, 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 following USD/JPY weekly chart, the pair’s sell-off has been severe. Currently, the price is well below the 200-week and 50-week simple moving average and at a level not seen since 1995. This puts USD/JPY in the Bollinger Band sell zone and, even though a retracement could be imminent, it could be an opportunity to sell rallies then buy on dips. The closest level of support is at the 161.8% Fibonacci extension of a low established in late 2007 and the 2008 high at 86.50. Resistance is at 94, the 10-week simple moving average.
Canadian Dollar 2009 Forecast
How Did the Canadian Dollar Trade in 2008?
It is almost hard to believe that a little more than a year ago, one Canadian dollar was worth more than one U.S. 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 two-year low against the U.S. dollar, a nine-year low against the euro and an eight-year low against the Japanese yen. However CAD weakness was not universal. The British pound and New Zealand and Australian dollars all lost ground against the Loonie. Looking ahead, the odds are still skewed towards further losses for the Canadian dollar.
Canada: Recession Only Beginning
According to Statistics Canada, the Canadian economy slipped into recession in the beginning of the fourth quarter, compared to the U.S., which has been in a recession since December 2007. Canada’s lag behind the U.S. isn’t surprising because, up until this summer, soaring oil prices kept part of the Canadian economy well supported. However, much has changed since then, and now Canada is faced with the double-blow of slowing U.S. 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 U.S. We are only beginning to see the weakness manifested in consumer spending and the labor market. In October, retail sales contracted by 0.9 percent, the largest drop in eight months. 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 Jim Flaherty predicts that GDP will shrink by 0.4 percent next year, which is nominal compared to a 1 percent decline expected for the U.S. 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 three 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 western 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 U.S. counterparts. The automobile industry is in such bad shape that Prime Minister Stephen Harper recently announced a CAD$3.3 billion rescue plan for the U.S. automakers in Ontario. Roughly 70 percent of Canada’s trade is with the U.S., so as long as the U.S. 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, Canada is one of the few countries to report higher inflation. In November, core prices rose 0.7 percent, pushing the annualized pace of growth from 1.7 to 2.4 percent. Headline prices, which include 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 Loonie’s weakness contributed to a sharp rise in food prices, which rose 7.4 percent year over year, the fastest pace of growth in 22 years. From the October 1 to November 30, the Canadian dollar fell more than 20 percent against the U.S. 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 (BOC) has cut interest rates by 275bp to 1.5 percent, the lowest level since 1958. While they have been fairly aggressive, more cuts are 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, so 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 U.S. 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 U.S. growth aren’t enough of a burden, 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 two-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 received a lot of criticism in 2008 and there is a strong chance that more political infighting could force his minority government to fall. Harper has already suspended Parliament until the end of January 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 U.S. 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, triggering a reversal in the currency pair that took it back below 1.20. The pair is still trading well above the 50-week and 200-week simple moving averages 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. If it fails to break that level and instead falls below 1.20, then we could see a move to the Fibonacci support at 1.15.
Australian Dollar 2009 Forecast
How Did the Australian Dollar Trade in 2008?
In July of last year, the big story was whether the Australian dollar would reach parity with the U.S. dollar. At the time, the currency pair was trading at 0.9845 – a 20-year high. However, when commodity prices peaked in July the Australian dollar came crashing down. The currency fell nearly 40 percent against the U.S. dollar to a five-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 dropping close to 50 percent to a record low.
Will Australia Avoid Recession?
Unlike many other nations, Australia has —so far — avoided recession. 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 eight years. If fourth-quarter growth was negative, Australia may be at risk of falling into a recession for the first time in 17 years.
Avoiding an Australia recession may be difficult, 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 and Chinese demand have 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.
Weak Australian Dollar Will Lead to Upward Revisions for Corporate Earnings
The global economy is slowing but we still could see Australian corporations report improved earnings. Since the beginning of the year, the Australian dollar has fallen 25 percent against the U.S. 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 U.S. 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 increased their earnings expectations on the idea that a weak currency will boost foreign demand for their products. Stronger earnings will help to pull the country out of any recession and perhaps engineer the second half recovery that many economists are looking for.
Slowdown in China Will Hurt
A major slowdown in China could be bad news for Australia. China has been the engine of global growth for the past 10 years and that engine has begun to slow. For the past few years, China has enjoyed double-digit growth rates.In 2008, however, growth is expected to fall to 9.8 percent, while forecasts for 2009 put growth below 7 percent. China has not been immune to the global financial and credit crises 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 Chinese could become more conservative with their spending, which will undoubtedly have a negative impact on the Australian economy.
Inflation to Ease, But Not By Much
The third quarter of 2008 (the latest available data), reveals that the annualized pace of consumer 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 Reserve Bank of Australia (RBA) still expects inflation in the 12 months through June to be at 2.5 percent, which is well within the bank’s 2 to 3 percent inflation target.
Dramatic Rate Cuts to Come to an End
The RBA has been extremely aggressive in 2008, cutting 300bp in just four months. The last cut in December slashed interest rates by a full percent. According to the RBA, monetary policy is now “expansionary,” which suggests that they are almost done 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 in the second half of the year.
Technical Outlook for the AUD/USD
In the first half of 2008, the Australian dollar soared within a whisker of parity with the U.S. dollar. However as the prices of commodities plunged, so did the AUD/USD. After hitting a five-year low of 0.60 in October, the currency pair has quietly consolidated, finally rising out of the Bollinger Band sell zone in December. 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 simple moving average and the October/December high. The turn in AUD/USD remains intact as long as the pair remains above 65 cents.
New Zealand Dollar 2009 Forecast
How Did the New Zealand Dollar Trade in 2008?
In the first half of 2008, the Australian dollar soared within a whisker of parity with the U.S. dollar. However as the prices of commodities plunged, so did the AUD/USD. After hitting a five-year low of 0.60 in October, the currency pair has quietly consolidated, finally rising out of the Bollinger Band sell zone in December. 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 simple moving average and the October/December high. The turn in AUD/USD remains intact as long as the pair remains above 65 cents.
Will the Recession Come to an End in 2009?
New Zealand is a small 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 five-year high in Q3. This triggered a sharp contraction in consumer spending, with retail sales falling 1.3 percent in 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. Reserve Bank of New Zealand (RBNZ) Governor Dr. Alan Bollard is optimistic, believing the recession may already be over and fourth quarter growth could be positive. However, economists beg to differinstead expecting 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 central 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
In the third quarter (the latest available data), 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 central bank 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 RBNZ was very aggressive with easing monetary policy in 2008, cutting interest rates by 325bp since July. In fact, the last rate cut of 150bp was the largest ever. 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 may be true, but not before another 100 to 150bp cut. After the last cut in December, Bollard said that he believes rate cuts will end in the middle of next year. When the RBNZ signals that they‘re 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. The Australian economy must stabilize before we see any recovery in New Zealand. Demand has not increased, and the kiwi’s weakness has been boosting the cost of exports. The end result is a widening current account deficit. For any country, such a 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 five-year low against the U.S. dollar. It is now trading out of the sell zone which suggests that a turn may be in place. The pair will find it’s closest resistance at 0.6085 — the 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 sell-off. On the flip side, if the pair breaks the first standard deviation Bollinger Band on the downside at 0.5500, 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 U.S. dollar, which became the second-lowest yielding currency in March. The fact that the yen was the only currency to appreciate against the 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 higher-yield, higher-risk currencies into lower-yielding ones, which typically have less risk. This helps to explain the franc’s 25 percent appreciation against the British pound and 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 the coming year, 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 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, those sectors have been hit hard by the credit crisis. UBS, Switzerland’s largest bank has already reported 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 (SNB) President Jean-Pierre Roth predicted that 2009 will be a year of recession. The bank expects GDP growth to contract between 0.5 to 1 percent in 2009. The UBS Consumption indicator hit a three-and-a-half-year low in November while the KOF leading indicators report fell to a five-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, often moving instead on the market’s risk appetite.
Inflation: Big Nose Dive Expected to Continue
Inflation is declining rapidly in Switzerland. November’s CPI figures (the latest available data) showed that inflation recorded the largest drop in 15 years. On a monthly basis, CPI declined by 0.7 percent, dragging the annualized pace of CPI growth 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 U.S. dollar limited the impact of foreign exchange fluctuation on price pressures. Falling oil prices therefore drove inflation lower, but such 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 increase the SNB’s flexibility to leave monetary policy easy.
Zero Interest Rates for Switzerland?
The SNB has been full of surprises this year, delivering a series of intermeeting rate cuts that took interest rates to the lowest level in four years. In just two months, the SNB cut interest rates by 225bp to 0.5 percent and, after their December rate cut, the bank suggested that they are open to taking interest rates to zero. The global economic slowdown has taken a big toll on Swiss economy and if economic conditions worsen, the SNB is ready to take further action if needed.
With interest rates at ultra low levels, the SNB may need to consider unconventional options like quantitative easing. Of course they would not be alone, as it is a road that the Fed and the BOJ have already taken. There is also talk of currency intervention, but we do not think that it is likely. The SNB has been highly 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, 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 economic outlook.
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 pair reversed violently, trading back within our Bollinger Band sell zone and resuming its downtrend. As long as the pair holds below 1.51 (the latest rally’s 50 percent Fibonacci retracement), we could see a further move back toward the October low — 1.4725. If the 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 >>