Currencies | Sep 15 2011
– Global demand for US dollars rising
– Occurs when US enters or threatens to enter a recession
– CBA adjusts currency shorter-term forecasts accordingly
– Bank retains the view the US dollar will be weak over much of next two years
By Chris Shaw
One consequence of the currently escalating eurozone sovereign debt crisis and the rising threat of a US recession according to Commonwealth Bank is global demand for US dollars is increasing.
This is because the US currency tends to rise whenever the US enters or threatens to enter a recession, as funding demand for the greenback rises as risk-averse market participants match out US dollar exposures.
As the US dollar is the world's most widely used currency, CBA chief currency analyst Richard Grace notes a small percentage lift in US dollar funding demand tends to generate a significantly large impact on global currency markets.
Another factor is some in the market anticipate the effects of a US recession being worse for other economies, which prompts an adjustment in currency pricing as non-US bond yields fall relative to US yields.
As well, Grace points out US residents tend to repatriate capital when the threat of a US recession increases. As US money market mutual funds can now receive interest in the deposits placed in US commercial banks, Grace suggests in the current environment the demand for US dollars is particularly strong.
To reflect the changed environment and a number of local and global factors Grace has adjusted near-term US dollar forecasts, which means a revising down of near-term estimates for the euro, British pound, Swiss franc and the Australian, New Zealand and Canadian dollars.
There is no change to Grace's view the US dollar will be weak over the best part of the next two years, so the changes to estimates are to allow for some temporary strength in the greenback through to the end of this year.
By early in 2012 Grace expects it will become clear the US has narrowly avoided going into a recession and there should be some resolution to the eurozone's sovereign debt issues, which should mean a subsiding of the current demand for the US currency.
For the Australian and New Zealand dollars, Grace notes softer global growth expectations are also likely to act as a headwind in coming months. As an example, Grace points out the International Monetary Fund is expected to revise down global growth forecasts to 4.0% for both 2011 and 2012, from 4.3 and 4.5% respectively.
While the impact of this change on the Australasian currencies should be somewhat muted given most of the growth revision is from outside the non-Japan Asian region, there will still be some impact. Having previous forecast a year-end rate for the Australian dollar against the greenback of US$1.09, Grace is now forecasting a rate of US$1.04. Estimates have also been trimmed slightly through the September quarter of next year, though there is no change to the December quarter of 2012 forecast of a rate of US$1.08.
It is a similar story for the New Zealand dollar, Grace now forecasting December quarter rates of US$0.82 this year and US$0.84 in 2012, down from previous estimates of US$0.86 for both periods.
Given the ongoing sovereign debt issues in Europe, softer eurozone growth, a widening in the EUR three-month basis spread and narrowing in the two-year bond spread, Grace has cut his euro forecasts. For the December quarter this year his estimate falls to US$1.39 from US$1.48, while estimates have been trimmed in all quarters next year. For the December quarter of 2012 Grace now expects a rate of US$1.43, down from US$1.47 previously.
Similar changes have been made to Grace's forecasts for the British pound, his December quarter estimate this year now standing at US$1.60, down from US$1.68, while for the same quarter of 2012 he now forecasts a rate of US$1.62 against US$1.69 previously.
A slowdown in both the Canadian economy and global growth expectations and a more dovish approach from the Bank of Canada sees Grace cut his Canadian dollar estimates. He now expects parity against the greenback for the December quarter this year against a rate of CAD$0.96 previously and a rate of CAD$0.98 for the same quarter next year against CAD$0.97 previously.
With the Swiss National Bank intervening in currency markets Grace has adjusted estimates for the franc as well, now forecast a rate of CHF0.8650 against the US dollar for the final quarter of 2011 and CHF0.8500 for the final quarter of 2012. This compares to previous estimates of CHF0.7400 and CHF0.7200 respectively.
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