The euro exchange rate should fall to 1.28 by year-end and lower in 2009

In Foreign Exchange Markets Yesterday in the New York morning, the US Dollar Exchange Rate broke out of the sideways range (of 1.3343 to 1.3538) from last Thursday. It sank under the previous intermediate low to 1.3286, crawled along sideways for the rest of the day, then put in another breakout move to a new low of 1.3205 so far this morning.

Foreign Exchange Analysts have come up with numerous explanations. The FT says "hedge funds were liquidating long positions in riskier assets funded by selling US dollars and returning to cash in anticipation of massive investor withdrawals." Also, according to the FT, the US dollar was supported by Bernanke’s support of a second fiscal stimulus, despite the hit to the deficit--foreign exchange traders like a pro-active stance instead of dithering. Bloomberg says Citibank analysts are encouraging euro sales on the grounds that the euro exchange rate is in for a perfect storm as the ECB cuts rates toward 2.5% on slowing growth. The euro exchange rate should fall to 1.28 by year-end and lower in 2009. Even the IMF is saying the ECB has room to cuts interest rates further (in association with its new lower growth forecast for the eurozone).

We say the Foreign Exchange market is not only buying dollars because US dollars are in authentic demand for transaction purposes, but also selling euros because of greater uncertainties in Europe than in the US. We simply do not know the extent of bad loans and investments. The ECB recently tightened colalteral rules but the suspicion runs high that the quality of European bank balance sheets (including stupid investments in toxic US paper) is lower than the quality of bank balance sheets in the US.

This reflects the bigger perspective that the US may have generated bad loans but then dumped them on unwitting foreigners.

This is somewhat parallel to selling Rockefeller Center to the Japanese.

This time the fear arises because today is settlement day for some Lehman CDS paper, an issue we don’t understand. Surely derivative paper comes nearly last on the recoverable list of a bankrupt entity and anyone holding it is screwed.

And interest rates do count, even if we don’t buy the argument that the ECB will stop being a one-note Johnny. In Australia, the Australian Dollar took a nosedive on release of the latest RBA minutes. This was the early Oct meeting at which the RBA decided to cut australian interest rates by 100 bp, and in the discussion, the policy committee determined that growth was getting so weak that inflation would subside faster than previously thought. The consensus is not that the RBA will cut aggressivley by another 50 bp and maybe 75 bp by year-end - wow.

(Pounds to australian Dollar exchange rate currently 2.5000. The Outlook for the Australian Dollar suggest that there may be further opportunities to buy australian dollars over 2.6000)

The Japanese Yen is quite confusing, having softened from the high last week under 100 to 102.42 early yesterday but now rising again to 100.73. We are talking about the Japanese yen exchange rate and not the dollars to yen exchange rate because the market is thinking about the yen as the bellwether for risk aversion/risk preference, and noting that it has been tightly linked to equities.

Really?

We say the relationship is sometimes very strong but lacks logic to forecast the yen based on what equities are doing.

It’s like forecasting the US dollar up because oil is down.

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Barbara Rockefeller
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