Emerging market currencies still look attractive, according to currency analysts,
but many of the majors may have already made their runs vs. the U.S. dollar.
That news drove financial-market volatility levels sky high, especially in mid-August and in November. Forex traders dumped carry trade positions as volatility peaked, but shifted back into these higher-risk trades when it decreased. Despite proclamations that the carry trade was dead, traders will most likely continue using the strategy in 2008, especially if volatility moves lower.
The Brazilian real (BRL) remained smoking hot in 2007, as bullish interest-rate differentials attracted carry trade money from around the globe (Figure 2). The real chalked up gains around 18.75 percent vs. the U.S. dollar (all data as of Dec. 19.)
The 2008 playing field
In speaking to a variety of forex market strategists, several key themes emerged.
Bryson’s research team at Wachovia is not calling for a recession globally or in the U.S.
Nonetheless, “the risk over the next two quarters for the U.S. is not insignificant,” he says.
Emerging market stars
Watch the BRICs
Rate differentials are always key
Wachovia’s Bryson agrees the outlook is bright for Asian currencies.
“The governments have an interest in having their currencies appreciate,” he says. “Economic fundamentals and politics point in that direction.”
Asian currencies also are poised to benefit from an unsteady dollar.
“There is the expectation the dollar will remain broadly weak, and the Asian currencies will bear the burden of adjustment,” Buskas says. She says “top tier” Asian currencies, from countries such as Japan, Malaysia, and Thailand, are those likely to see the most upward adjustment.
Noticeably absent from the potential winners list are any of the major currencies. Buskas sees limited upside potential for currencies such as the Canadian dollar, British pound, and euro.
“These currencies have had their rallies,” she says. “They’ve had their day in the sun.”
Is the dollar bear being tamed?
“The big theme of the year could be the reversal of the U.S. dollar cycle,” says Vassili Serebriakov, senior analyst at 4Cast Inc. “The dollar has been in decline since 2002 and we could see a big reversal in that trend.”
Standard & Poor’s Wyss is forecasting three more quarter-point cuts in the fed funds rate, with a bottom at 3.50 percent in mid-2008.
“That means the dollar will continue to decline until the Fed stops loosening or the ECB starts loosening,” he says.
Wyss and others expect the European Central Bank to pull the trigger on a rate cut possibly in June, with another potential rate cut towards the end of the third quarter. The European
repo rate currently stands at 4.00 percent.
In the early part of 2008, most strategists expect continued U.S. dollar softness as the weak economic picture unfolds, with potential for a reversal around mid-year.
“This time last year we were thinking the downturn in housing would be shallow,” Buskas says. But there’s still a long way to go for the U.S. before it gets back on its feet.” Nonetheless, some argue the bear is, perhaps, being tamed.
“I think the major move in terms of the dollar has already happened,” says Kathleen Stephansen, director of global economic research at Credit Suisse. “I don’t think we will see that same type of weakness. The rate of depreciation will be slower.”
A euro top
Several strategists forecast near- to medium-term strength in the euro/dollar pair to around 1.55, with the euro stalling and reversing around that level (Figure 5).
Serebriakov forecasts a three-month target of 1.55, a six-month target of 1.50, and a 12-month target of 1.40.
Jamie Coleman, managing editor at Thomson FXHub.com, was much more optimistic on the prospects for the greenback in early 2008.
“I think we will see a reversal of what we saw in 2007,” he says. “The sub-prime crisis/credit crunch will ultimately impact Europe more severely than the market realizes now. If you look at their housing situation, there is anecdotal evidence there are more new houses for sale in Spain than there are in the U.S. There are 40 million Spaniards and 300 million Americans.
“I think the dollar will do better. It is no longer a one-way street. I think the dollar will be one of
the biggest winners as we see a big reversal of the weak dollar trend, which will come primarily vs. the euro and British pound. The fear of wholesale liquidation of the dollar has all but died.”
Coleman forecasts a dollar-bullish 1.37 euro/dollar price at the end of first quarter.
“We’ve been tested and we’ve seen the worst,” he says.
Many currency watchers have turned sour on the prospects for the British pound in the wake of the sterling’s historic rally above the $2.00 mark in 2007. The last quarter of 2007 was disastrous for the pound, as the currency fell precipitously vs. the greenback (Figure 6).
But many say the sell-off is just beginning, arguing the UK economy is very exposed to global housing and credit stress and the potential exists for rate cuts from the Bank of England.
Brian Dolan, chief currency strategist at Forex.com, says the pound is one of this year’s potential big losers.
“They are facing a housing bubble,” he says. “The strength from the UK economy over the last decade has come from the financial sector and the housing sector. Now, both sectors are under pressure.”
Dolan sees the pound continuing to retreat toward 1.90-1.80 in the year ahead.
Many ifs remain
“There is a lot that depends on global themes and how fast the credit market returns to normal,” 4Cast’s Serebriakov says. “That is the biggest risk going forward, and I don’t think anyone can give you a confident estimate of when that will happen.”
Forex.com’s Dolan adds, “this is definitely one of the most uncertain environments at the start of a year that we’ve seen in many years, and that makes long-term forecasting very difficult.”
BY CURRENCY TRADER STAFF
- Outlook 2008: Avoiding the "R" word
- Fistful of Dollar, a bundle of contradiction
- Dollar Fate: Dustbin of History or Cynical Recovery?
- Riding The Yet Roller Coster