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Forex Forecasts Revised as Fears of a Global Recession Loom

Monday, 17 November 2008 11:44:52 GMT  |  David Song, Currency Analyst

We revised our FX forecasts on 24 October – in between our regular forecast updates. Most notably, we raised all our short-term USD forecasts and pencilled in more JPY and CHF strengthening, along with more SEK and NOK short-term weakness. As risk sentiment was deteriorating sharply and no obvious triggers for this to end were in sight, we found it likely that things could worsen further.

Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank

Weekly Bank Research Center 11-17-08

 

Cutting Forecasts Further

Stephen Roach, Head Economist, Morgan Stanley

Only one month since we last lowered our estimates for growth, inflation and interest rates, we are cutting our numbers again substantially. While we had been looking previously for a technical recession in the euro area, we now believe that a full-blown recession that will at least be on par with the one in the early 1990s is the most likely scenario for the coming quarters. As a result, we are cutting our 2009 GDP forecast from 0.2% to -0.7% – the same rate of contraction registered in 1993. If confirmed by official data, this would make 2009 the worst year in terms of economic performance since the early 1980s. Along with a slight downgrade to our estimates for this year, we are again cutting our forecasts over the 2008/09 horizon by a full percentage point. Further, we now think that the recovery is unlikely to materialise before the middle of next year. As a result, our first stab at 2010 GDP growth, which we are also rolling out for the first time today, yields a disappointing 1.1%. Falling oil prices, at least in the near term, and easing lower core inflation rates bring our inflation forecast profile down to around 2% next year and thus broadly in line with the ECB definition of price stability. As result, we are looking for further significant monetary policy easing by the ECB in the coming months. Our new refi rate target is 2%, one percentage point lower than before.

 

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Time for Change? Not Yet?

Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank

We revised our FX forecasts on 24 October – in between our regular forecast updates. Most notably, we raised all our short-term USD forecasts and pencilled in more JPY and CHF strengthening, along with more SEK and NOK short-term weakness. As risk sentiment was deteriorating sharply and no obvious triggers for this to end were in sight, we found it likely that things could worsen further. The rapid rise in risk aversion has stopped – albeit at a high level – and the immediate drivers for further JPY and CHF appreciation have thus faded. Unfortunately, we called off our predicted rise in EUR/GBP too early, as we – in line with most other forecasters – underestimated the amount of negative news already priced into the pound at a time when sterling-denominated assets were heavily sold off. We remain guided by the dual themes of a financial crisis and a global recession. Recent data has further confirmed the outlook of the global economy falling into recession, and we do not expect global activity to begin expanding until H209. Key data will continue to be depressed and both household and business conditions are likely to worsen further, as access to credit has been severely tightened. Demand for a fiscal stimulus is increasing, but the implications for fiscal sustainability remain unclear. We do not see a significant bettering of financial conditions before well into 2009, and it is still too early to dismiss the possibility of a new wave of financial distress. Accordingly, we still see support to the counter-cyclical currencies CHF, JPY and USD – especially in the short term. However, given the reduced systemic risk since our last forecast update, we have opted to pencil in less CHF and JPY strength, implying higher USD/JPY and EUR/CHF forecast profiles.

 

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Rates and Credit in a Recession

E. Silvia, Ph.D. Chief Economist, Wachovia

We expect persistently weak economic growth for this quarter and the first half of 2009. From this fundamental driver comes a view that inflation will not be a major issue in 2009. However Treasury deficits and corporate profits will raise investor concerns. In addition, we expect that weak economic growth will keep the Federal Reserve on hold and the funds rate below one percent for all of next year. Inflation concerns are just not a barrier to the Fed’s program of liquidity/credit supply to financial intermediaries. With these fundamentals in place, what can we expect from interest rates? For Treasuries we expect continued low short rates with the two-year Treasury remaining between 1.6 and 2.0 percent for the next year. Historically, the two-year Treasury has served as a good benchmark for pricing private instruments but also as a proxy for expected future Fed funds rate moves. For us, we expect that the two-year will be consistent with no Fed moves but some upward pressure on rates as Treasury debt financing becomes a concern. We expect a steady rise in rates for 5, 10 & 30 year benchmark Treasuries as deficit financing concerns will weigh on investor demand.

 

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So Much For a Shallow U.S. Recession

Steve Chan, Economist, TD Bank Financial Group

In another week of plunging equity markets and sour economic news, attention turned to the actions of governments to contain the impact of the credit crunch and economic fallout. In the United States, the Treasury announced substantial changes to its Troubled Asset Relief Program (TARP), abandoning its original plan to purchase mortgage-backed securities from financial institutions. Meanwhile in Canada, the federal government did quite the opposite, upping its plan to buy pools of insured mortgages from Canadian banks. This weekend, attention turns to the leaders of the G20 as they meet in Washington to explore ways of dealing with the crisis. Any thoughts that the recession in the United States will be mild were exorcised by the economic data out this week. For the last several quarters the one sector supporting U.S. growth has been the export sector. Back when the U.S. housing sector was the key source of U.S. weakness, export strength was enough to completely offset the drag. That support was pulled out in dramatic fashion in September. Real export volumes fell by a whopping 7.8%, the steepest one month drop in the history of the series going back to 1994. The fall was widespread with every major sector posting decline. It is of little comfort that imports also fell dramatically in September as this simply augers for a much weaker domestic economy – evidence of which was more than provided by the October retail sales report and the astonishing rise in U.S. jobless claims for the first week of November.

 

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Bank of England Warns on the Economy, Sterling Wilts

Trevor Williams, Chief Economist at Lloyds TSB Financial Markets

A stark warning by the Bank of England on the outlook for the UK economy next year precipitated further selling in sterling this week against its major counterparts. The pound slumped below 1.16 vs the euro and dropped to 1.4557 against the dollar as worries of a more prolonged UK economic downturn escalated. Market participants also reacted to the growing probability that the BoE will again lower interest rates in December. The fact that the UK has rapidly changed from being one of the best to one the worst performing G7 economies this year makes sterling vulnerable to a further depreciation as overseas investors reassess their exposure to sterling denominated assets. The dollar was one of the strongest gainers in the currency markets this week despite another batch of very weak US economic data. Instead, participants concentrated on the fall in oil prices which is helping to shrink the US trade deficit.

 

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Compiled by David Song, Currency Analyst

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