The Global FX Monthly AnalystGoldman Sachs Global Economics, Commodities and Strategy ResearchDecember 2009
We continue to expect cyclical near-term Dollar weakness, followed by a gradual Dollar recoveryfurther out. Our EUR/$ forecast remains at 1.55, 1.55 and 1.35 in 3, 6 and 12 months. Our $/¥ path remains unchangedat 98, 98 and 105. Current GSDEER: EUR/$ 1.20; $/¥ 107.
Motivation for Our FX View:
In the near term our Dollar-bearish views are driven by a combination of weak BBoPfundamentals, expectations of very easy US monetary policy and a constructive outlook for cyclical assets globally.Given the strong negative Dollar vs risky asset correlations currently observed, the latter would be consistent withDollar weakness remaining in place for some time. Further out, however, we see potential for Dollar strength; the exacttiming is uncertain but we have it pencilled in on a 12-month horizon. This is mainly due to potential structural factors,such as a possible recovery in capital inflows combined with a much narrower current account deficit, which together would ultimately push the BBoP into Dollar-supportive territory.
Monetary Policy and FX Framework:
The Fed has a dual growth and inflation target. As a result, monetary policyhas generally been more volatile and reactive than in pure inflation-targeting countries. The exchange rate floats freely;however, the US Treasury and the Fed both occasionally comment on currency issues.
We recently rolled out our 2010 and 2011 outlook for the US economy. We expect realGDP to grow +3% annualised in the fourth quarter, slowing to a 1.5% pace in late 2010, and then graduallyreaccelerating in 2011. We expect the unemployment rate to continue to creep up, reaching 10.75% by mid-2011. Wealso expect the large output gap to underpin disinflationary pressures, with core inflation expected to ease to 0%yoy bylate 2011.
Monetary Policy Forecast:
We expect the large output gap, high unemployment rate and disinflationary impetus tokeep the Fed on hold through 2011. The main risks to our Fed view are a much faster than expected pace of economicrecovery, or if we see a large run-up in asset prices, which could prompt earlier hikes than justified from a real-economy perspective.
Balance of Payments Situation:
We expect continued gradual improvement in the current account deficit, whichshould stabilise at around 2.5%. The trend narrowing in the US trade deficit means the US should have less difficultyattracting the necessary funding than in previous years. For now, though, we are not seeing strong capital inflows, apartfrom US Treasuries, which are likely to be largely FX-hedged anyway.Things to Watch: The Dollar may be sensitive to rate hike expectations in response to strong activity data. Overall risk sentiment also continues to be an important factor. Year-end dynamics often lead to Dollar weakness, in particular relative to European currenceis, and need to be watched in the next few weeks. We continue to monitor capital flowtrends in the monthly TIC data, given the potential for Dollar-supportive flows upon further stabilisation in the USeconomy, as mentioned above.
Net UST Flows 93.6 132.3 -58.2 89.1 196.6 62.0Other Net BondFlows236.2 297.6 315.7 208.5 -121.7 -346.6Net Equity Flows -25.2 -98.4 2.4 110.3 55.8 5.7Net FDI Flows -170.3 76.4 -1.8 -163.8 -12.3 -70.3
% of GDP -3.8 -2.6 -4.1 -5.2 -4.1 -5.4Official Buying 314.9 213.3 310.8 269.9 543.5 237.1
% GDP -1.3 -1.0 -1.6 -3.1 -0.3 -3.7
The Outlook for the US BBoP
US: BBoP vs. Current Account
-8-7-6-5-4-3-2-101295 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
% GDP4-qtr ma