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04 01 12 Erste Currency Analysis EURUSD

04 01 12 Erste Currency Analysis EURUSD

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Erste Group Research – Currency Analysis EURUSD
Page 1
Erste Group Research
Currency Analysis | EURUSD04. January 2012
 
Currency Analysis EURUSD
Dollar - safe haven for Eurozone crisis?Fed vs. ECB: Ever more complex, but slightly euro-negativeFundamental “fair value” at EURUSD 1.25Technical outlook: “Sell euro rallies”
Analysts:Fundamental view
Mildred Hager
mildred.hager@erstegroup.com  
 
Technical view
Ronald Stöferle
Ronald.stöferle@erstegroup.com  
The long-lasting discussion about the dollar’s status as a safe haven,which is regularly contested, entered a new stage by mid-2011. Bythen, the Eurozone debt crisis also started to impact the EURUSDexchange rate
(which prior to that was not the case). Due to persistentlybetter growth perspectives in the US and a lack of alternatives, we expectthe dollar to retain this safe haven status throughout 2012 as well.However, it is also worth mentioning that the quantitative extent remainslimited.
As a consequence of the debt crisis and corresponding downsiderisks to the Eurozone economy and inflation, we also expect the ECBto expand their monetary policy stance more than the US Fed in 2012,which is euro-negative.
Despite the Fed’s ongoing Operation Twist andpossible forthcoming MBS purchases, the ECB’s very generous liquidityprovision, expected rate cuts and possible further easing is likely to be ofgreater importance. This should also impact the interest rate differential,which should support the dollar on a relative basis.
Finally, long-term fundamentals
(in particular, purchasing power parity,but also a still narrower trade balance deficit of the US and especially thedollar’s status as the world’s first reserve currency)
also point to astronger dollar, so that we expect appreciation to EURUSD 1.25(perhaps even beyond) throughout the year.Technical outlook:
The current rebound may continue for some time and afurther rise to EURUSD 1.31 seems likely. Following this technical bounce,we believe that the euro-bears are most likely to strike again, as the overalltechnical bias remains clearly bearish.
A “sell the rallies” approach isadvisable.
We believe that trend acceleration may lead to a 1y low at 1.188(low June 2010). This should be the final leg of the downtrend and a verysolid support level. Afterwards, we envisage 1.26 as a major target on theupside.
 
Erste Group Research
Currency Analysis | EURUSD04. January 2012
 
Erste Group Research – Currency Analysis EURUSD
Page 2
Fundamental OutlookThe dollar’s traditional status as a safe haven is as often confirmed asit is contested. Indeed, the property does not seem to be stable overtime, and in the dollar’s case appears to be threshold-triggered (sothat the dollar appreciates only in case of extreme financial marketstress
). Indeed, there is no visible correlation of the EURUSD exchangerate with any measure of financial market stress, such as volatility (e.g., theVIX as in the following chart inverted on the right-hand side) or otherfinancial stress indicators. However, in the event of extreme stress (asmarked in blue in the following chart), the dollar almost systematicallyappreciates. Hence, in the event of renewed financial market turmoil, thedollar should appreciate further.
11.11.21.31.41.51.61.7
       0       3  .       0       1  .       2       0       0       5       2       3  .       0       5  .       2       0       0       5       1       0  .       1       0  .       2       0       0       5       2       7  .       0       2  .       2       0       0       6       1       7  .       0       7  .       2       0       0       6       0       4  .       1       2  .       2       0       0       6       2       3  .       0       4  .       2       0       0       7       1       0  .       0       9  .       2       0       0       7       2       8  .       0       1  .       2       0       0       8       1       6  .       0       6  .       2       0       0       8       0       3  .       1       1  .       2       0       0       8       2       3  .       0       3  .       2       0       0       9       1       0  .       0       8  .       2       0       0       9       2       8  .       1       2  .       2       0       0       9       1       7  .       0       5  .       2       0       1       0       0       4  .       1       0  .       2       0       1       0       2       1  .       0       2  .       2       0       1       1       1       1  .       0       7  .       2       0       1       1       2       8  .       1       1  .       2       0       1       1
-70-203080130180EURUSD VIX, inverted rhs
 
Source: Bloomberg, Erste Group Research 
Beyond that, the stress related to the Eurozone debt crisisincreasingly impacts the EURUSD exchange rate.
In 2010, severalfactors counteracted the safe haven status of the dollar. For example, othersafe havens seemed more appealing on a fundamental basis (e.g., CHF),but have now been eliminated by central bank intervention. Furthermore,QE2 had contributed to a weaker dollar in 2010 (see next section). Sincemid-2011, the dollar has increasingly become a safe haven.
This is visiblein the following chart, showing the onset of a co-movement of theexchange rate with peripheral yield spread increases
.
We expect thisto persist, but do not see it as any manifestation of a “euro crisis”, asthe extent of exchange rate sensitivity still remains relatively mild
(incontrast to the EURCHF’s past reaction, for example).
 
11.11.21.31.41.51.61.7
       0       3  .       0       1  .       2       0       0       5       0       3  .       0       7  .       2       0       0       5       0       3  .       0       1  .       2       0       0       6       0       3  .       0       7  .       2       0       0       6       0       3  .       0       1  .       2       0       0       7       0       3  .       0       7  .       2       0       0       7       0       3  .       0       1  .       2       0       0       8       0       3  .       0       7  .       2       0       0       8       0       3  .       0       1  .       2       0       0       9       0       3  .       0       7  .       2       0       0       9       0       3  .       0       1  .       2       0       1       0       0       3  .       0       7  .       2       0       1       0       0       3  .       0       1  .       2       0       1       1       0       3  .       0       7  .       2       0       1       1
-2.52.57.512.517.5EURUSD 10Y Spread gips-DE, rhs inverted
 
Source: Bloomberg, Erste Group Research 
Analyst
Mildred Hager
 
mildred.hager@erstegroup.com 
 
Erste Group Research
Currency Analysis | EURUSD04. January 2012
 
Erste Group Research – Currency Analysis EURUSD
Page 3
Besides perceived or real risk factors, the expected return of an assetis of course one of the main driving forces of its price. Higher interestrates (or smaller monetary aggregates) support a currency’s relativeattractiveness, so that the monetary policy stance is of greatimportance for the exchange rate.
As long as interest rates are strictly positive, nominal and real interestrate/yield differentials of different maturities are the main reflection of thecurrent and expected monetary policy stance. Short-term interestrates/yields are directly linked to the setting of the main refinancing rate. Weexpect the ECB to lower the main refinancing rate to 0.5%, which is already“priced in” in 2Y yields. This points to the EURUSD decreasing towards 1.25quite rapidly.
11.11.21.31.41.51.61.7
      J     ä    n .     0     5      J    u      l .     0     5      J     ä    n .     0     6      J    u      l .     0     6      J     ä    n .     0     7      J    u      l .     0     7      J     ä    n .     0     8      J    u      l .     0     8      J     ä    n .     0     9      J    u      l .     0     9      J     ä    n .     1     0      J    u      l .     1     0      J     ä    n .     1     1      J    u      l .     1     1
-3-2-10123EURUSD2Y Yield differential (rhs)
 
Source: Bloomberg, Erste Group Research 
Once the short-term rate is at zero, the central bank can relax monetaryconditions further through balance sheet measures. In the case of theEURUSD, this will be one of the most complex issues in 2012. Anexpansion of the balance sheet (such as QE or expanded liquidity provision)can affect the exchange rate through the relative “provision” of currency, orexpectations in this respect. Indeed, the expansion of liquidity provision interms of maturity and collateral by the ECB has already led to a relativeincrease in the ECB’s balance sheet as compared to the Fed’s (see thefollowing chart), thus exerting a weakening pressure on the euro.
Weexpect the ECB to remain more generous than the Fed
(even if the latterwere to consider MBS purchases),
thus weakening the euro.
 
11.11.21.31.41.51.61.7
        J       ä      n  .       0       5        J      u        l  .       0       5        J       ä      n  .       0       6        J      u        l  .       0       6        J       ä      n  .       0       7        J      u        l  .       0       7        J       ä      n  .       0       8        J      u        l  .       0       8        J       ä      n  .       0       9        J      u        l  .       0       9        J       ä      n  .       1       0        J      u        l  .       1       0        J       ä      n  .       1       1        J      u        l  .       1       1
0200400600800100012001400160018002000EURUSD M0 US / M0 EU
 
Source: Bloomberg, Erste Group Research 

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