April 28, 2008

Based on historical performance, a Canadian broker gave the view that the greenback was beginning to stabilise despite a continuation of negative news coming from the US, said Adam Cole.

"We believe we are at a point in the cycle where the market is prepared to look forward and see the [US Federal Reserve] interest rate cuts as a positive six months down the line," he said.

Cole said that during the last four out of five recessions, with the exception being 1973-75, the market has begun to price in a recovery at this point in the recession cycle. He expects to see evidence that the dollar will stage a sustained recovery by the end of this quarter. "This really is the testing time," he said.

The bank scored highly with accurate yen cross rates that required the Japanese unit to lose significant value over the month. USD/JPY needed to gain 3.9% to reach an expected rate of 103, while EUR/JPY needed to jump 6.3% from spot rates at the time of forecasting to reach the bank's predicted rate of 163.

Cole said that during the month, the yen not only suffered from a strengthening dollar, but also from signs of a re-emergence of risk appetite. He explained that up until then, the yen had gained from its status as a 'safe haven' currency, given capital flows indicated that, from a fundamental perspective, the unit should be weaker. "For example, retail investors buying foreign bonds - those flows are continuing. If market risk stabilises, the yen could retrace quite sharply," he explained.

Looking ahead 12 months, the bank expects significant pullbacks in EUR/USD and GBP/USD to 1.36 and 1.80, respectively.

While the latter is to some degree a dollar recovery, it also represents independent sterling weakness. "We see the UK as characterised by similar forces driving the US economy 12 months ago. The market is moving to discount a much more aggressive central bank," said Cole.

Once the European Central Bank (ECB) got over the 'hump' of inflation concerns, the euro was due a similar retreat, he said. "The ECB has been very accommodating of the exchange rate as a disinflationary force. When the next move in interest rates is down, this could signal quite a rapid reversal for the euro."