The minutes of the latest monetary-policy meeting

October 6 2010 by Milla Schmidt in Forex Release |No Comments

Jyske Bank’s FX forecasts

FX overview – USD, GBP, CHF, JPY, NOK, SEK, CZK, PLN, HUF, TRY, MXN, BRL, ZAR and CNY

In short

The US dollar – USD

The third quarter was overwhelmingly one of anxiety over the possibility of the US economy performing a double dip and of speculation that a new round of quantitative easing on the part of the Federal Reserve (the Fed) may be in the pipeline. This pushed down US yields, and the value of the dollar dropped. The IMM positions also show that speculative investors now hold net short positions in USD against EUR for the first time since December 2009, and the EUR/USD rate has again crept above the 40-week moving average, which was earlier a reliable indicator of the longer-term trend. We have long argued that the dollar would lose value over time, but we must admit that things have moved faster than we anticipated. So long as the US indicators do not convince market participants that the economy is back on track, there is significant risk that the dollar depreciation will continue. Overall, however, several things indicate in our view that the EUR/USD rate will fall towards the end of the year.

1. The recent dollar depreciation was extensively driven by concern over a possible double dip in the US economy and by speculation about new quantitative easing by the Fed. We on our part expect the US economy to continue along a moderate path of growth, and we therefore do not believe in additional easing of the monetary policy. If we are proved right, a gradual improvement of the indicators over time will support the dollar, since the markets will gradually tone down expectations of additional quantitative easing.

2. Economic growth in Europe has shown a favourable trend, and this has helped to support the euro. However, Europe traditionally lags the US in the economic cycle, and therefore we find that there will be scope for slower growth in the euro zone over the coming months. Other things being equal, this may cause additional pressure against the euro.

3. The PIIGS and CDS spreads of the border states of the euro zone are still widening, and if the FX markets focus on this problem again, the euro may come under additional pressure.

4. Although on the one hand, the IMM positions indicate that sentiment among speculative investors has turned from highly bearish for the EUR/USD rate over the spring and the summer to currently neutral to slightly positive, positions indicate that investors have room in their books for selling EUR/USD, if focus in the market turns to the weaknesses within the euro zone.

Even if we maintain our expectation of a setback for the EUR/USD rate over the coming months, we have chosen – in the light of recent developments – to raise our EUR/USD forecast slightly across the curve. Moreover, we stress that risk is higher at the moment, and that the dollar appreciation we expect for the coming quarters may fail to materialise if the Fed, contrary to our expectations, begins a new round of qualitative easing. Our new dollar estimate:

Estimate – EUR/USD:

3M: 5.73

6M: 5.60

12M: 5.36

Sterling – GBP

Sterling is still weighed down by the huge publicsector deficits, the growing debt burden and the prospects of slower economic growth. For some time, the Bank of England has been in the quandary of having to choose between high inflation and declining economic growth. A few months ago, the mounting inflationary pressure caused a member of the Bank of England’s monetary-policy committee to vote in favour of an interest-rate hike. The minutes of the latest monetary-policy meeting, in September, showed that several members had become more concerned about the growth prospects, and some of these members felt that there was increased probability that it may be necessary to stimulate the economy again. We do not expect the Bank of England to ease the monetary policy further, but the deeper concern about global economic growth may feed speculation that the Bank of England may start a new round of quantitative easing. This may well help to maintain pressure against sterling over the coming months, and therefore we have chosen to lower our estimate for EUR/GBP at 3 months from 83 to 87 and from 82 to 84 at 6 months.

For the longer term, we still expect GBP to head higher as uncertainty about economic development lessens, and the high risk premium which has weighed on sterling since the financial crisis peaked gradually narrows. For the time being, we therefor maintain our price estimate at 80 for EUR/GBP at 12 months.

Estimate – EUR/GBP:

3M: 8.98

6M: 9.09

12M: 9.31

The Swiss franc – CHF

The Swiss National Bank (SNB) left interest rates unchanged at 0.25% at its latest monetary-policy meeting held in September. The announcement was expected in the market, but the SNB lowered its expectations of growth and inflation in 2011, because the strength of the franc puts a damper on the competitive power and on exports. This made yields fall, and the currency depreciated. All in all, the franc lost just over 3% against the euro over the past month, to almost 133. From the technical point of view, there is room for a short-term depreciation of the franc towards 134.80 and subsequently 135.45 against the euro. For the long term, however, we are still bullish for the franc, and we therefore still recommend investors to benefit from downward corrections of the franc to close their franc financing or alternatively to hedge risk. Read more about our view of franc in the publication CHF: On the up and up.

The Japanese yen – JPY

There has long been only one way for the yen – upwards. This was strengthened in September by the spreading talk of quantitative easing in the US, which caused yield spreads to narrow. On 15 September, the Japanese Finance Ministry seemed to have had enough and asked the Bank of Japan to intervene in the FX market in an attempt to weaken the yen – against the dollar, in particular. The mission was accomplished at the first attempt, but the direction of the USD/JPY rate soon turned down again, and the rate closed at a USD/JPY level close to the point where the BoJ first intervened, viz. at around 83. Whether the BoJ will succeed in slowing the skyrocketing yen in the longer term remains a moot question, but a comparison with the period in 2003-2004, when the BoJ last intervened in the FX markets, shows much to indicate that the central bank has got its job cut out. At the time, the central bank intervened relatively sweepingly on its own without succeeding in earnest in slowing the slide of the USD/JPY rate, and only when the G7 central banks stepped in concertedly did the trend turn. Back in 2003-2004, the global economy was booming, so the scope for economic manoeuvre was larger. This time, several of the world’s large economies are still licking their wounds after the financial crisis, so concerted action to weaken the yen is hardly likely to be top of the agenda. For the short term, however, we still expect the yen to be stable to stronger against the euro, but as uncertainty in the financial markets lessens, and the prospects for global growth improve, pressure against the yen will slowly increase. For the longer term, the yen will also be adversely affected by a widening of yield spreads, particularly if we are proved right in that quantitative easing in the US is not implemented. Moreover, deflation remains a topic in Japan, and in our view this means that there are no prospects of interestrate hikes until some time in 2012. For comparison: we expect that several of the large central banks will begin to restrict their monetary policies in the course of 2011. But we do not expect the Federal Reserve or the ECB to change interest rates until towards the end of our estimate period, and therefore we do not expect the yen to depreciate markedly within the next twelve months.

Estimate – EUR/JPY:

3M: 6.77

6M: 6.48

12M: 6.21

The Norwegian krone – NOK

As expected, Norges Bank left interest rates unchanged at 2% at its monetary-policy meeting in September. After the meeting, Norges Bank announced that economic developments in general had been more or less as expected, but that inflation had fallen by more than had been anticipated, and that there are signs that, for the coming time, it will be marginally lower than expected in the monetary-policy report from June. In that respect, Norges Bank announced that the objective of meeting the inflation target and ensure stable development in production and employment requires interest rates to be low, and that expectations that interest rates will be kept low in other countries support this. Although Norges Bank maintained its comment that interest rates are gradually to be normalised, we do not expect Norges Bank to be on the brink of raising interest rates, so we do not expect any interest-rate hike at the next monetary-policy meeting in October. Going forward, we expect the disappointing performance of the Norwegian economy during the first six months of 2010 and the prospects of slower growth in the global economy will cause Norges Bank to be reluctant to raise interest rates.. Therefore we have adjusted our expectations of the central-bank rate and now expect the hike, if any, to be made later than originally expected. This supports our former expectation that the Norwegian krone, after performing impressively in 2009 and 2010, is in for a more stable period. We maintain our recommendation of a stable to slightly stronger Norwegian krone.

Estimate – EUR/NOK:

3M: 0.9310

6M: 0.9370

12M: 0.9430

The Swedish krona – SEK

The performance of the Swedish economy has been slightly surprising for the past quarters, and this has given more support to the Swedish krona than anticipated in our forecast. Jyske Bank’s Macroeconomic Research team has just raised its growth estimate for 2010, but this was mainly based on the strong growth we have seen during the first six months of the year. As we see it, there are still prospects of the Swedish economy losing steam towards the end of the year, and therefore we do not think that the krona can continue to ride on the wave of euphoria we have seen over the summer. Although a stable economy and sound public finances with low indebtedness and balanced public budgets will continue to support the krona, we take the potential to be relatively limited at present compared with the impressive spurt performed by the krona since the financial crisis peaked at mid-2009. Indeed, the technical picture supports this view, since the EUR/SEK rate is more or less back within the old trading range from before the crisis erupted. We still see potential for the krona to strengthen over the coming months – although only at a relatively slow pace in comparison with what we have witnessed so far this year.

Estimate – EUR/SEK:

3M: 0.7926

6M: 0.8098

12M: 0.8142

The US dollar – USD

The world’s largest economy and one of the world’s highest GDP per capita. The largest trading partners are (% of exports): Canada (20.1%), Mexico (11.7%) and China (5.5%). The large industries in the US include oil, steel, auto and air transport. US GDP per sector: Service (79.6%), Manufacturing industry (19.2%), Agriculture (1.2%).

Fundamental valuation

Based on the purchasing power parity, USD is undervalued – equilibrium around 1.21 (EUR/USD) and 6.15 (USD/DKK).
We expect much higher growth in the US compared with the euro zone in 2010 and 2011.
Interest-rate increase from the Fed in September 2011. The ECB will wait until Q4 2011. We do NOT anticipate further quantitative easing in the US.
The debt crisis and the need for fiscal-policy easing will have an adverse effect on growth in the euro

Price triggers

Improvement in economic indicators from the US and a deterioration of indicators from the euro zone.
The Fed rejects the possibility of further quantitative easing – alternatively it will launch a less comprehensive purchase programme than anticipated by the market.
Narrowing of the interest-rate spread between Europe and the US will support USD.
Negative surprises in the euro zone, e.g. in the form

Investment case

Improvement of US indicators will reduce speculations of quantitative easing and support USD.
Expectations about slower euro-zone growth will at the turn of the year contribute to a more balanced picture of the power balance across the Atlantic.
The yield spread will narrow in favour of USD over the coming quarters.
Continued widening of the PIIGS and CDS spread on the euro-zone border states. Renewed focus on this will put EUR under pressure.

Risk factors

For the short term: risk of USD weakening if US economic indicators continue to disappoint.
Contrary to our expectations – the Fed initiates a new round of quantitative easing.
Need for fiscal-policy tightening in the US may delay the first interest-rate hike.
Doubt about the status of USD as a reserve currency may enhance the pressure on USD in the long term.

Sterling – GBP

The UK has one of the largest economies in Western Europe and is Europe’ financial centre. The largest trading partners are (% of exports): The US (13.1%), Germany (11.5%), The Netherlands (7.8%). Banking and insurance services make up the largest part of GDP: Service (80.4%), Manufacturing industry (18.2%), Agriculture (1.4%).

Fundamental valuation

GBP is undervalued based on the purchasing power parity – equilibrium is approx. 0.7360 (EUR/GBP) and 10.13 (GBP/DKK).
The upturn in the UK is still weak and massive savings on public budgets will over the coming years slow down growth even further.
Inflation and inflation anticipations are, however, rising and this leaves the BoE in a dilemma.

Price triggers

A widening of the yield spread to the euro zone (2Y and 10Y) will support sterling.
Economic indicators improve and the upturn gains momentum.
An end to the quantitative easing which keeps market rates artificially down.
Inflation will be more sustainable and hikes will be made sooner than expected.

Investment case

We anticipate a stable to slightly weaker pound sterling in the coming months since speculation about further monetary-policy easing will maintain the pressure on the currency.
In the long term, the normalisation of the monetary policy will support the pound sterling.
A gradual improvement of the economy will reduce the uncertainty and reduce the risk premium of the currency in the long term.

Risk factors

The UK falls back into recession and interest rates remain low for a longer period than expected.
An escalation of the financial crisis may result in a higher risk premium on GBP due to the exposure to the financial sector in London.
Renewed uncertainty about the sustainability of the UK economy may raise doubt whether the UK will be able to maintain its current credit rating.
The euro-zone countries succeedd in putting a damper on the worst uncertainty and EUR is lifted.

The Swiss franc – CHF

Switzerland has a wealthy and stable economy with GDP per capita among the highest in the world. The largest trading partners (% of exports): Germany (33.3%), Italy (11%), France (9.4%). Important industries: machines, watches, bank and insurance. GDP per sector: Service (73%), Manufacturing industry (23%), Agriculture (4%).

Risk of further CHF appreciation

Our scenario of an upward shift to a new level of the Swiss franc is still relevant (see the research report CHF: On the up and up.
At the June meeting, the Swiss National Bank (SNB) did maintain its rate, but its subsequent comment did not contain the by now so well-known remark that it would ‘prevent any excess strengthening of the Swiss franc’.
Instead the SNB said that it would intervene if the appreciation becomes a problem again in respect of renewed risk of deflation.
The SNB also stated that the threat of deflation practically seems to have been eliminated.
This indicates that at this point in time, the SNB is not overly concerned that an appreciation of the franc will have serious consequences for the economy, and with these signals there is every indication that the franc will appreciate further.
The debt crisis in Southern Europe has so far prompted the SNB to leave its interest rates unchanged but seen in isolation developments in the domestic economy indicate that a hike may soon be appropriate. When the SNB indicates a tightening of its monetary policy, it will be yet another supportive factor for the currency.
Fundamentally, there are many indications of a stronger franc for the period ahead.
Technically, EUR/CHF is in a downtrend with resistance at the moment around 140 and for the short term around 136-136.50.
It seems increasingly likely that we will see a test of 134.80 in EUR/CHF.
There are thus still many indications of a shift to a new level for the Swiss franc where the new, strong level is maintained for both the short and long term.
Investors should therefore use corrections towards 140 in EUR/CHF to close Swiss franc funding.
The new major range in EUR/CHF is now 122-140.

The Japanese yen – JPY

In terms of GDP (PPP), Japan is the world’s third largest economy next to the US and China. The largest trading partners (% of exports): The US (17.8%), China (16%), South Korea (7.6%). Japan produces: motorcycles, electronics, ships and chemicals. GDP per sector: Service (66.4%), Manufacturing industry (27.9%), Agriculture (4.4%).

Fundamental valuation

Based on purchasing power parity, JPY is overvalued – equilibrium around 1.46 (EUR/JPY) and 5.09 (JPY/DKK).
Economic growth slows down – the effect from fiscalpolicy easing and inventory adjustment fades away.
Slower global economy and a strong currency rate put pressure on growth and exports.
Need for consolidation of the public finances.
Deflation is still strong in Japan and we do not believe that interest-rate hikes will be on the agenda until 2012 at the earliest.

Price triggers

Increased appetite for risky assets.
A widening of the yield spread between Japan and the other G10 nations gives renewed focus on the yen as a funding currency.
Further steep intervention may weaken JPY.
The BoJ increases its purchase of government bonds (extend the quantitative easing).
Higher focus on the development in public debt (approx. 200% of GDP) may create distrust in JPY.

Investment case

We expect a yen weakening for the long term.
Intervention may put a damper on the upswing of JPY in the short term.
Due to its battle against deflation until 2011, Japan will not tighten its monetary policy before 2012.
We expect that the other G10 central banks will start tightening their monetary policy early next year (BoE in February and Fed in March 2011).
A widening of the yield spreads will squeeze the yen.

Risk factors

Renewed outbreak of risk aversion due e.g. to the debt crisis in the euro zone.
The global crisis is slow in progress and the normalisation of the interest-rate levels in the other G10 countries is long in coming.
Further quantitative easing in the US may put so much pressure on JPY that further intervention will have no effect.
Technical breach of 108 for EUR/JPY may pave the way for a further JPY strengthening towards 100.

The Norwegian krone – NOK

Norway has a solid and wealthy economy and one of the world’s highest per capita GDP. The largest trading partners are (% of exports): The UK (27%), Germany (12.8%), The Netherlands (10.4%). Main industries: oil, gas, shipbuilding and chemicals. GDP per sector: Service (76%), Manufacturing industry (21.1%), Agriculture (2.9%).

Fundamental valuation

NOK is slightly undervalued with respect to purchasing power parity – equilibrium 7.71 (EUR/NOK) and 96.66 (NOK/DKK).
The upswing in Norway has begun.
Norges Bank has begun the normalisation of the interest-rate level and has already hiked three times by a total of 75 bp to 2% since October.
We expect growth of 1.9% and 2.6% in 2010 and 2011, respectively, and we expect further hikes totalling 100 bp to 3% at 12-months’ term.

Price triggers

Increased appetite for risky assets will support NOK.
Further widening of the yield spread between Norway and the other G10 nations supports NOK since the prospect of a positive return supports the demand for NOK.
Any rises in the oil price may support NOK.

Investment case

The krone has already strengthened somewhat over the past twelve months.
We believe in a stable to slightly positive development in NOK over the coming year: True, Norges Bank will raise interest rates but only gradually.
The krone has already strengthened by 15% in 2009, and we therefore assess that the potential will be more limited going forward.
Range trading between 775 and 820 in EUR/NOK.

Risk factors

The NOK strengthening may prompt Norges Bank to postpone the hikes to help the weak manufacturing industry to get back on track. Growth has disappointed in early 2010 and if this trends continue it may have consequences for Norges Bank’s future interest-rate path.
A possible deterioration of the sentiment in the financial markets may put pressure on NOK.

The Swedish krona – SEK

The Swedish economy has been hit hard by the global crisis but is slowly recovering. The largest trading partners are (% of exports): Germany (10.4%), Norway (9.5%) Denmark (7.4%). Iron, steel, defence equipment and automotive are the largest industries. GDP by sector: Service (70.5%), Manufacturing industry (28%), Agriculture (1.6%).

Fundamental valuation

SEK is undervalued based on purchasing power parity – equilibrium 7.61 (EUR/SEK).
The upswing has begun in 2010 after the deep recession.
Consumers are still optimistic, and the industry and exports are now also improving.
We expect growth in Sweden of 4.2% and 2.8% in ’10 and ’11, respectively (against 1.6% and 1.4%, respectively, in the euro zone).
The Riksbank has started to raise interest rates, and we expect further hikes of a total of 100 bp over the coming years.

Price triggers

Increased appetite for risky assets will support SEK.
Signals from the Riksbank of a further tightening of the monetary policy and an early ‘normalisation’ of the interest-rate level.
Positive surprises with respect to economic indicators globally as well as locally (including continuing improvements in exports).

Investment case

Riksbanken has indicated that the monetary-policy tightening will continue.
Key figures have been decent, but we expect them to turn in Q4.
We expect that higher growth and interest-rate differences between Sweden and the euro zone will support SEK.
Technically, SEK is back at a level from before the crisis, i.e. a limited potential in this respect.
Possible range trading between 900 and 950 in EUR/SEK.

Risk factors

An outbreak of risk aversion in the financial markets (e.g. based on a government-debt crisis).
The global upturn loses momentum, and the Swedish economy is put under renewed pressure.
Market rates reflect anticipations of interest-rate hikes of approx. 60 bp this year. Risk of disappointments if the global growth picture deteriorates.
The market seems to hold a ’heavy’ position in SEK. This constitutes a risk of a strong reaction in case of disappointments in key figures or an outbreak of risk aversion.

The Czech koruna – CZK

Compared with the other former communist states, the Czech Republic is the most stable and wealthy economy. The largest trading partners are (% of exports): Germany (30.3%), Slovakia (6.6%), Russia (6.2%). Primary industry: auto, metal and machinery. GDP by sector: Service (56.2%), Manufacturing industry (37.6%), Agriculture (2.3%).

Fundamental valuation

In the Czech Republic, exports account for around 80% of GDP and a large part of this is bought by Germany. Hence, the recent positive surprises from the German key figures have been positive for CZK.
In May, a parliamentary election was held. The government holds 118 out of 200 seats in the new composition of the parliament. Previously, the distribution was 100/100. This increases the probability of a reduction of the budget deficit (5.9% of GDP in 2009).  This is supported by a sound bank sector.

Price triggers

The Czech central bank raises interest rates from the current level of 0.75%. We expect to see the first hike in Q2 2011.
Recent months’ very positive development in the German key figures continues.
Further increase in EUR/USD will, all things being equal, be positive for CZK.
The government reduces the budget deficit.

Investment case

We expect over the next 12 months that CZK will continue its long-term uptrend and gradually strengthen against EUR.
CZK strengthened relatively sharply in July. In the short term, we may see a period with a minor weakening of CZK – particularly if the German key figures start to disappoint.
The introduction of the euro does not currently have high priority in the Czech Republic.

Risk factors

A period with disappointing German key figures will be negative for CZK.
Falling EUR/USD will, all things being equal, be negative for CZK.
The government is less willing than assumed to reduce the budget deficit. The Czech public debt only account for 34% of GDP (2009) and, hence, the public debt does not constitute a similar risk as in many developing counties.

The Polish zloty – PLN

Poland has successfully liberalised its economy since 1990. First in line to adopt the euro. Largest export countries: Germany (24.4%), France (6%), Italy (5.9%). Large industries: machinery, iron, steel, coal, chemicals, ships. GDP by sector: Service (67.3 %), Manufacturing industry (28.1 %), Agriculture (4.6 %).

Fundamental valuation

As the only country in the region, Poland weathered the global economic slowdown without negative growth rates. Notably domestic demand supported growth and Poland is in a strong fundamental position for the period ahead.
Poland’s weak point is the budget deficit which was 7.5% of GDP in 2009. The parliamentary election next year reduces the likelihood that an ambitious plan will be launched to narrow the budget deficit.

Price triggers

A more ambitious plan for reducing the budget deficit.
Positive sentiment about the euro zone.
The Polish central bank raises interest rates from currently 3.50% earlier than expected (Jyske Bank expects Q3 2011, the market currently discounts +25 bp this year).

Investment case

Over the next 12 months, we expect the zloty to appreciate against the euro; zloty volatility is still high and the currency may fluctuate significantly in the uptrend.
The introduction of the euro is not given the same high priority as before and it should not be introduced until 2014/2015. At the moment, Poland only complies with one of the Maastricht criteria.

Risk factors

PLN is often used to take a negative view on Eastern and Central Europe and the euro zone. Hence, PLN is vulnerable to a negative sentiment about the region.
The government does not reduce the budget deficit.
In April, the Polish central bank intervened for the first time in ten years against the zloty. Further intervention is a risk but the new Central-Bank Governor Belka appears less willing to use the intervention tool.

The Hungarian forint – HUF

Hungary is dependent on exports to the other EU countries. The country is challenged by high private indebtedness in foreign currencies. Largest export countries: Germany (25.4%), Italy (5.2%), Romania (5.1%). Large industries: mining, machinery, textiles, chemicals. GDP by sector: Service (62.4%), Manufacturing industry (34.3%), Agriculture (3.4%).

Fundamental valuation

Economic activity in Hungary remains very low. Domestic demand is slow, and the growth recovery is dependent on demand from Germany in particular.
Hikes are not just around the corner (we expect Q3 2011) and may only be an issue if the forint must be supported.

Price triggers

The government undertakes to keep the budget deficit below 3% of GDP from 2011 and onwards and/or indicates that the cooperation with the IMF will be resumed (in July the two parties discontinued negotiations on an extension/a new loan agreement – the current loan agreement expires in October.
An increasing EUR/USD rate and an increased appetite for risk should support the forint.

Investment case

The political announcements after the local elections on 3 October will decide whether the forint will depreciate against the euro over the coming months or whether the prospects will be more neutral/slightly positive.
The economic development still does not point to significant appreciation of the forint.
Over the next 12 months, we expect the forint to appreciate marginally against the euro., but there is a risk of major forint fluctuations, and a period of pressure on the forint is very likely.

Risk factors

Focus on the debt problems in the euro zone.
Increasing risk aversion.
A falling EUR/USD will, all things being equal, adversely affect the forint.
The government is not committed to keeping the budget deficit lower than 3% of GDP.
Due to a high proportion of Swiss franc loans in Hungary, the forint is vulnerable to appreciation of the Swiss franc.

The Turkish lira – TRY

The Turkish economy is a mix between modern industry and trade and a traditional agricultural sector. The largest trading partners are (% of exports): Germany (9.8%), the UK (6.2%) and China (7.8%). Large industries: textile, auto and electronics. GDP by sector: Service (45.8%), Manufacturing industry (24.7%), Agriculture (29.5%).

Fundamental valuation

Turkish growth has involved positive surprises lately. Turkey is expected to see growth for 2010 of some 6- 7%. The Turkish growth recovery is supported by a relatively sound banking sector.
A public debt of 46% of GDP involves a smaller need for a consolidation of the public finances in coming years.
The government is preparing for the introduction of a fiscal-policy rule – but the implementation has been delayed.

Price triggers

The Turkish central bank raises interest rates from the current level of 7.00%.
The government’s implementation of the fiscal-policy rule proceeds faster than anticipated.
Upgrades by credit-rating agencies – S&P may upgrade Turkey within 12-24 months.
A decline in EUR/USD will support the lira against the euro, other things being equal.

Investment case

Over the next twelve months, we have a neutral view on the lira against the dollar.
The lira is a dollar-related currency, and the development of EUR/USD will be decisive for the development of the lira against the euro. Investors can buy the lira against 50% euro and 50% dollar to eliminate this risk.
Next year’s parliamentary election may increase lira volatility. From a market point of view, a comfortable victory to the incumbent government is preferable.

Risk factors

A further increase in EUR/USD will adversely affect the lira against the euro, other things being equal.
Increasing risk aversion.
The fiscal-policy discipline of the past years is not continued.
The CBRP waits too long to raise interest rates.
A growing current-account deficit may involve a risk to the lira.

The Mexican peso – MXN

Mexico is also called the 51st state of the US since the country is highly dependent on exports to the US. Largest export countries: the US 80.5%, Canada 3.8% and Germany 1.4%. Large industries: food, beverages, tobacco, oil and chemicals. GDP by sector: Service (65 %), Manufacturing industry (31 %), Agriculture (4 %).

Fundamental valuation

Q2 growth was strong (3.22% q/q).
Inflation has slowed from 6.5% y/y to 3.7% in two years.
Much depends on developments in the US which accounts for some 80% of Mexico’s exports.
Given expected fair US growth in 2010 (2.8%) and 2011 (2.8%), exports are solidly supported.
But Mexico’s GDP is not back to the pre-crisis level.
Due to the lack of oil-sector reforms it has become harder to maintain the oil production and thus important tax revenues.

Price triggers

The peso is correlated with the dollar, which is more or less alpha and omega for the peso against the euro, i.e. a lower EUR/USD rate will usually cause the peso to appreciate against the euro.
Good US growth and job data and good news from the domestic economy will support the peso.
If the opposition party PRI (the Social Democrats) and the governing PAN party (the Liberals) agree on some of President Calderon’s minor reform proposals, the peso will be supported.

Investment case

The peso has underperformed most other Latin American currencies in the past two years. Will this still be the case?
Yes, because market rates have plunged and are much lower than in Brazil, which lowers the inflow.
Yes, because the growth and inflation expectations are low compared with the remaining Latin America.
No, because we are hopeful about US growth.
No, because peso bonds are included in Citi’s global bond index, which increases the inflow.

Risk factors

Intervention – Banxico buys dollars.
Increased focus on drug-related violence. If this violence escalates, it may adversely affect Mexico’s credibility and thus the peso, but it is not a direct threat to the public institutions, since it is not politically motivated.
Political deadlock at the moment. Major reforms are almost unimaginable prior to the presidential election in 2012, so there is a risk to the peso, if the election campaign starts early and if the parties try to outdo each other.

The Brazilian real – BRL

South America’s largest economy and one of the powerful BRIK countries. Has since 2002 improved its economy in key areas. Largest export countries: the US (13.7%), Argentina (8.7%) and China (8.1%). Large industries: textiles, auto, chemicals and wood. GDP by sector: Service (67.7%), Manufacturing industry (25.8%), Agriculture (6.5%).

Fundamental valuation

Brazil weathered the crisis quickly and growth landed at an impressive 8.8% y/y in Q2.
President Lula’s approval rate is very high, and there is every indication that ”his” candidate Ms Dilma Rousseff wins the presidential election in October. There are prospects of continuity.
Like Lula, Ms Rousseff must cooperate with the centre party PMDB, which means that it is difficult to implement reforms.
Brazil would like to have a more important say internationally. Until now, with qualified success. Brazil has a seat in the UN Security Council until end- 2011.

Price triggers

We expect the key rate to reach 12.50% in 2011, which will support the real.
A rating upgrade will support the real.
Unemployment is 6.7% and has formed the basis of an increase in real wages and a larger middle class. If this trend continues, the economy and the real will be supported.
FDI in the oil industry will strengthen the real. Investments are necessary to exploit the oil reserves off the coast of Rio and will support the real.

Investment case

The real is supported by high market rates and real rates of interest compared with EM alternatives.
In 2010 the central bank has raised interest rates by 2 percentage points to 10.75%, but it is on hold now for the rest of the year due to uncertainty about the global recovery.
Solid FDI supports the real.
The finance minister has warned that an FX war is around the corner. This is an expression that the central bank is worried about the strong real and it may be an indication of intervention.
Therefore, we only expect the real to appreciate marginally.

Risk factors

Intervention – purchase of the dollar against the real.
The government previously introduced a 2% tax on capital inflows. There is speculation on further such initiatives, which will adversely affect the real.
Focus on public expenditure. Public spending instead of investments will weaken the real.
A rising current-account deficit. Negative news about the current account will adversely affect the real.

The South African rand – ZAR

Many natural resources and healthy banking sector but after-effects of apartheid – e.g. high unemployment. Largest export countries: Japan (11.1%), The US (11.1%) and Germany (6.8%). Large industries: mining, machinery and textiles. GDP by sector: Service (64.4 %), Manufacturing industry (32.1 %), Agriculture (3.5 %).

Fundamental valuation

Inflation for August was 3.5% y/y, which is close to the lower limit of the target range of 3-6%. The current-account deficit was only 2.5% of GDP in Q2. In 2008, it was 8.8%.
Growth landed at a solid 3.2% y/y in Q2.
In the first year of his term, Zuma has supported the moderate ANC people for whom economic stability is on top of the wish list (appreciated by the market). However, Zuma is squeezed by the left wing which is in favour of better living conditions for the poor. This means that ANC stability is under pressure.

Price triggers

Increasing commodity prices support the rand.
If inflation goes on falling, the rand will be supported.
A continued inflow into the bond market will support the rand.
Thanks to the FIFA World Championship, South Africa has attracted positive attention. If this trend continues, it will support the rand.
Political intervention has been mentioned to weaken the rand for competitive reasons. We expect that over time it will fade out to the benefit of the rand.

Investment case

The rand is at a several-year high against the dollar and the euro. Will it go on appreciating?
Yes, because South Africa is doing well economically at the moment.
No, because of domestic instability in the form of internal disagreement in the ANC, disputes about mining rights and increased wage requirements from the workers.
We have a neutral view on the rand at the moment.
Yields are attractive relatively to EM alternatives, and we recommend exposure via the bonds.

Risk factors

The introduction of capital restrictions will weaken the rand.
HSBC is buying70% of Nedbank. The purchase is expected to be finally completed in November, but if not, it will adversely affect the rand.
A dispute is going on about mining rights. An escalation will have an adverse impact on the rand.
Strikes in the public sector and the auto sector have characterised the past two months, since the workers require higher wages. Higher wage increases may lead to inflationary pressure and a weaker rand.

The Chinese yuan – CNY

China has moved from planned economy to a rapidly growing market economy and is now a key player in the global economy. Largest export countries: The US (17.7%), Hong Kong (13.3%) and Japan (8.1%). Large industries: mining, consumer discretionaries and machinery. GDP by sector: Manufacturing industry (48.6%), Service (40.5%), Agriculture (10.9%).

Fundamental valuation

Observers widely agree that the yuan is undervalued.
After being fixed at a rate of about 6.83 against the dollar from mid-2008 to mid-2010, the Chinese central bank again let the yuan appreciate against the dollar in June 2010.
The international society urges China to revalue the yuan, but an increasing pressure will not necessarily lead to a large and quick revaluation of the yuan.

Price triggers

An increase in the trade-balance surplus.
A better-than-anticipated development in global growth.
Sharp depreciation of the dollar may lead to gradual appreciation of more than 5% a year.

Investment case

We expect the yuan to appreciate gradually against the dollar over the next 12 months. Appreciation of some 5% a year is expected.
For investors whose base currency is the euro, the development of EUR/USD will be highly important for the value of the yuan against the euro.
The Chinese central bank has indicated increased yuan volatility and therefore some periods of yuan depreciation may be seen during the gradual appreciation of the yuan against the dollar.

Risk factors

A decline in the trade-balance surplus may reduce the yuan appreciation. This will also be the case in the event of disappointing global growth.
A period of sharp appreciation of the US dollar. It is not unlikely that such a scenario may lead to a rise in USD/CNY.
Increasing risk aversion.

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