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The USD has been on a bull run, strengthening since September, due to favourable interest rate differentials over other currencies. Recently, it rose above the key resistance level of 90.77. This was technically crucial as it coincided with the EUR-USD breaking below 1.1870 and USD-JPY above 117.00. In fact, the USD was so strong that it was not affected by news of the record and massive trade deficit of USD 66.1 bn for September and USD 59.3 bn for August. The market is unsure when the Fed interest rate hikes will end, but as it expects interest rates to increase, the USD appears well-supported in the near-term.
Among the major currencies, the JPY’s performance has been disappointing. We had expected the JPY to further strengthen this year based on Japan’s economic recovery and strong equity market performance, but this has not happened. Several factors have caused the JPY to weaken. Firstly, high oil prices and strong domestic demand have led to a deterioration of Japan’s external trade surplus. Interest rate spreads have also become higher. In addition, Japanese investors have been adventurous in placing their money in other currencies to earn higher yields, increasingly on an unhedged basis. With these developments, we raise our year end forecasts from 108 to 115.
The weakening of the JPY is less of an issue for some Asian cities compared to others. Thailand, Indonesia and the Philippines do not compete directly with Japan for third markets in many industrial sectors. Hence, the weakening JPY is not much of a concern to them. However, Taiwanese and and South Korean goods will be less competitive. Strong market performances in Taiwan and South Korea could also worsen the currency misalignment in the near-term.
In 2006 , we expect a rebound in Asian currencies, and especially in the JPY. The longer the near-term JPY downtrend continues, the greater the potential that the JPY will see a significant strengthening across the board. Fair value for USD-JPY is around 102-103 according to our estimates. JPY is cheap and should boost Japanese exports in future. Furthermore, we expect the Bank of Japan (BoJ) to end its easing; its low interest rates, some time in 1H 2006. BoJ is likely to signal to markets that it will change its monetary policy from easing to tightening ahead of time. Given this, the pullback in oil, the cheap JPY, the likelihood that the Fed will end its tightening cycle by March 2006 and the prospect of increased Japanese investor repatriation ahead of their fiscal year end, we look for a lower USD-JPY particularly in 1Q 2006.
On a broader note, we believe that structural negatives (such as the US trade deficit) will weaken the USD in 2006. This will translate to additional support for major currencies such as the EUR and our call is for EUR-USD to rebound to 1.27 by end-2006. |
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Dollars & Sense
