FX winners and losers

FX winners and losers

Emerging market currencies still look attractive, according to currency analysts,
but many of the majors may have already made their runs vs. the U.S. dollar.

The U.S. sub-prime mortgage credit crunch debacle will most likely go down as one the most important financial market themes from 2007 — and the full financial ramifications for many of the major lending institutions involved are still unknown.

That news drove financial-market volatility levels sky high, especially in mid-August and in November. Forex traders dumped carry trade positions as volatility peaked, but shifted back into these higher-risk trades when it decreased. Despite proclamations that the carry trade was dead, traders will most likely continue using the strategy in 2008, especially if volatility moves lower.

The U.S. dollar continued the bear trend that has dominated the currency since 2002. Action in the U.S. Dollar Index (DXY) was basically a oneway street in 2007, as that index hit an all-time low around 74.75 in November (Figure 1). Into year-end, however, some interest in buying the U.S. currency emerged.

The big winners in 2007




The Brazilian real (BRL) remained smoking hot in 2007, as bullish interest-rate differentials attracted carry trade money from around the globe (Figure 2). The real chalked up gains around 18.75 percent vs. the U.S. dollar (all data as of Dec. 19.)

The Canadian dollar (CAD) placed second in the currency appreciation contest last year, gaining nearly 16 percent vs. the U.S. dollar (Figure 3). The dollar- Canada pair (USD/CAD) dipped below parity (1.00) for the first time in decades — meaning the U.S. dollar was worth less than the Canadian dollar.

Third in the line-up was the Swedish Krona (SEK), which gained 11.75 percent vs. the greenback (Figure 4). The Australian dollar (AUD), bolstered bycarry trade action and strong global commodity demand, posted an 8.81-percent gain vs. the U.S. dollar.

The euro, which made new all-time highs last year and came within a penny of the historic $1.50 level in late November, came in fifth place with gains around 8.75 percent vs. the dollar.

For currency traders, of course, the most important question is whether any of these trends will continue, and which currencies will emerge as winners and losers in 2008.

The 2008 playing field

In speaking to a variety of forex market strategists, several key themes emerged.

Assessing global economic activity is the first step in understanding where key currency moves may lie in 2008. After posting global gross domestic product (GDP) growth around 4.5 percent in 2007, most economists are forecasting a global slowdown in 2008, with projections around 4.0 percent. Dislocations from the credit crunch are one factor behind the downsized global forecast for this year.

Economists, however, highlight the potential for an asymmetrical type of slowdown, with weakergrowth seen in the G4 (the U.S., Eurozone, UK, and Japan), while emerging markets continue to plough ahead.

David Wyss, chief economist at Standard & Poor’s, predicts growth in the U.S., Japan, and the Eurozone to be around 2 to 2.5 percent in 2008 vs. projected 10-percent GDP growth in China and 9.5 percent in India. Jay Bryson, global economist at Wachovia, notes that while slowerglobal growth is expected by most, 4.0 percent is still slightly above the 3.7-percent average of the last 35 years.

Bryson’s research team at Wachovia is not calling for a recession globally or in the U.S.

Nonetheless, “the risk over the next two quarters for the U.S. is not insignificant,” he says.

Economists say the first half of 2008 is crucial for the U.S. — a period when recessionary conditions could develop, although for now most are calling for a narrow miss of negativegrowth.

Emerging market stars

Almost uniformly, economists and currency strategists heap praise on several emerging-market countries. Despite the dislocations occurring in financial markets amid the credit crunch, emerging markets are holding their own.

“I do see some of the emerging market countries remaining steady vs. a decade ago, when they were the catalyst for a lot of global jitters,” says Charmaine Buskas, senior economic strategist at TD Securities.

“It would surprise me if a wave of crises [breaks out] across the developing world,” echoes Wachovia’s Bryson. “The fundamentals of these economies are stronger than they were 10 years ago. I do believe [emerging economies] can punch above their fighting weight in their contribution to world growth.”

Michael Woolfolk, senior currency strategist at Bank of New York Mellon, agrees. “2008 will be a good year for emerging markets via economic growth, foreign investment in their economies, and the strength of their respective currencies,” he says.

However, Woolfolk says this is contingent upon the Bank’s baseline scenario, which assumes the U.S. will not have a hard landing and that financial markets on a global basis will be orderly.

Watch the BRICs

Woolfolk points to the BRIC countries (Brazil, Russia, India, and China) as possible forex winners

in 2008.

“These four countries represent some of the fastest growth among emerging markets and have very strong exports,” he says.

Woolfolk forecasts roughly 5 percent appreciation in the Brazilian real, Russian ruble, and the Indian rupee vs. the U.S. dollar in 2008. He sees potential for a 10-percent gain in the Chinese

yuan this year.

Rate differentials are always key

Regarding the Brazilian real’s doubledigit gains in 2007, Enrique Alvarez, head of Latin American research at Ideaglobal, says it was basically an interest- rate play.

The Brazilian selic rate (the country’s central bank lending rate) currently stands at 11.25 percent and has a steady outlook. While the U.S. federal funds rate is currently at 4.25 percent, widespread expectations are for two or three 0.25-percent cuts over the next several quarters.

Alvarez expects global forex traders to continue playing the carry-trade interest- rate differential strategy in the first half of 2008, with a bullish edge predicted for several Latin American currencies. He points the real, the Columbian peso (with rates at 9.50 percent), and the Chilean peso (with rates at 6.00 percent and rising) as top contenders for the carry-trade strategy.

“A very big determinant is what the Fed does, and we suspect they will go lower,” he says. “[In early 2008], I think the thrust of momentum in investment will be in favor of these currencies. It looks like foreign investors will continue to view Brazil in particular positively. At least initially there will be some upside.”

Asia Currency strategists also point to Asian currencies as likely winners in 2008. “Asia looks quite good simply because they have very strong structural underpinnings and have gone to mostly current account surpluses,” TD Securities’ Buskas says.

Wachovia’s Bryson agrees the outlook is bright for Asian currencies.

“The governments have an interest in having their currencies appreciate,” he says. “Economic fundamentals and politics point in that direction.”

Asian currencies also are poised to benefit from an unsteady dollar.

“There is the expectation the dollar will remain broadly weak, and the Asian currencies will bear the burden of adjustment,” Buskas says. She says “top tier” Asian currencies, from countries such as Japan, Malaysia, and Thailand, are those likely to see the most upward adjustment.


The majors

Noticeably absent from the potential winners list are any of the major currencies. Buskas sees limited upside potential for currencies such as the Canadian dollar, British pound, and euro.

“These currencies have had their rallies,” she says. “They’ve had their day in the sun.”

Nonetheless, there has been quite a bit of market chatter about the potential for a major reversal in the U.S. dollar during 2008.

Is the dollar bear being tamed?

“The big theme of the year could be the reversal of the U.S. dollar cycle,” says Vassili Serebriakov, senior analyst at 4Cast Inc. “The dollar has been in decline since 2002 and we could see a big reversal in that trend.”

Standard & Poor’s Wyss is forecasting three more quarter-point cuts in the fed funds rate, with a bottom at 3.50 percent in mid-2008.

“That means the dollar will continue to decline until the Fed stops loosening or the ECB starts loosening,” he says.

Wyss and others expect the European Central Bank to pull the trigger on a rate cut possibly in June, with another potential rate cut towards the end of the third quarter. The European
repo rate currently stands at 4.00 percent.

In the early part of 2008, most strategists expect continued U.S. dollar softness as the weak economic picture unfolds, with potential for a reversal around mid-year.

“This time last year we were thinking the downturn in housing would be shallow,” Buskas says. But there’s still a long way to go for the U.S. before it gets back on its feet.” Nonetheless, some argue the bear is, perhaps, being tamed.

“I think the major move in terms of the dollar has already happened,” says Kathleen Stephansen, director of global economic research at Credit Suisse. “I don’t think we will see that same type of weakness. The rate of depreciation will be slower.”



A euro top




Several strategists forecast near- to medium-term strength in the euro/dollar pair to around 1.55, with the euro stalling and reversing around that level (Figure 5).

Serebriakov forecasts a three-month target of 1.55, a six-month target of 1.50, and a 12-month target of 1.40.

Jamie Coleman, managing editor at Thomson FXHub.com, was much more optimistic on the prospects for the greenback in early 2008.

“I think we will see a reversal of what we saw in 2007,” he says. “The sub-prime crisis/credit crunch will ultimately impact Europe more severely than the market realizes now. If you look at their housing situation, there is anecdotal evidence there are more new houses for sale in Spain than there are in the U.S. There are 40 million Spaniards and 300 million Americans.

“I think the dollar will do better. It is no longer a one-way street. I think the dollar will be one of
the biggest winners as we see a big reversal of the weak dollar trend, which will come primarily vs. the euro and British pound. The fear of wholesale liquidation of the dollar has all but died.”

Coleman forecasts a dollar-bullish 1.37 euro/dollar price at the end of first quarter.

“We’ve been tested and we’ve seen the worst,” he says.



The pound




Many currency watchers have turned sour on the prospects for the British pound in the wake of the sterling’s historic rally above the $2.00 mark in 2007. The last quarter of 2007 was disastrous for the pound, as the currency fell precipitously vs. the greenback (Figure 6).

But many say the sell-off is just beginning, arguing the UK economy is very exposed to global housing and credit stress and the potential exists for rate cuts from the Bank of England.

Brian Dolan, chief currency strategist at Forex.com, says the pound is one of this year’s potential big losers.

“They are facing a housing bubble,” he says. “The strength from the UK economy over the last decade has come from the financial sector and the housing sector. Now, both sectors are under pressure.”

Dolan sees the pound continuing to retreat toward 1.90-1.80 in the year ahead.


Many ifs remain

“There is a lot that depends on global themes and how fast the credit market returns to normal,” 4Cast’s Serebriakov says. “That is the biggest risk going forward, and I don’t think anyone can give you a confident estimate of when that will happen.”

Forex.com’s Dolan adds, “this is definitely one of the most uncertain environments at the start of a year that we’ve seen in many years, and that makes long-term forecasting very difficult.”



BY CURRENCY TRADER STAFF

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