EURUSD toppish at $1.38 says UBS

The USD set historical lows against the EUR but then reversed course as US yields shot up. While milder risks in the US bode well for global growth, the USD is still under pressure and has the potential to cause global waves. This could be negative for carry trades but is unlikely to truly reverse the tides, according to UBS Investor’s Guide, dated June 22, 2007.

The fundamental factors that have been keeping EURUSD range-bound have not changed. However, with some indications that the US economy is rebounding, markets are happy to buy the USD at what is still, by historical and purchasing price parity standards, quite attractive levels. While May 2007 set new highs for the EUR, it also stayed within broad ranges. The market is jubilant about prospects in both the US and

Europe, but the possibility for disappointment is much more likely from North America, where housing markets continue to pose a threat.

“As we now expect the Fed not to start cutting rates before December, the USD will creep back up, with 1.36 likely in three months and 1.38 emerging as the New Year approaches,” note UBS analysts who nevertheless add that EURUSD near 1.40 is unsustainable, as the euro zone will feel the pain of strong exchange rates and investors will unwind EUR positions, pushing the pair back down.

A slowing US economy has repercussions for risk appetite. However, with UBS global forecast for moderate inflation and growth, a softer US does not constitute a dramatic threat to risk-seeking. Carry currencies are increasingly out of line with traditional

assessments of equilibrium rates. The Reserve Bank of New Zealand’s intervention to limit NZD appreciation confirms other policy makers’ threats; markets are demanding too little compensation for risk.

 

USDCHF: UBS analysts forecast and expect USDCHF to be at 1.24, 1.20, 1.23 in 3, 6 and 12 months’ time respectively (previous target was 1.20 for the next 12 months.). In the short term UBS analysts expect CHF weakness to continue, as they still do not see any reasons for an unwinding of carry trades as long as the current risk-loving environment persists. As soon as the US economy starts to decline as a consequence of the slowdown in the housing market, USDCHF should move down to 1.20. The CHF will benefit from this situation as investors will look for safe haven currencies. Then the Fed will cut interest rates, which will help the US economy and at a later date also the USD. At this point USDCHF could move up slightly.

 

USDJPY: The upward trend remains intact from a technical viewpoint. UBS analysts are looking for a test of the resistance at USDJPY 125. Higher levels would force the market to price in a hike by the Federal Reserve, which UBS analysts do not expect. “We also remain skeptical regarding central bank interventions to stop JPY weakness. However, levels above 125 would lead to rumors on the market. USDJPY levels around 130 would in our view spur the central banks into action or at least prompt comments,” UBS analysts noted.