Investors have become more risk aware in the last few weeks due to the financial market turmoil and we think increased cautiousness is here to stay. This has clear consequences for foreign exchange markets leading UBS strategists to change their forecast accordingly.
UBS analysts have replaced their old 3-month forecast, which reflected a comfort with carry trades, with the old 12-month forecast, which stands for a increasing importance of fair values. EURUSD is now forecast to reach 1.32 in 3 months and then fall even further to 1.25 in 6 and 12 months.
The same considerations apply to other currency pairs. UBS analysts now forecast USDJPY to reach 110 in 3 months, 108 in 6 months and to eventually come back to 112 in 12 months. They also expect the strongly overvalued GBP to depreciate versus the USD to 1.94 in 3 months, 1.87 in 6 months and 1.84 in 12 months, while EURCHF should fall to 1.60 in 3 months, 1.58 in 6 months and 1.55 in 12 months.
There might still be periods when carry trades look promising, but in general we would advise selling into rallies of higher yielding currencies – or else being very selective and preferring fundamentally sound high-yield currencies over macroeconomically challenged currencies. “We call this new theme “respect for fundamentals†and think it will replace the “surge of carry-trades†which dominated currency markets in 2006 and 2007,†note UBS analysts in the latest UBS Investors Guide.
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EUR weaker against USD
UBS expects the EUR to weaken against the USD over the next year. The depreciation should bring this exchange rate to the 1.20-1.30 area, where it was very comfortably set from 2004 through 2006. Since then, many EUR-long positions have been built up, based on the strong economic momentum in the euro zone. Now we expect an unwinding of these longs against the JPY and the CHF, as European growth is topping out and the strongly overvalued rates should correct. This influence should dominate a USD-negative factor stemming from interest rate cuts in the US, which are already reflected in the US yield curve. The US current account deficit will in our view hurt the USD some time in the future, but most probably not over our 12-month forecast horizon. We expect the huge US current account deficit to hurt the USD in times of rising inflation pressure rather than in times of falling inflation and growth. In these times, export-dependent countries like Japan, China, Russia and others will try to stabilize the USD. On the other hand, these countries will also have an incentive to sell USD as soon as it reaches relative strength, which we identify in the 1.20 to 1.25 area. On a very long, i.e. 3-year horizon,
we expect EURUSD to fluctuate between 1.20 and 1.40.
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Mispricing to help the greenback
Updating our USDCHF forecast, UBS analysts now expect USDCHF at 1.21, 1.26 and 1.24 in 3, 6 and 12 months’ time, respectively (their earlier forecasts were 1.20, 1.19 and 1.21).
For now, both the USD and the CHF are benefiting from current financial market uncertainties. We see USDCHF hovering around current levels for the next three months.
UBS analysts expect the Fed to make three interest rate cuts; thereafter we think the USD should be broadly supported by investors looking to correct extreme mispricing in foreign exchange markets. We think one of the results of this larger move might be that USDCHF could move to 1.26 in three months and 1.24 in 12 months. However, we see some risk that USDCHF might stay at the current level of 1.21 for more than 3 months.
UBS have updated their EURCHF forecast to reflect the increased uncertainty following the recent financial market turmoil. We now expect EURCHF at 1.60, 1.58 and 1.55 in 3, 6 and 12 months, respectively (previously 1.68, 1.64, 1.60). As a safe haven currency, the Swiss franc has already benefited from the flight to quality as risk-aversion rose lately. EURCHF fell briefly from 1.66 to 1.62, but later moved up to 1.64.
We expect the downward trend to continue since many investors have lost faith in carry trades. Although we expect Swiss inflation to remain at moderate levels, the relevance of this economic indicator has diminished. In the current environment, we expect neither inflation nor the monetary policy of the Swiss National Bank (SNB) to have a big negative impact on the CHF.
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