Credit Suisse's currency outlook

Is it time to go long yen, and short dollar?
I am near-term bearish on the US dollar, but still expect a recovery longer term. Two primary drivers - the US dollarÆs favourable valuation versus European currencies, and its historically strong interest-rate advantage û should continue to be regarded as positive factors for the greenback on a 12- month horizon, in my opinion. I have therefore significantly revised my 12 month forecasts for the major currencies and presume that the US dollar may be weak short-term, and on a 12-month view, will succeed in holding the ground it gained in 2005, but not go higher.

The expected resumption of the interest-rate-hiking cycle by the US Federal Reserve once the upcoming pause has finished, should help preserve the dollarÆs interest-rate advantage versus other major currencies, with any nearterm erosion of this advantage likely to be reversed on a 12-month view. For the time being, however, I would be cautious on the dollar. The major reason for this û apart from the market action itself û was the recent statement issued by the G7.

This was interpreted by markets as suggesting that a generally weaker US dollar would resolve the problem of global imbalances û even though the G7 may have been referring only, or mainly, to the currencies of the emerging economies in Asia (in particular China). The G7 statement also suggests that among the major currencies, the Japanese yen should remain strong.

But if it gets too strong, or moves very rapidly, Japanese officials may try to halt its rise, at least via statements. The question is how investors should position themselves in this difficult market environment.

I have closed my recommended trade to buy the US dollar (USD/CHF, EUR/USD, GBP/USD) with a loss and would not advise taking any new long positions in the greenback against the prevailing negative backdrop for the dollar. I would not build up any strategic long positions in the dollar until clear signs emerge that the US currency has bottomed out.

Next move by the Bank of England on the interest rate front is a hike
I have long since anticipated that the Bank of England (BOE) would refrain from cutting interest rates. Recent economic indicators in the UK have not only confirmed my expectations, but also revealed the risk that an interest rate hike could be on the cards in 2006. Robust purchasing managersÆ indices and the noticeable recovery of growth in the euro area providing impetus for British exports, as well as renewed increases in housing prices, all speak in favour of an initial rate hike by the BOE in the second half of this year.

Hence, the British pound will likely remain a high-interest-rate currency within Europe. Although the pound is still overvalued compared with most major currencies and the UK registers a current-account deficit, the outlook for a rise in interest rates should underpin the British currency.

Structural weakness of the Swiss franc is not an issue at present
The Swiss franc has gained substantial ground against the euro in the wake of the favourable macroeconomic data released in Switzerland and the focus by the financial markets on global imbalances, as well as the recent comments by Swiss National Bank Chairman Jean-Pierre Roth. He stated that accelerating depreciation of the Swiss franc would lead to easing of monetary conditions and accordingly prompt a reaction from the SNB.

I have therefore revised my threemonth forecast to EUR/CHF 1.55 because the risk-adjusted carry has also declined markedly with the rise in volatility. But since the inflation prospects in Switzerland remain favourable û notwithstanding the high crude-oil prices - I do not expect any pick-up in the interest-rate-hiking cycle in Switzerland compared with the euro zone.

Consequently, the interest-rate differential will likely remain at the current level in the next 12 months. While the absolute interest-rate advantage of the EUR minus CHF favours the single European currency, I do not anticipate any structural weakness of the Swiss franc, particularly in light of valuation considerations, which indicate the fair value of the EUR/CHF rate at below the 1.50 mark.

Commodity currencies: Canadian dollar advances, but Australian dollar still favourite
The Canadian dollar has continued to gain ground against the US dollar, climbing to its highest level in nearly 30 years. My recent recommendation - to buy the Australian dollar against the Canadian dollar - has realised a gain of roughly 1%. I advise keeping this trade open and raising the stop-loss to 0.84.

Australia continues to reap considerable benefits from ChinaÆs robust appetite for commodities and the sharp spurt in metals prices. In addition, the Reserve Bank of Australia has surprisingly hiked its key interest rates by 25 basis points to 5.75%.

Meanwhile, in New Zealand, I continue to recommend reducing positions in that countryÆs currency. The New Zealand dollar remains overvalued, the interest rate-hiking cycle is over, and the high current-account deficit still lingers. I therefore recommend selling the NZD/CHF, with a target rate of 0.71 and stop-loss at 0.81.

Norwegian krone and Swedish krona hold appreciation Potential
Despite the strong advances racked up by the euro recently, both of the Scandinavian currencies, the Swedish krona (SEK) and the Norwegian krone (NOK), managed to gain ground against the single currency. I am sticking to my forecast calling for the gradual appreciation of these two currencies versus the euro and am revising my exchange rate profile for the EUR/NOK accordingly.

Robust economic growth, high current account surpluses and a continuation of the moderate interest-ratehiking process point to a strengthening of the SEK and NOK from a fundamental perspective. My recommended trade - to buy the Norwegian krone against the New Zealand dollar (NZD) - did not reach my set entry level of 0.2460, which was below the spot price of 0.25.

Nevertheless, since publication, the NOK has outperformed the NZD by roughly 5%.

The above article is reproduced from the Summer issue of Asian Private Capital, a supplement to FinanceAsia magazine.
¬ Haymarket Media Limited. All rights reserved.
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