Goldman's EURUSD Forecast Is Now Most Erratic Ever

One of the classic comedy themes of the year has been Goldman's series of failed recommendations on the EURUSD, where the hedge fund has had about a 1 out of 10 "success" rating (for its clients). Today, the Markets Strategist Mark Tan recaps the firm's 3, 6 and 12 month forecast on the EURUSD, which are, conveniently, 1.22, 1.35 and 1.38. That's like saying the S&P will be in a range of 950 to 1500. At least the firm is sure to "hit" its projected range.... And be sure to watch that major inflection point some time in December which send the dollar sharply lower: is Goldman implicitly saying the "real deal" QE will now come around New Year's, just after the elections and just before the government has to raise the debt ceiling regardless? One thing we agree with, as we have long claimed: look for strikes and other expressions of non-appreciation to spike once everyone is back from vacation. As Goldman says: "One of the main reasons we incorporated downside risks to our EUR/$ forecast (1.22 in 3-months) is to reflect the potential for rising political tension again. This could potentially occur as Europe returns from its summer lull and is confronted with the reality of unpopular austerity measures." What are the InTrade odds on CNBC broadcasting the next storming of the Greek parliament?

Below are the arguments for firm's broad projection range:

 EUR/$--Watching Long Rate Differentials and CDS Spreads

In the period of QE announcements from late 2008 through the first half of 2009, EUR/$ was tied into a very tight correlation with the US-Eurozone rate differentials at the long end. This is unsurprising given rock-bottom front end rates left long rates reflecting most of the perceived impact of the QE measures. As Francesco Garzarelli highlighted in the Aug 11 Global Market Views, we see a further 20bps 10y swap spread widening by early next year, which should underpin upside support for EUR/$ into year end. This is in-line with our EUR/$ forecast of 1.35 in 6-months and 1.38 in 12-months, essentially reflecting our view of relative Eurozone vs US growth differentials. We have Eurozone forecast to grow at a faster clip relative to the US over the next few quarters, which is even more significant if you consider the assumed higher trend growth rate in the US. Relative BBoP fundamentals also continue to favour the Eurozone.

But we do see near term risks for the EUR. One of the main reasons we incorporated downside risks to our EUR/$ forecast (1.22 in 3-months) is to reflect the potential for rising political tension again. This could potentially occur as Europe returns from its summer lull and is confronted with the reality of unpopular austerity measures. We are seeing again some noise on this front in recent days with the EUR being weighed upon with news headlines such as possible Spanish deviation from fiscal austerity measures. It is interesting also to note that sovereign CDS spreads in the European periphery has also started to creep back up in recent weeks. This is something that we will be paying close attention to in coming months. For now, we think our EUR/$ forecasts of 1.22, 1.35 and 1.38 in 3, 6 and 12-months adequately reflect the balance of risks and current views.

Overall, Goldman sees the start of QE season as broadly negative for the dollar. Yet, if John Taylor is right, and he has been pretty spot on in his predicitions over the past 6 months, to think that Europe won't be hot on the heels with its own version of QE, once the downward economic inflection point is hit, is rather naive.

Potential QE2 and Implications for the Dollar

Tuesday’s FOMC meeting produced a dovish statement and the announcement to reinvest MBS proceeds. Risk assets reacted relatively well initially to the prospect of easier financial conditions while the Dollar also weakened broadly initially. However, the risk bounce and Dollar sell-off was short-lived as global growth slowdown fears were thrust firmly into the spotlight. This was led by some softness in the Chinese activity and broad money data, while the build up of short USD positions over the last few weeks (as indicated by the latest IMM positioning report) also contributed to the sharpness of the broad Dollar rally. Of our current tactical trade recommendations, our short $/SGD trade and to a lesser extent long AUD/CAD has suffered from this correction, although we are still above our entry points on all of them. These trades are geared to our main themes of broad USD weakness (short $/SGD and short $/CNY) and the differential exposure to US slowdown risks (long AUD/CAD and long CLP/MXN) which we have structured deliberately in a more risk neutral fashion given the heightened uncertainties. Overall, we think the current global macro and policy backdrop is still one that is supportive of broad Dollar weakness for the rest of this year, albeit with risks.

Taking a quick flashback into the US QE specifics, the Fed first announced the beginnings of the original QE plan back in November 2008 with the initial asset purchases (up to $100bn in GSEs and $500bn MBS). This was followed up in March 2009 with the announcement of additional $750bn in MBS, $100bn in agency debt and $300bn in long term USTs. The most recent FOMC announcement is a ‘baby step’ towards more QE in the not too distant future. Our US team’s expectations are for asset purchases (and to have a meaningful impact total at least $1 trn) by the end of this year or early next year, as the unemployment rate potentially creeps back up to 10% again.

As we have discussed in our previous research, additional QE and the impact on FX can be broadly assessed along the lines of the typical currency weakening impact of additional monetary easing. So in other words, the specter of potential QE should weigh on the Dollar, as we explain further below. The risks though are of a sharper US slowdown (than even our cautious baseline views) and signs of softness in other parts of the world that essentially raises market fears of ‘recoupling’. In this case, broader risk aversion and a more symmetric growth shock would likely lead to broader USD strength following the still persistent cross-asset correlations. But this is not our base case view. In particular, we expect firmer signs of a move towards policy easing in China---our China economics team has flagged recently that subtle shifts are already underway.

Overall, our baseline views of a weaker US (but no ‘double dip’), relatively stronger rest of world (led by China as domestic financial conditions ease sequentially—see Mike Buchanan’s Aug 9 Asia Views), unsupportive US BBoP fundamentals and now a potential shift into QE again by the US, should all argue for broad Dollar weakness for most of our forecasting horizon.

Comments

[Moonrajah]

So Goldman is actually saying, that in 3 months time Treserve Sachs LLC will let EU suicide itself, and later on they will bring similar pain to the other side of the Atlantic. After all, fair is fair.

[fiddler_on_the_roof]

Yes. January 2011 onwards should be a bad time for dollar + stocks.

[LeBalance]

lol: everyone has to "come back from vacation" to find their country and lifestyle raped and then "go on strike" to show their displeasure.  Ummm....but only on cool days and there are coffee breaks on this "protest" deal, right? /sarcasm OM/

[newstreet]

I just bought the new low on the week.

[DavidC]

I would sooner be a holder of Euros than Dollars even if the Dollar is still 'the Reserve currency of the World'.

Even with the spectre (English spelling) of the Greek and other potential defaults, Germany is still VERY strong. The ECB has resisted throwing the baby with the bathwater as far as QE (I hate that term, why don't just call it what it is, making money out of thin air) is concerned, more responsibly in my view. And interest rates for the Euro are still higher than the Dollar.

I think at some point there is going to be a disjunction between the Dollar and other currencies, where people will be spurning it as a currency even while there is deflation occurring (stock markets falling). That's where the fun would start (start?!).

DavidC

[i-dog]

QE (I hate that term, why don't just call it what it is, making money out of thin air)

Why not call it what it really, really is: counterfeiting?!

[Sherman McCoy]

Goldman many be the most outspoken, but they wern't the only flip floppers who were wrong. Citi was adament 1.30 was a top advising all their clients to get short, then when we printed 1.31, they were adament we'd get to 1.35 and suggested getting long. Never got the call saying they'd stopped themselves out.

Let's face it, the street is like a shill at a casino, the only thing they're any good at is taking the vig when you place a bet. It's just like the line from Mortimer Duke in "Trading Places"; "At Duke and Duke, whether our customers make money or lose money, we always get a commission."

[Paper CRUSHer]

MISSION STATUS UPDATE 10:

"SERGEANT TYLER,......... FXLaunch Trajectory reading comin'n SIR......."

"...mark...one.......... two two,one.....three five....one.....three....eight,SIR"

"WHAT WAS THAT AGAIN"

"REPEAT,mark 1.22,1.35,1.38"

"Shit Serg'.........thats bullshit sir",

"Hey Private.....GET YA SORRY LOOK'N ASS OVER HERE"

"HEY TROOPER LOOK AT ME WHEN AM TAKIN' TO YOU"

"HOW LONG HAVE YOU BEEN WITH THIS OUTFIT TROOPER?"

"Sir not long....served as strategist while serving time with the Goldman Sachs FX Militia
Force"

"I see,t'was one o' ya boys who gave a mark....1.15FX EURO/USD reading a few weeks ago?"

"Yes sir"

"Corporal, show our new recruit what we do to soldiers who relay inaccurate readings the ol' fashioned way"

"Affirmative Sir.OK MEN I WANT OUR NEW RECRUIT BLINDFOLDED AND PLACED WITH HIS BACK AGAINST THE WALL"

"Corporal....CORPORAL,HAND ME THAT OL'PAULSON BAZOOKA"

"YES SIR"