The Latest EUR Smackdown Comes Courtesy Of BofA, Which Lowers It 2011 EURUSD Target To 1.10 From 1.20
First Goldman came out with a "favorite tactical short" of the EURUSD, targeting a 1.18 rate several days ago, now BofA is out with the latest hit job on the European currency: the bailed out bank's John Shin has said that he is lowering his "forecast for the euro, pushing down the year-end 2010 target to 1.15 from 1.28 and the year-end 2011 target to 1.10 from 1.20." He continues, "the evolution of the crisis has not only been a near-term negative for the euro, but signals poorly for its medium and longer-term future." Now this is very ironic, because as we pointed out two short days ago, the very same firm's European strategist, Hans Mikkelsen, espoused a much different optimistic point of view: "While we continue to view funding pressures as contained due to the
ECB/Fed currency swap lines, the main risk to our tactical long credit
positions remains any disorderly declines in the Euro as that would
undermine the credibility of the ECB to contain the sovereign crisis." Presumably the take home here is that as long as the decline from 1.20 to 1.10 is orderly all shall be well? Because as has been repeatedly demonstrated, hedge funds always align calmly, in single file, when the Central Bank theater is burning, happy to see their sell EUR orders executed if and only if RBS, BofA, Barclays and GS so desire... We eagerly await Mikkelsen's positive spin to Shin's note, as otherwise those defending Europe's less than rosy liquidity situation may be down one more advocate.
In the meantime, IMM COT reports that EUR shorts actually dropped to a 5 week low, down to -93,325 net spec total shorts, from -106,736 in the week before, and down from a record -113,890 in the week edned May 11. With the EUR down to 5 year lows, look for this number to once again reverse toward in a bearish direction.
Full EUR beatdown from BofA:
USD: forecast adjustments for EUR
We have adjusted our core EUR-USD forecast lower, as we believe the euro is likely to push past our previous already-negative targets. As a result, a number of our other forecasts have endogenously moved. However, the only other direct forecast shift we have made is to slightly lower our AUD-USD profile. Our expectations for USD-JPY are unchanged, roughly in the mid-90s range for 2010.
Lowering EUR-USD end of year target to 1.15 (from 1.28)
Our core view of extended euro weakness remains unchanged, but EUR-USD has continued to surprise us on the downside and has moved past our original negative targets. While we remain worried about upside short squeezes, we believe the near-term consequences of the sovereign debt crisis are clearly negative. Markets are still clearly expressing skepticism that the debt crisis has passed even in the short term despite recent improvement (Chart 1). The longer-term impact will likely be quite persistent, as the euro’s status as a dominant global currency has been tarnished. The discord caused by having one currency for countries with such different fiscal policies, bond markets and labor markets will not fade despite the time bought by the EU/ECB/IMF aid package. FX reserve managers, who just last year had been thought to be moving away from the USD and toward the EUR for asset allocation, are now reconsidering such a move. As a result, we have also moved our 2011 forecast target to 1.10.
Shifting other forecasts: GBP-USD, AUD both lower
Our forecasts for other European currencies have moved given our shifts in EURUSD. The largest one is in GBP-USD, which we now expect to drop into 1.40-type levels as the euro goes lower, even though we have left our core EUR-GBP forecast unchanged. We have also pushed down slightly our AUD-USD forecast profile. The crisis has definitely hit risky currencies, but our Australia economics team has pulled back on their RBA expectations, looking for only one more rate hike at the very end of the year. The key forecast that has not changed is USD-JPY, which should stay mired in the mid-90s range in 2010.
The US side of FX markets has been (relatively) boring
The US side of the FX story has been relatively uninteresting. Of course, macro data have taken a distinct back seat during the crisis, but the US macro picture has remained fairly stable. Growth continues to amble along at a post-WWII average of around 3.2%. As a growth story alone, USD should remain the clear outperformer in G4, compared to the hobbled Eurozone, the weak UK, and deflationary Japan.
Meanwhile, as expected by our US economics team, inflationary pressures continue to surprise markets on the downside, and confound fears that the Federal Reserve’s expanded balance sheet will result in USD-negative inflation pressures. Rate expectations are of diminished importance to FX markets at the moment, as our economics team does not expect any of the G4 central banks, including the Federal Reserve, to hike rates this year.
EUR: lowering our forecasts
We lower our forecast for the euro, pushing down our year-end 2010 target to 1.15 from 1.28 and our year-end 2011 target to 1.10 from 1.20. The evolution of the crisis has not only been a near-term negative for the euro, but signals poorly for its medium and longer-term future.
Greece is only the start
While Greek debt was the key trigger to the Eurozone crisis, it also shed light on the difficulty of holding a currency together without a similarly unified fiscal authority, bond market or labor market. Market concerns have now shifted toward the broader periphery. The EU/ECB/IMF emergency package announced in the wee hours of Monday, May 14 attempted to buy time for peripheral countries to get their fiscal houses in order, but otherwise did not directly attack debt problems.
Moreover, the disjointed policymaking process, highlighted most recently by Germany’s unilateral move toward banning certain types of short selling, is also a bad sign for the euro. The need for IMF involvement also shows markets that the Eurozone cannot deal with a crisis without outside help. The tightness of dollar funding in Europe, on fears that the sovereign debt crisis could become a banking crisis, signals that the impact of the debt crisis clearly lingers. As a result, we lower our year-end target to 1.15 from 1.28.
Upside short-term risks for EUR-USD
We remain cautious on near-term jumps higher given the lopsided state of positioning in FX markets and heightened sensitivity to possible policy shifts. Oversized reaction to the rumor that China was considering changing their Eurozone bond holdings, its denial demonstrates the vulnerability of currency markets of substantial short-term moves. Thus, we lower our short-term forecast for the end of Q2 from 1.32 down only to 1.26.
Downside risks definitely still lurk
The major downside risk, in our view, is the possibility of debt restructuring. Even now, policymakers have been denying that any forced debt restructuring was even contemplated, as they clearly understand that such a move would be another major short-term market negative. However, ultimately buying time for three years may prove to be insufficient to fix the periphery’s fiscal problems.
Pushing year-end 2011 forecast to 1.10 from 1.20
Our more skeptical view has also led us to push our longer-term 2011 year-end forecast from 1.20 down to 1.10, as we do look for a more extended decline. Elevated wage and price levels in the periphery (Chart 2) point to both a grinding disinflationary environment and the need for a lower currency to regain competitiveness. Moreover, the crisis has more definitively eliminated the euro as a substantial competitor to the USD in terms of being a dominant international reserve currency. FX reserve managers, who have been a key feature in the euro’s previous rise, will likely be far more cautious in allocating assets toward the EUR.
And for JPY fans - bad news: BofA goes all friendo on the yen as well.
JPY: gradual downward trend
The JPY is likely to remain choppy in the immediate period ahead given remaining risk aversion, and then enter a gradual downward trend from midyear. If, as we expect, risk aversion originally triggered by the European sovereign crisis begins to subside relatively soon, rather than persist and undermine global growth prospects, the JPY should restore a gradual downward trend. Improving risk appetite should foster Japanese investors’ unhedged capital outflows and JPY-funded carry trades.
However, subdued US rate hike expectations will probably limit the upside for US market rates, so we expect only gradual USD-JPY gains in coming months. Late in H2 2010, wider US-Japan yield differentials on expectations of an eventual Fed tightening should make it easier to recycle Japan’s current account surplus with unhedged capital outflows. The BoJ is likely to be the last G10 central bank to begin hiking rates over the next 12 months, so the JPY should be popular as a funding currency.
Still-fragile US rate expectations in the near term
Although the recent “crisis mode” has strengthened correlation between JPY crosses and risk aversion indicators, there remains a stable relationship between USD-JPY and US-Japan yield differentials (Chart 3). In view of the downward forces on US growth and inflation from the European crisis, market expectations of US rate hikes have recently retreated significantly. Our US economics team does not expect a Fed funds rate hike until August 2011. Until a receding of the crisis mode leads to expectations of the Fed’s eventual liquidity withdrawal and an FOMC statement language change, the room for rises in US yields should be limited. Therefore, we expect only a gradual upward trend in USD-JPY.
BoJ basically on hold throughout 2010
The BoJ is likely to maintain its current accommodative stance this year. It will shortly introduce a special liquidity provision scheme to support bank lending to selected growing industries. However, a bold quantitative easing is not likely. Over the next 12 months, the BoJ will probably lag behind other G10 central banks in rate hikes. This should leave the JPY as the most attractive funding currency with the lowest short-term rates in the G10 over the next year.
More capital outflows over the next year
The likely passage of the postal services reform bill ahead of the July Upper House election should be medium-term JPY negative as well. Expected shifts of conservative retail investors to postal savings from regional financial institutions, in anticipation of implicit government guarantees, will probably boost portfolios for the Japan Post Bank (Yucho) and Japan Post Insurance (Kampo) in the next several quarters. Both are giant JPY-funded institutional investors and significantly under-diversified at present. Comments from Internal Affairs Minister Haraguchi and Financial Services Minister Kamei, as well as the Japan Post Insurance’s asset allocation plan, suggest a positive stance toward foreign bondinvestment. Thus, they could become stable JPY sellers for the medium term.
BofA doesn't stop there: the momentum chasers also have an "opinion" on the GBP, the CHF, the NOK, the SEK, the CAD, and of course the AUD and the NZD. Full report here.