Not surprisingly, following the earlier downgrade of the US economy by Jan Hatzius, the firm's FX team has just released its complete list of updated FX projections based on the premise of a slowing economy, i.e., RIP Reverse Decoupling, or the key trope that drive the global economy in H1. As Thomas Stolper says, "The gist of our forecasts implies that the US will experience the largest amount of a slowdown relative to the rest of the world. And this ongoing US underperformance, partly a result of a deep protracted fiscal adjustment, will likely also warrant a prolonged divergence in monetary policy between the US and the rest of the world. These dynamics... underpin our a strong Dollar-bearish view." And here is why Goldman is about to really piss of the BOJ and the SNB, already heavily involved in FX market intervention: "The two main changes we have introduced to our FX forecasts come in response to significant appreciation pressure in the JPY and CHF. For the former, we are revising our $/JPY forecast to 77, 76, 74 in 3, 6 and 12 months, down from 82, 82, 86 previously. For the EUR/CHF, we change the path to 1.10, 1.15 and 1.20 in 3, 6 and 12 months, from 1.23, 1.23 and 1.25 previously. Overall, these changes mean that we forecast that our broad USD TWI will fall by -5.1% over the next 12 months, from –4.3% previously." Alas, it is now fireman hat time as we all prepare for an escalation in the global central banking wars as soon as Monday.
Since our EUR/$ forecast tends to receive a lot of attention, we think it is worth noting that our unchanged forecast of 1.45, 1.50, 1.55 in 3, 6 and 12 months implies a EUR TWI appreciation of 2.7%, so that our EUR/$ forecast is to a significant degree a reflection of our view of broad USD weakness. That said, while additional policy steps in Europe are clearly and urgently needed in Europe at the current juncture, as pointed out by Dominic Wilson in the latest Global Market Views published earlier today, we believe that these will ultimately be taken, reinforcing our view that the 12-month direction for EUR/$ is in line with our forecast.
In the case of $/JPY, three factors drive our forecast change:
- We expect Japan’s trade balance to improve as supply-chain disruptions continue to fade. When we looked at the empirical links between the Yen and Japanese BBoP flows in the 2009 Foreign Exchange Market, we found that the trade flows were important drivers of the Yen. Thus, the improvement in the Japanese trade position is likely to be positive for the Yen.
- Our examination of Japanese portfolio flows shows stronger than usual inflows relative to history. This suggests that the earthquake has changed Japanese appetite for foreign assets. On the assumption that a small proportion of these flows are unhedged, this does point to Yen strength. Less appetite for foreign bonds/repatriation could be a reflection of the need to keep funds at home for the rebuilding effort; therefore, outflows are only likely to increase again once the rebuilding effort is complete. Again, we see this as JPY-positive on our forecast horizon.
- Lastly, a key element of our global forecast changes is the downward revision in our US 10-year Treasury yield forecast, which brings our forecasts for December 2011 and December 2012 to 3.00% and 3.50% from 3.75% and 4.25% previously. We see this as reinforcing our Dollar-bearish bias, also in line with this forecast change. Of course, it is also the case that—as part of all this—the probability of intervention has increased, as highlighted this week by Japan’s first intervention since March. However, the fact that the intervention was unilateral and found little policy support among the G-7 suggests to us that it will not be sufficient to reverse the $/JPY down trend. Fiona Lake has discussed the JPY dynamics in detail in a Global Markets Daily this week.
With respect to our EUR/CHF forecast, we have argued extensively for CHF appreciation but the recent rally has gone beyond our original
expectations. Given the significant appreciation pressures, we recognize the potential for the CHF to rally further in the near term to 1.05. And, of course, if Euro-zone tensions escalate further, parity should not be excluded. This is, however, not our baseline view. Ultimately, we think that European policymakers will take needed policy steps to meaningfully reduce the Euro-zone risk premium weighing on the EUR. As a result, we see the risk premium that weighs on EUR/CHF fading somewhat on a one-year horizon. This will allow EUR/CHF to head somewhat closer towards its ‘fair value’, which our GSDEER model currently puts at 1.44.
Elsewhere, our forecast revisions reflect a combination of weaker growth and a marking-to-market. Notable changes are for the TRY, which we revise weaker on a 12-month horizon ($/TRY from 1.55 to 1.63), reflecting the results of the newly introduced monetary easing by the CBRT.
In Latam, the notable forecast change is for the MXN, which we revise weaker on a 12-month horizon ($/MXN to 11.90 from 11.50) on the back of our downgrading of Mexico’s growth from 4.4% to 4.1% this year and from 4.5% to 3.9% in 2012.
Finally, in non-Japan Asia, our forecast changes generally reflect a marking-to-market in the near term. The exception is India, where we are upgrading our forecast to 44.00, 43.70, 43.00 in 3, 6 and 12 months from 46.00, 46.20 and 47.00 previously, on a more favourable balance of payments, and in particular a pick-up in FDI inflows.
And the summary table: