While Goldman continues to resolutely predict that the EURUSD will any minute now go back to 1.50 (and 1.55 in 12 months or so), Morgan Stanley has for once decided not to ape its far more capable and client "fornicating" competitor Goldman and has thrown up all over the EUR, slashing its EURUSD forecast "significantly lower" to 1.30 by year-end and 1.25 in Q1 2012, before stabilizing in the second half of next year because the now second rate bank believes that "economic, political, constitutional and monetary policy developments in Europe have now become more challenging for the EUR, while international support is likely to decline." Its conclusion: "As a result, the EUR's attraction as an alternative reserve currency is likely to be reduced." So, let's do the math: EUR: not a reserve currency? Check. CHF: not a reserve currency? Check (and pegged to the former). USD: about to be gang banged by the windowless corner office at the Marriner Eccles building housing America's central planners? Check. So.... what is left if one is looking for a reserve currency?
We have revised our EUR forecast significantly lower, and we now expect EURUSD to decline to 1.30 by year-end and 1.25 in Q1 2012, before stabilizing in the second half of next year. We have also taken our forecast for the EUR crosses lower in most cases. Indeed, we believe that economic, political, constitutional and monetary policy developments in Europe have now become more challenging for the EUR, while international support is likely to decline.
Within Europe, we view recent developments as highly significant for the EUR. The less hawkish tone of the ECB, the resignation of Stark from the ECB Executive Board and the German Constitutional Court ruling all add to the already deteriorating economic and fundamental picture in Europe in our view, pointing towards a weaker EUR.
Following the more dovish tone of the ECB at last Thursday's press conference and the resignation of ECB member Stark (Stark was seen as the most hawkish member of the ECB) we expect the EUR will become more exposed to negative events and data as market rate expectations will likely adjust more readily. Indeed, traditional interest rate and yield models are now suggesting that EURUSD is set to move sharply lower (our relative EU-US yield curve model is generating negative EURUSD signals).
The ECB bond purchases are also leading to an expansion of the ECB's balance sheet, which will undermine support for the EUR, especially given that the Fed’s balance sheet has now stabilized. As a result, the EUR's attraction as an alternative reserve currency is likely to be reduced.
Moreover, while the fundamental picture for the EUR has deteriorated, internationally supportive flows, which provided the EUR with protection from negative news over recent months, appear to have started to decline. The EUR has been one of the major beneficiaries for Central Banks’ FX reserve diversification programmes. However, evidence of a global slowdown suggests that the pace at which central banks accumulate reserves will slow.
Indeed, FX reserve accumulation is closely correlated to global growth and trade. In the case of China, the acceleration in the pace of CNY appreciation is another factor pointing towards a slowing of currency reserve accumulation. This implies that central bank reserve diversification will also slow, resulting in a reduction of EUR buying from this source.
We expect the anticipation of a global slowdown will have a broader impact on currency markets over the remainder of the year and the beginning of 2012, which will put the pro-cyclical and commodity currencies under pressure more generally, before stabilizing in the second half of 2012. We forecast the AUD to undergo a more significant setback to 0.99 against the USD for year-end with a further decline to 0.95 in Q1 2012, from where a gradual recovery would be anticipated.
GBP is expected to feel the effects of the global slowdown, especially if this is accompanied by a more challenging global investment environment. Hence, we have revised our GBPUSD forecast lower to 1.53 for year-end and 1.51 for Q1 2012. The economic picture in the UK is also deteriorating rapidly with the BoE appearing to be shifting more towards the dovish side. Indeed, the QE discussion in the UK is gaining momentum. There is also evidence that safe haven flows into the UK Gilt market have declined, reducing support for GBP.
As far as the CHF is concerned we expect the SNB to maintain the 1.20 EURCHF floor through to the end of the year, but believe the risk is for this to give way early next year as the broader downward pressure on the EUR builds.
Overall, we expect the USD to regain ground. A lack of safe haven and alternative reserve currencies suggest that the USD will move, at least temporarily, back into favour. Hence, a moderate recovery for the USD is now projected with the MS Dollar Index (MSDI) forecast to rise by 2.4% going into the year end and 4.4% by 1Q 2012.