C&C- commodities and currencies

Date:   12/22/2005 1:00:35 PM ( 19 y ago)

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Thursday, December 22, 2005 - Vol. 7 No. 256

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Currencies in 2006



Thomas Fischer, Manager of International Client Relations at Jyske Bank Private Banking, Copenhagen, is a member of the Sovereign Society Council of Experts.

Dear A-Letter Reader:

We are only days away from the new year, but before making any predictions for 2006, let's look back at currencies in 2005.

United States: In 2005 the US was still struggling with a huge trade balance, current account deficits and a zero savings rate. The equity market hardly made any progress, the DJIA was up a measly 0.4% and SP500 4.6%, although many companies showed record earnings. Mr. Greenspan and the Fed however, stuck with the restrictive monetary policy and increased interest rates throughout the year; the fed funds rate is now 4.25%. In 2006 rising interest rates will put a damper on demand and raise corporate sector financing costs. The dollar, however, weathered the predicted 2005 storm and actually appreciated against many major currencies and at the time of writing it is at 87 in trade-weighted terms against 81 at the beginning of 2005.

Europe: We saw further tensions within the EU as both France and the Netherlands rejected the EU constitutional treaty which was later "postponed". London was hit by terrorist attacks but the reaction of the financial markets showed that we are getting used to threats and attacks in the West. The equity markets in Europe showed some hefty gains; Austria was up almost 50%, Denmark 36% and Germany 25%.

Asia:

China made its presence felt as a major player in the commodity markets and is now the world's largest consumer of copper and the world's second largest consumer of aluminum. Consequently, these commodities saw impressive price increases and are up 50% and 24%, respectively.
Japan is at long last winning the fight against the ugly deflation monster and will probably abandon the zero interest rate policy sometime during 2006. The Japanese banks are in a better shape and, for the first time in almost 15 years, are solvent and are upgrading their earning forecasts. The Nikkei 225 increased by almost 40% in 2005, but is still 60% below the record high.

Looking Ahead to 2006

The dollar's status as a reserve currency in line with both the Swiss franc and the Japanese yen, because of historically low interest rates, is now a thing of the past. The dollar now ranks fourth among Western high interest currencies and is joining the group of traditionally high interest currencies, such as the New Zealand and Australian dollars and the British pound sterling. Thus the dollar has become too expensive to speculate against.

United States: Keep an eye on the new Fed chairman, Mr. Ben Bernanke. In 2006, it is vital for dollar investors to keep an eye on chairman Bernanke, as he and the other members of the Fed hold the key to the fate of the dollar. The foreign exchange market is still haunted by Bernanke's earlier unusual statement about dropping dollar notes from helicopters to keep the US economy going. Post-Greenspan, if his monetary policy talents are called into question, I fear that the dollar will be in for a very rough ride indeed in 2006.

Many market participants are still confused and surprised at the performance of the US dollar in 2005 and are just waiting for an excuse to strike back. Deep down there is a fundamental distrust of the US dollar due to the historically high economic imbalances of the US, and the old adage that "you cannot sustain something that is unsustainable" still rings true.

So far, the greenback has been helped by high interest rates and Asian central banks that have been buying dollars as if there was no tomorrow. It is not because they want to save the US, but because they have a vested interest in keeping the US consumer afloat so that he will keep buying their products. There is an unspoken agreement between the US, China and Japan in which the US consumes, China produces and Japan finances the party.

In 2006 you should keep your eye on these currencies:

Japan:
The Japanese yen has depreciated from 104 to 120 in 2005. I expect it to make a strong recovery and move towards 100 in the course of the next 12 months. The impressive rise of the Nikkei 225 and the budding economic upswing ought to have resulted in a stronger yen, but many Japanese investors did not hedge their investments or unwind their existing hedges in the US (by selling the US$/yen). That was because the monetary policy pursued by the US meant significantly higher interest rates and a general dollar appreciation. As mentioned, the Nikkei is still far away from the record high and a potentially good bet would be to buy a Nikkei stock tracker or a mutual fund investing in Japanese shares.

Europe:

Norwegian kroner could become the darling of the foreign exchange markets in 2006. Norway belongs to the exclusive club of creditor nations, plus the country's petroleum fund holds in excess of NOK1,200 billion (approx. US$150 billion) allowing Norway to use its fiscal policy to stimulate the economy (and this will grow year by year as the fund swells) regardless of a general slowdown in the world economy. NOK appreciated 7% against the euro in 2005 and if Norwegian interest rates go up next year, as is generally expected, the krone may be much stronger vis--vis the euro and the US dollar in 2006.

The Swedish krona has always been volatile as the central bank pursues a very aggressive monetary policy. Given the pace of the economy, the krona is very undervalued due to the low level of interest rates and a likely narrowing of the interest rate gap would be very positive for SEK.

Commonwealth Nations: The commodity currencies of New Zealand, Australia and Canada have performed impressively and are all trading at very high levels against the euro and the US dollar. Investors should note, however, that we may see some profit taking and set backs, but high commodity prices and high interest rates of course still support these currencies - but again, watch out.

Emerging markets: Here currencies could experience much higher volatility in 2006, if the Fed continues its interest rate hikes. The tightenings in 2005 have so far been absorbed without any problems, but combined with a potentially stronger US dollar, (although my outlook for the dollar is negative for 2006), we could see much higher volatility. Countries such as Iceland, Hungary and Turkey become increasingly exposed in times of rising global interest rates and their currencies are likely to depreciate against the euro and US dollar.

There are a few emerging market countries that can stand higher interest rates. Their economies are more robust and less vulnerable to monetary tightenings from the US Fed. This is true of Brazil, Poland and Mexico . None of these countries struggle with budget or current account deficits and therefore their currencies will be less volatile over the coming 12 months. In Brazil, a parliamentary election has been called in 2006 which means a potential political risk, although the high level of interest rates still supports the BRL.

In 2006, the markets will become increasingly good at listening until they have familiarized themselves with new Fed chairman Bernanke and his rhetoric. I expect we will see some uncertainty and nervousness resulting in major fluctuations in the market. I am sure we are in for a very exciting time.

Good luck and good hunting,
Thomas Fischer
Copenhagen, Denmark
E-mail: fischer@jyskebank.dk




 

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