NEWS / Foreign Exchange

US dollar reaches record low vs. Euro

• SNB expected to hike interest rate

• EUR/JPY reverses before it hits old highs

US dollar

The euro hit new highs in mid-month vs. the USD. However, trading failed to be sustained over the level of EUR/USD 1.43 and the euro weakened as a consequence slightly to 1.42 USD. However, there was no further correction of EUR/USD after the significant increase since September. At present, the market is testing how bad sentiment really is for the US economy. The data for the US real estate market are fuelling insecurity, but at the same time, the current (record) level of the EUR/USD is making investors cautious.

The latter is even truer, considering that the other economic data are not indicating any imminent recession in the US. The latest data from the labour market as well as retail sales are still pointing to a growing economy in the US. By contrast, the data released up to now for the housing market for September were bad, and neither is much good news expected of the data to be released. However, we believe that the data for September is distorted, as the turmoil on financial markets in August definitely burdened the real estate market. Thus, even though there is no doubt about the further need for correction on the US housing market, the pace of the downswing should slow versus the September data. The assessment of the real estate market will be a major factor for the interest rate decision of the US Fed on 31 October. After the interest rate cut in mid-September by 50 bps, we do not expect any change to key lending rates in the US for now. Interest rates will be cut again only as of December. As regards the real economy, it does not make any difference if the cut comes six weeks earlier or later. The upcoming interest rate decision will depend on what the central bank wants to signal to the markets. Another interest rate cut already at the end of October would imply that there is major insecurity prevailing at the Fed, thus influencing expectations regarding the future pace of interest rate cuts. We do not believe that the US Fed will want to send such signals, especially not before a backdrop of a very weak USD. Regardless of the outcome of the meeting, stronger fluctuations of the EUR/USD exchange rate seem likely as a consequence. Until the end of the year, the USD should remain at a low level, but by then, a crash scenario for the US economy should have become less likely.

Swiss franc

On 11 October, the EUR hit a new high versus the franc at a level of over 1.68 EUR/CHF. Then the franc received verbal support from the Swiss central bank. SNB President Roth made it clear that the interest rate hiking cycle in Switzerland is possibly not over yet. The market had viewed the probability of a further interest rate hike as very low after the last hike and due to the statements made at the press conference after the decision. Not least, because the franc gained value due to the turmoil on capital markets and a further increase of the franc had been expected. Now, in an environment of a weak franc, President Roth pointed out the concurrent inflationary risks and said that the central bank would not hesitate to increase interest rates.

The good economic situation would offer the SNB sufficient opportunity to raise interest rates higher. Despite the turmoil on the capital markets, economic researchers expect real GDP growth of around 2% for 2008, which is very good level for Switzerland. A slight downswing of the export dynamic is expected, but it should be possible to compensate this slowing by higher consumption. These optimistic forecasts are supported by the positive sentiment among companies as well as by the increase in employment.

The sustained weakness of the franc has led us to change our forecasts. We still continue to believe that the franc will trade around 1.55 EUR/CHF by the middle of next year, but it will probably take a while until it gets there. At the same time, we expect another interest rate hike, with December 2007 still being possible, but it is more likely that it will come in March of next year.

Yen

After the steady decline of the yen, a firming set in as of mid-September. The downturn on the stock markets was supportive of this movement, but even more crucial was profit-taking from short-term currency positions in our view. One must stress in this context though that the latest reversal of the yen started at EUR/JPY 167, which is well ahead of the all-time high of EUR/JPY 169. Another attempt to pass the old high cannot be ruled out, but the first one has failed.

However, the environment for achieving a new high is becoming increasingly difficult. The Bank of Japan left interest rates unchanged at 0.5% at its most recent meeting as expected, but the statements of the participants of the meeting indicate an interest rate hike this year. Even though the interest rate spread between the US and Euroland is still considerable, in conjunction with the declining interest rates in the US, the unchanged interest rates in Euroland for now and the lofty heights at which the euro is trading, the risk for yen short positions is growing. The most recent macro data from Japan do not point to any inflationary pressure once again, and therefore, do not imply any need of the Bank of Japan to take immediate action. Thus, the measures of the central bank will continue to be determined by the need to adjust interest rates over the medium to long term. As long as this situation does not change, we expect two interest rate hikes with a total volume of 50 bps per year. Even if inflationary expectations were disappointed in the last 12 months, the setting is still one of upwards pointing risks in this area. The Japanese economy is in the longest expansion phase since the end of World War II and energy prices are steadily rising. Therefore, the pace of the interest rate cuts might become even faster in the coming year than generally expected at present.