Fx & Interest Rate Monthly

The euro is set to decline against the dollar...
Euro weakness is our key call for 2009. We forecast that: economic outperformance will be replaced by underperformance; its yield premium will be cut as a consequence; and its status as a safe haven will be under pressure as member countries' credit ratings are downgraded. The US dollar is set to be the key beneficiary of these trends.
…as de-leveraging remains the key driver of markets...
Capital flows will be key to FX markets, as de-leveraging remains the dominant force in capital markets in 2009. The main beneficiaries are likely to be the yen and the dollar. For emerging market countries, capital flows have always been important, and there is a strong correlation between short-term financing requirements and the performance of the currency. While some had expected that emerging countries with large currency reserves would be immune, currency intervention has proved only a temporary pallative against worsening fundamentals and has been no substitute for policy action.
...but government policy responses to the crisis should be an offsetting factor.
However, quantitative easing adds a complicating factor to these trends, targeted as it is at offsetting some of the effects of de-leveraging. Although the US has led the way in quantitative easing, we believe that it is more likely to prove a potential negative for the yen, since it lacks other supporting factors and this vulnerability tempers our forecasts of further yen appreciation.
Yield premiums are being eroded for currencies...
In a synchronised global recessionary environment, we see a convergence of the interest rate cycle across countries, reducing yield differentials. That will support currencies (such as the dollar and the yen) whose rates are already at, or close to, zero, as their yield disadvantage is reduced.
...as interest rates across the world are cut to emergency levels.
We forecast that interest rates will generally be cut to emergency levels – as close to zero as is appropriate for the functioning of the local banking system. While we forecast that economic recovery will start in the second half of 2009, it will be 2010 before growth is likely to be sufficiently robust to require monetary tightening.