While interest rates converge, we expect that volatility will stay high... The implication of convergence on zero interest rates and quantitative easing targeting bond yields is a reduction in volatility for yield differentials. However, we expect that macroeconomic uncertainty will continue to drive high levels of volatility in FX markets. This is likely to dissuade yield-hungry investors from backing higher-yielding currencies for the time being.
...as macro-economic factors remain key to currency movements... Quantitative easing is a clear negative for a currency, but it is far from the only factor for FX. We believe that, in the current global recession, the macro-economic risks outweigh the support for a currency of a more restrictive monetary policy. Hence, we are happy to buy the US dollar and the yen, if not sterling or the Swiss franc, against the euro.
…with the main risks in emerging Europe. The G20 agreement to recapitalise the International Monetary Fund in order to increase its lending capacity by $750 billion provides potential support for more vulnerable currencies and may reduce the number of crises. Yet we still expect that the global recession will lead to further currency devaluations, especially in Eastern Europe .
The convergence of interest rates... Interest rates are being cut to emergency levels – as close to zero as is appropriate for local banking systems. This process is well advanced, and we believe that we are almost at the low point for global policy rates .
...is likely to be a persistent feature as interest rates stay low for an extended period. Although we forecast that we will have seen signs of economic recovery before the end of 2009, it will in our view be well into 2010 at the earliest before growth is likely to be robust enough to require monetary tightening. The fight against deflation will require policy rates to stay low for an extended period .
