Federal Reserve Chairman Ben Bernanke’s outlook of the U.S. economy as remaining "unusually uncertain" has gained a whole new level of meaning. Since then, the world saw political gridlock in the United States that nearly resulted in unprecedented default, a continued slowdown in economic numbers that has left some analysts wondering if this is more than just a "soft patch" and the loss of the United States’ AAA credit rating from S&P.
In Europe, sovereign debt concerns still dominate analysts’ outlooks, with some saying the second bailout package approved for Greece merely kicked the can down the road. With such uncertainty in both the dollar and the euro, markets continue to vote with their feet by seeking safe havens such as the Swiss franc and Japanese yen or by bolstering commodity currencies such as the Australian and Canadian dollars.
The U.S. Dollar Index began the year at 79.31 and quickly posted its high for the year the next week at 81.63. It then quickly gave ground and settled into a trading range of 73 to 77 for most of May through August. As the dollar has dropped, so too have the growth expectations for the United States, with the Bureau of Economic Analysis recently decreasing first quarter real GDP growth to just 0.4%.
"The outlook for the U.S. dollar is not promising at all right now. Even though the debt ceiling was raised, there’s still the issue of slow economic growth. That’s been the behind the scenes story," says Kathy Lien, director of currency research at GFT.
She goes on to say that much of the current federal deficit problems are an extension of the 2008 sub-prime credit crisis. "The problems in the financial crisis led to the federal deficit problems because if the economy was booming, there would be enough tax receipts to cover our bills," she says.
Lien says that with the recent downgrade in U.S. debt by Standard & Poor’s to AA+, the U.S. Dollar Index could get down to 70 and says that may hold only because it is a psychological level. She puts medium-term resistance at 75 to 77.50, but expects the index to finish the year on the higher end because she says the U.S. economy will have settled by then.
In the past, the U.S. dollar largely was considered a safe haven currency alongside the yen and franc, but Andrew Wilkinson, senior market analyst at Interactive Brokers, says that is not necessarily the case anymore. "You can come in any given morning and flip a coin whether the dollar is a safe haven or not," he says.
Wilkinson goes on to say that the dollar still is viewed as a mostly safe bet, especially when the alternative is the euro. "People have referred to the currency market as an ‘ugly contest’ and the dollar just is being deemed ‘less ugly,’" he says.
Brian Dolan, chief currency strategist at Forex.com, points to a slew of poor economic numbers concerning the U.S. economy when discussing the U.S. dollar. "The dollar has its own set of problems, not the least of which being a stalling recovery. ISM was terrible in July, consumer spending dropped for the first time in two years, the unemployment situation shows no signs of significant improvement and housing remains in the tank. The Fed is going to stay on hold and, although I dismissed it earlier, [a third round of quantitative (QE3)] looks like a real possibility," he says (see "How about a dip?").
In the medium-term, Dolan put the U.S. Dollar Index in a range of 73.50 to 80 and expects a year-end number around 78.
Dean Popplewell, currency analyst at Oanada, agrees that QE3 is looking like an increasingly real possibility. "Without the labor department improving, the Fed may have to get QE3 off the shelf and start considering implementation," he says. July nonfarm payroll grew by 117,000. That was an increase over June and better than expected.
He says that the budget restrictions passed in the debt ceiling compromise will limit growth from government spending. "The budget reduction means the government will not be spending, which is counter-active to QE3 or stimulative measures that had been implemented over the last year or so," Popplewell says.
He says that should the Fed implement QE3, the dollar should weaken and is likely to remain on the course we’ve seen so far this year.
Like this time last year, the Eurozone still is struggling with the sovereign debt crisis. Unlike last year, which saw the EUR/USD drop as low as 1.18, the euro is benefitting from bad news coming from the United States that is helping support it above the 1.40 level.
"We’re still looking at a market that is very concerned about Eurozone debt. The threat of contagion to Italy or Spain continues to be a potential flare-up," Dolan says. "Markets continue to vote with their feet by selling Spanish and Italian debt, and the major reason is disappointment in the size of the European Monetary Fund."
That threat of contagion to Spanish and Italian debt led the European Central Bank (ECB) to announce its own easing measures by committing to buy bonds from Spain and Italy. Some indications show the ECB may buy up to $1.2 trillion worth of sovereign debt, a move that Germany in particular opposes.
Between the ECB’s easing measures and the continuing debt saga, some analysts and traders have begun wondering whether the single currency still is viable when there are such discrepancies between the financially stable heartland of Europe and the periphery nations.
Wilkinson says the euro probably isn’t going anywhere anytime soon. "It used to be the case that if the euro were going to dissolve, it would be the bigger countries walking away. If it were to happen now, it would be the lesser countries being given marching orders by the Franco-German block. I don’t see an end to the euro," he says.
Looking at the current situation, he says the second round of bailout funds issued to Greece did nothing to help get the country on the road to sustained recovery. "They’re not going to get out of this bind without some strengthening in the growth scenario. Right now that’s just not in the cards, so you can count on ongoing disenchantment with the euro throughout the rest of the summer," he says.
Wilkinson expects the EUR/USD to trade in a range of 1.38 to 1.48 with the risk to the downside.
Lien says one factor that has supported the euro has been the ECB’s recent hawkishness. "The euro has remained firm because the ECB has remained active in a tightening cycle," she says. "If that continues, it will be positive for the euro, but [Jean-Claude Trichet, president of the ECB] is leaving in November, so we could see a slowdown in rate moves."
Lien expects a lot of volatility in the EUR/USD over the next several months with support at 1.40 and resistance around 1.50. She expects the pair to trade around 1.45 at year-end.
Dolan sees even more risk to the downside. "Between the debt concerns spreading to Italy and Spain and the likelihood that the ECB will step back [from rate hikes], the euro is likely to remain on the weak side compared to most other currencies," he says.
Dolan expects a trading range of 1.45 to 1.35 in the coming months with the pair settling around 1.35 to end the year.
It comes as no surprise that investors have parked their assets in other currencies they feel are safer. Consequently, both the Swiss franc and the Japanese yen are trading at near-record levels despite intervention by their central banks to devalue the currencies (see "Havens in rough waters").
The USD/CHF opened the year at 0.9354 and over the last eight months has worked its way down to 0.7494 at the time of this writing, making fresh records almost daily through late July and early August. In addition to flooding the market with more liquidity, the Swiss National Bank set a target three-month Libor rate as close to zero as possible.
"What we’re seeing now is a real catch-22 situation. We saw the Swiss National Bank jump in and try to devalue its currency because of the risk-averse mentality we’ve seen out there," Popplewell says. "If QE3 does come to the table, we should see the dollar ease against most of the other currencies. At the same time, we have other national banks desperately trying to control their own currencies."
That intervention provided very short-term relief because within days the currency pair was trading at even lower levels. Popplewell says the 0.75 level will be defended aggressively by the Swiss and sees support at 0.83 to 0.85. He expects the USD/CHF to trade around 0.85 by year-end. In the USD/JPY, he sees support at 83 and resistance at 76.25.
The Japanese also intervened in the currency market in early August, but long-term effects may be hard to see. Lien says that while Swiss and Japanese central banks may intervene in the currency markets, she doesn’t believe it will have a long-term effect because of the slowdown in the U.S. economy. She sees the USD/CHF trading in a range of 0.75 to 0.80 and trading at 0.80 at year-end. In the USD/JPY, she sees a range of 75 to 80 and trading at 80 at year-end.
All that glitters
The AUD/USD opened the year at 1.02 and raced as high as 1.10 before worries of a global slowdown accelerated in early August. From Aug. 1 to Aug. 8, it slid from 1.09 to 1.03. Throughout this time, the Aussie largely moved in step with oil (see "Pumping down under").
Wilkinson says the Aussie had performed so well this year because it is closely linked to China, but now that China is manufacturing its own soft landing, the Aussie is suffering. Additionally, he points to the Royal Bank of Australia’s decision to leave rates alone in August because it deemed the risks to global growth outweighed the threat of domestic inflation. Wilkinson expects the AUD/USD to trade mostly in the range of 1.03 to 1.10 and expects the pair to end the year around 1.08. Dolan expanded the range to 1.13 on the upside and favors that area for the year-end.
Because of its proximity to the United States, the Canadian dollar has not performed quite as well but has stayed north of parity since the year began and the CAD/USD reached as high as 1.06. "Canadian fundamentals are looking very good. Employment numbers have been really good and we’re expecting that to continue," Popplewell says. "Their economy has done very well despite 70% of its trade being tied to the United States." He sees a trading range of 1.02 to 1.08 and expects 1.04 at year-end.
Dolan expects the global slowdown to have a negative effect on the Canadian dollar as well. "It’s pretty clear that the world already is in slowdown mode. We’re not necessarily going to see sustained recession this time, though, because we’re not in as bad a situation," he says. Dolan expects the CAD/USD to trade from 1.0250 to 1.06 with it approaching parity at year-end.
Between uncertainties about a slowing global economy, ongoing sovereign debt concerns in multiple parts of the globe and a credit rating cut to U.S. debt, it is no wonder currency markets are voting with their feet and seeking shelter in safe haven currencies. Whether this is short-term in nature or a shift in longer-term trends is yet to be seen.
"Risk sentiment is to the downside. [Fiscal year] 2012 is going to be a very difficult year because that is when austerity measures in the U.S., U.K. and Europe really start to take a bite," Wilkinson says. "We’re now four years into what increasingly is looking like a ‘lost decade’ for the G7."