Still too early to pass the FX baton to USD!

There have been quite discussions in the market that the weak USD days are over. The argument goes like this - as the global slowdown broadens and commodities begin to crack, the new dawn will come as the ECB and Bank of England are probably curting rates and the US prepares to tighten.

I have no issue with this logic. But, I am damn sure that this will not happen in the next 6 months. Beyond that, it is a function of the rate of de-leveraging US financial market, a capitulating US housing market, commodity cycle and issue of twin-deficits in the US.

As we are not having a perfect 20/20 vision for anything beyond next 6 months, else, it is would be pure academic to discuss in times far ahead of us.

I however, stick rigorously to the view that slower European growth will be more challenging and Pound Sterling is still a sell given the mounting evidence of an economy not so much on the cusp but more over the edge and into a sharper economic slowdown.

As the bullish USD can be founded on a combination of worsening European fundamentals and on much bigger picture long term valuation type criteria, I argue that this has been a ‘slow burner’ move with Major FXs to be generally range-bound. USD fundamentals remain poor but Euro fundamentals are worsening slightly faster through the turn of the year.

I anticipate 2009 will be a sell Euro year and without a significant monetary tightening on the other side of Atlantic, the EUR/USD likely to trade in the mid range of 1.40-1.46 and closer to long term fair-value of 1.15-1.25. One, however, should not ignore the possibility that the ECB is still capable of raising rates in the context of fast slowing economy, pre-occupied still with the concern of inflation expectations.

Globally, all central banks remain somewhat ‘handcuffed’ in terms of policy as it faces deteriorating domestic economic conditions but also persistent food and energy prices, which are threatening price stability. Even though, the CRB index has dropped by more than 11% in July and the front-end Nymex oil futures contract was lower by 11%, it remains a far from conclusive that we are at the end of the current commodity cycle.

I continue to target Reminbi (RMB) appreciation of at least 10% p.a, even though weaker external demand has raised speculation that the appreciation will slow in 2H08. It would take a more marked deceleration in export and commodity prices to slow the pace of appreciation markedly. The Indian Rupee (INR) remains strong on a faster pace of monetary tightening, intervention in FX market and more recently, an improvement in sentiment due to the re-constitution of the ruling coalition government. Korean policy makers have clearly stated that they are determined to support the currency, even though this would entail significant FX reserves losses going forward.