Recent currency movements have prompted Stephen Jen, Morgan Stanley’s global head of currency research, to revise some of his forecasts, particularly concerning the yen, and the Canadian, Australian and New Zealand dollars, which he now feels far more optimistic about.
The US dollar should reassert itself as the US economy accelerates, while euro-dollar and sterling-dollar trade should fall, he says. The yen will weaken and the Australian, New Zealand and Canadian dollars “can continue to do well, as a derivative of a buoyant Chinese and global economy”, Mr Jen says.
“We maintain our year-end target of 1.28 for EUR/USD, but have tweaked our target for USD/JPY slightly higher to Y118 (from Y114) and Y112 by end-2008. The biggest change in our forecasts relates to the Canadian, Australian and NZ dollars, with their new year-end targets being $1, $0.88 and $0.78, respectively.
The global economy will remain strong and benign, “supporting risky assets”, says Mr Jen. “Higher P/E ratios and higher interest rates would still be consistent, given the still wide yield gap between these two markets.” Overall, he sees a “benign ‘Goldilocks’ environment, with some risk of occasional inflation scares, but not actual inflation”.
As the US economy reasserts itself, so should the dollar, he says, “especially” against the euro and the pound. As for Japanese yen, “the ‘portfolio shift’ should remain dominant, but we are watchful of a buoyant Nikkei. Don’t go against the trend: USD/JPY could keep drifting modestly higher as the world’s policy interest rates rise, ‘leaving the JPY behind’.”
However, in 2008, watch for a Nikkei-inspired yen rally, reflecting strong economic fundamentals with low inflation risk, Mr Jen says.
On China and the “commodity currencies”, Mr Jen expects the emergence of China to continue to be “very supportive” for the Canadian, Australian and NZ dollars. “Until now, we have been bearish on these currencies because of valuation and the risk of a late-cycle slowdown in these economies. However, we have changed our view and turned positive on these currencies.”