Investment Research

17 May 2010

FX Forecast Update
More EUR weakness ahead – but the worst is likely behind
In several issues of FX Forecast Update we have written about the risk related to the debt Key point’s
situation in the PIIGS countries. Admittedly however, we did underestimate the impact on
the FX market – not least on EUR/USD. We revised our 3M EUR/USD forecast lower on  Following recent weeks’ extraordinary
28 April to 1.27, see FX Research: The good, the bad and the ugly EUR scenario, but as events in Euroland, we pencil in more
EUR/USD is currently trading below 1.24 – a level not seen since the beginning of 2006 euro weakness. Political risks, lower
– the revision was obviously too modest. See the grey boxes below for a detailed insight rates for longer time and subdued
into EUR/USD going forward. economic growth weigh on the euro.

The EU/IMF/ECB rescue package announced on 9 May resulted in a short relief for the  Our EUR/USD, EUR/GBP, EUR/CHF,

euro. European solvency concerns returned and the CDS market continues to price a high EUR/SEK and EUR/NOK profiles have all
probability of a sovereign default in southern Europe. In our view, the package did been revised lower. EUR/USD is however
address a lot problems and ought to remove some of the current risk-premium attached to not projected to fall throughout our
the euro. Perhaps most importantly, no country is allowed to default on liquidity whole forecast horizon.
constraints and ECB has shown its commitment to step in as buyer of last resort in the  We remain positive on the Scandies
European sovereign debt markets. The latter should mitigate contagion from Greece to (though global risk sentiment needs to be
other PIIGS countries in respect of the interest rate level and secure the ability to issue monitored) and we continue to see a
debt in the market at a manageable price. The interventions are expected to be sterilised, larger potential for SEK than NOK.
i.e. the monetary base will not be expanded, and are therefore not euro negative by
Forecast table (detailed)
construction. Furthermore, the re-opening of the dollar swap-lines has eased the USD-
shortage in the money market even though the price for dollar liquidity seems 1M 3M 6M 12M
surprisingly high. Finally, the package also showed a strong political commitment, EURUSD 1.22 1.20 1.15 1.27
intended to dampen “euro break-up” risks. USDJPY 94 95 99 102
EURCHF 1.39 1.38 1.37 1.41
We think that EUR remains likely to depreciate further against the dollar on the
EURGBP 0.85 0.84 0.83 0.82
short and medium horizon (3-6 months), although any sell-off in our view will be less
EURSEK 9.60 9.50 9.40 9.20
violent than what we have witnessed in recent months, particularly if the liquidity
EURNOK 7.70 7.65 7.60 7.60
issues are alleviated by the announced measures. There are three main reasons for this:
AUDUSD 0.91 0.92 0.94 0.90
 Political risk weighs heavily on the euro. The market remains extremely nervous on NZDUSD 0.72 0.73 0.76 0.72
Euroland debt and focuses on the issues that are not being solved with the rescue USDCAD 1.01 1.00 1.02 1.10
package. There are still significant risks ahead for the European banking sector. EURDKK 7.44 7.44 7.45 7.46

Greece might not default in the near future, but the mark-to-market loss is evident and Links to detailed forecasts:
a deep new recession in Greece is likely to result in new banking losses.  EUR/USD - page 4
 USD/JPY – page 5
 Relative rates are expected to favour the dollar relative to the euro throughout
 EUR/GBP – page 6
the year. While the Fed is gradually escaping from quantitative easing and preparing
 EUR/CHF – page 7
for a normalisation of monetary policy, the ECB is undertaking substantially more
 EUR/SEK – page 8
alternative stimulus to an extent we don’t know the scope of yet. Our Interest Rate
 EUR/NOK – page 9
Strategy team expects the Fed to begin hiking rates in Q1 while the ECB is expected
 EUR/DKK – page 10
to keep rates on hold until H2 2011. The 2Y swap spread is expected to move around
 AUD/USD – page 11
40bp in favour of the dollar on the 12-month horizon from the current level, roughly
 NZD/USD – page 12
corresponding to another 5-7% decline in EUR/USD.
 USD/CAD – page 13
 The substantial fiscal tightening is set to drag heavily on economic growth in
Europe. Investors are accordingly expected to flee to regions with higher expected
returns which can lead to more downward pressure on the single currency.

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FX Forecast Update

With EUR/USD set to decline on the 3- and 6-month horizon, we find it likely that
EUR/GBP also adjusts lower, albeit to a smaller extent, as sterling often is ‘left in
the middle’. Even though having gained around 4% against the euro this year, the pound
remains significantly undervalued according to for example PPP analysis. The outcome of
the UK election was regarded as positive for the pound by financial markets but the
upcoming fiscal tightening is set to be painful and might curb sterling’s strength as it
crowds out any monetary tightening and decreases economic growth. The latest BoE
Inflation Report was quite dovish and higher UK rates are beyond our forecast horizon.
The UK is in our view likely to be downgraded in Q2, which probably also presents some
downside limit for how low EUR/GBP can go.

The Scandinavian currencies SEK, NOK and DKK have fared well in recent
months, even when the Euroland debt woes spread to other asset classes and
affected risk aversion in a broader sense. Sweden, Norway and Denmark all have
sound fiscal balances and higher rates in H2 are expected to support SEK and NOK
further. We project that both Swedish and Norwegian kroner will perform against the
euro throughout our forecast horizon, albeit at a significantly slower pace than seen in the
past 16 months.

EUR/CHF has moved sharply lower to trade just above 1.40 - the profit target in our
short EUR/CHF recommendation from May 5 and our old 6-month forecast. The
arguments for why the 1.4325 level would prove unsustainable likely also applies to the
current 1.4000 floor – though it probable requires the current negative euro sentiment to
continue. As a result, and since the fundamental strong Swiss franc story remains valid,
we look for EUR/CHF to move even lower in the coming months. We have thus opted to
revise lower our EUR/CHF profile, with an expected 1.37 trough at the 6-month horizon.

We don’t think EUR/USD will continue to decline at the end and beyond our
forecast horizon (12 months) though. As we see it, this is not the beginning of a longer-
lasting dollar appreciation, even though the euro has lost massively in a relatively short
period against the US currency. We focus on three reasons why EUR/USD is likely to
correct towards the current spot level or perhaps even higher in the longer term:

 The increased focus on government debt in Europe and the sudden will to
address the problems can turn out to be a very positive thing for the euro.
Despite the diversity among member states, Euroland is ‘only’ running a budget
deficit of 6.6% this year and the debt burden is around 85% of GDP. This is of course
not good – but it is actually lower than in the UK, the US and Japan. UK sovereign
debt to GDP will surpass the Euroland average by 2011, as will the US’s, while
Japan’s is already more than double. The US and UK budget deficits will be in double
digits this year and probably next.

 The US flow situation is negative and the US is running an unsustainably large

current account deficit, set to widen further in the coming years. In contrast,
Euroland’s external balances are neutral for the euro. This factor is currently gaining
in momentum as competitiveness in Europe is decreasing and vice versa.

 The surprise element can benefit the euro. Currently, investors are almost
universally dooming Euroland and the euro. An ECB hike is not priced into markets
until two years from now while many are strong believers in a robust US upswing. In
FX markets this shows for example in the tremendous amount of short EUR /long
USD positions. But with expectations at extremes, sentiment on EUR/USD can
rapidly change if things do not turn out as planned.

2| 17 May 2010
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FX Forecast Update

Exchange rate forecasts

Forecast Forecast vs forward outright, %
Spot +1m +3m +6m +12m +1m +3m +6m +12m
Exchange rates vs EUR
USD 1.229 1.22 1.20 1.15 1.27 -0.7 -2.4 -6.6 3.0
JPY 113.3 115 114 114 130 1.6 0.7 0.8 15.2
GBP 0.853 0.85 0.84 0.83 0.82 -0.3 -1.5 -2.8 -4.2
CHF 1.401 1.39 1.38 1.37 1.41 -0.7 -1.3 -1.9 1.3

DKK 7.44 7.44 7.44 7.45 7.46 0.0 -0.1 0.1 0.1
NOK 7.71 7.70 7.65 7.60 7.60 -0.1 -1.1 -2.2 -3.1
SEK 9.60 9.60 9.50 9.40 9.20 0.1 -1.0 -2.1 -4.4

Exchange rates vs USD

JPY 92.0 94 95 99 102 2.3 3.2 7.9 11.8
GBP 1.44 1.44 1.43 1.39 1.55 -0.4 -0.9 -3.9 7.4
CHF 1.14 1.14 1.15 1.19 1.11 0.0 1.1 5.0 -1.6

DKK 6.06 6.10 6.20 6.48 5.87 0.7 2.4 7.1 -2.8
NOK 6.25 6.31 6.38 6.61 5.98 0.6 1.4 4.7 -6.0
SEK 7.81 7.87 7.92 8.17 7.24 0.8 1.5 4.8 -7.1

CAD 1.04 1.01 1.00 1.02 1.10 -2.7 -3.7 -1.8 5.5
AUD 0.88 0.91 0.92 0.94 0.90 4.3 6.1 9.4 6.9
NZD 0.70 0.72 0.73 0.76 0.72 3.0 4.9 9.8 5.8
Source: Danske Markets

3| 17 May 2010
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FX Forecast Update

EUR/USD – more euro losses ahead

EUR/USD has continued its dramatic decline and is now trading at a level not seen since
the beginning of 2006. The decline has primarily been due to investors’ concern over EUR/USD overview
Euroland debt and can in magnitude be compared to the move seen following the collapse Recent moves 1W 1M 3M
of Lehman Brothers in fall 2008. Spot change -3.8% -8.9% -9.6%

Outlook Spot, high 1.310 1.352 1.382

Spot, low 1.224 1.224 1.224
 We expect the decline in EUR/USD will continue most of this year. Heightened
political risk, movements in relative rates and the substantial fiscal tightening in Outlook 1M 3M 6M 1Y
Europe drag down on the euro. Increased competitiveness in Europe, a negative US Forecast 1.22 1.20 1.15 1.27

flow situation and a change in sentiment suggest there is a downside to EUR/USD Forward 1.23 1.23 1.23 1.22
though. We project EUR/USD at 1.20 at 3M, 1.15 at 6M, and 1.27 at 12M. Carry (pips) 3 9 21 48

Key arguments
Source: Danske Markets
 On the 3-6 month horizon, we think that:

 Political risk will weigh on the euro. Even though the EU/IMF/ECB package is EUR/USD forecast and option implied
substantial, it is not guaranteed that it will work completely as intended. There are probabilities
still significant risks ahead for the European banking sector. Greece might not
default in the near future, but the mark-to-market loss is evident and a deep new 1.6
EUR/USD
1.5
recession in Greece is likely to result in new banking losses. 1.4
1.3

 Relative rates are expected to favour the dollar relative to the euro throughout the 1.2
1.1
year. While the Fed is gradually escaping from quantitative easing and preparing 1.0
0.9
for a normalisation of monetary policy, the ECB is undertaking substantially more 0.8

alternative stimulus to an extent we don’t know the scope of yet. Jun Sep
09
Dec Mar Jun
10
Sep Dec Mar
11
90 pct. region Spot (incl. DB forecast)
50 pct. region Forward
 The substantial fiscal tightening is set to drag heavily on economic growth in
Europe. Investors are accordingly expected to flee to regions with higher expected Source: Danske Markets

returns which can lead to more downward pressure on the euro.

 On a 12-month horizon and beyond we think that: EUR/USD and PPP estimate
1.6 1.6

 The increased focus on government debt in Europe and the sudden will to address 1.5 1.5
1.4 1.4
the problems can turn out to be a very positive thing for the euro. The US, UK and 1.3
EUR/USD spot
1.3

Japan have fiscal challenges ahead that need to be addressed as well. 1.2 1.2
1.1 1.1
PPP estimate
 The US flow situation is negative and the US is running an unsustainably large 1.0 1.0
0.9 0.9
current account deficit, set to widen further in the coming years. In contrast, 0.8 0.8
0.7 0.7
Euroland’s external balances are neutral for the euro. This factor is currently
0.6 0.6
gaining in momentum as competitiveness in Europe is decreasing. 80 85 90 95 00 05 10

 The extreme investor positioning, currently hurting the euro, can be reversed. Source: Danske Markets

Key risks
 The FX environment is currently very uncertain, which makes any forecasting
extremely difficult. Very little guidance from technical research.

 The euro can extend its decline throughout our forecast horizon if Europe is lagging
more behind in economic and monetary terms than thought at present.

Things to look out for

 News from policy makers – especially in Europe.
Senior Analyst
John Hydeskov
+45 45 12 84 97
johy@danskebank.com

4| 17 May 2010
www.danskeresearch.com
FX Forecast Update

USD/JPY – risks are still to the upside

As the Euroland debt crisis has begun to impact global assets on a broader scale – driving
a sell-off in risky assets – the pressure on the yen has eased taking USD/JPY slightly USD/JPY overview
lower. Relative interest rates are even pointing to the potential for a test of 90. Recent moves 1W 1M 3M

Outlook Spot change -1.3% 0.0% 1.4%

Spot, high 93.6 95.0 95.0

 Risks are skewed to the downside for the yen, which we expect to depreciate during
Spot, low 91.8 88.3 88.1
2010. We project USD/JPY at 95 in 3M, 99 in 6M, and 102 in 12M.
Outlook 1M 3M 6M 1Y
Key arguments
Forecast 94 95 99 102
 Relative interest rates have been and will be the dominating driver of USD/JPY. Forward 92.0 92.0 92.2 92.6
Given the combination of low Japanese rates contained by the outlook of a zero Carry (pips) 7 -1 -18 -60
interest rate policy well into 2011 and rising US rates due to an improved economic
outlook, the direction for USD/JPY is clearly upwards. Source: Danske Markets

 Indications from the Bank of Japan (BoJ) are that measures will be taken to counteract
any potential excessive strengthening of the yen – either via additional quantitative USD/JPY forecast and option implied
easing or potentially even via intervention on the currency market. The emergency probabilities
BoJ meeting in December indicates that a policy imposed floor exists below
USD/JPY. This reduces downside risks in the pair. 120.0
USD/JPY
110.0
 Despite increased concerns about the build-up in government debt in most developed 100.0

economies, the combination of very low interest rates, improving economic activity, 90.0

80.0
and strong company earnings is a very favourable environment for risky assets. We
70.0
remain fairly constructive on the outlook for global equity markets (though significant 60.0
risks remain), which should act to weaken the yen. Jun Sep Dec Mar Jun Sep Dec Mar
09 10 11
90 pct. region Spot (incl. forecast)
 A resumption of a Chinese yuan appreciation will most likely weigh on the yen. 50 pct. region Forward

When Singapore recently appreciated its dollar, a broad-based yen selling followed. Source: Danske Markets

 The yen is likely to become one of the preferred G10 funding currencies in H2 2010 if
volatility stays low or even declines further. USD/JPY and PPP estimate
Key risks 350 350

300 300
 A bigger sell-off in risky assets (triggering a bear-market signal) could imply JPY
250 250
support. The collapse in USD/JPY to 88 on 6 May, when stock markets temporarily
USD/JPY spot
200 200
moved sharply lower, emphasises the still high correlation with risky assets.
PPP estimate
150 150

 Despite positive momentum in economic data and an upward trend in risky assets, US 100 100

bond yields have failed to move markedly higher. Continued range-trading in yields 50 50

might delay a potential JPY depreciation later in 2010. 0 0

80 85 90 95 00 05 10

Things to look out for Source: Danske Markets

 Positive surprises in non-farm payroll data usually lead to spikes in USD/JPY – more
pronounced than downward moves in EUR/USD.

 Capital flows – both Japanese and US – remain important to follow.

 The yen (more so than the US dollar) is a safe-haven currency and tends to strengthen
Senior Analyst
when risk appetite escalates. Hence, an escalation of the current negative market John Hydeskov
sentiment could trigger a more pronounced drop in USD/JPY. +45 45 12 84 97
johy@danskebank.com

Senior Analyst
Kasper Kirkegaard
+45 45 13 70 18
kaki@danskebank.com

5| 17 May 2010
www.danskeresearch.com
FX Forecast Update

EUR/GBP – lower levels ahead but not

without obstacles
The pound has performed well against the euro but failed to break the 0.84-level, where it
EUR/GBP overview
has had problems on several occasions. The pair trades with high volatility but the 0.85-
0.86-range has replaced the 0.86-0.88-range. Recent moves 1W 1M 3M
Spot change -1.1% -2.9% -1.7%
Outlook
 We expect to see the pound appreciating gradually against the euro throughout our Spot, high 0.875 0.884 0.915
forecast horizon even though the actual trading probably will be much more volatile Spot, low 0.845 0.843 0.843
than the forecasts indicate at a first glance. We see EUR/GBP at 0.84 in 3M, 0.83 in Outlook 1M 3M 6M 1Y
6M, and 0.82 in 12M. Forecast 0.85 0.84 0.83 0.82
Key arguments Forward 0.85 0.85 0.85 0.85
 Political risks for sterling are fading and markets have welcomed the new coalition
Carry (pips) 3 7 15 31
government which will present a ‘crisis budget’ within 50 days. The risk premium on
Source: Danske Markets
sterling is being reduced.
 The debt situation in the UK is however very serious and can evolve into a real
EUR/GBP forecast and option implied
problem for the country, despite the favourable starting point. We expect the UK will
probabilities
lose its AAA rating, which could send GBP weaker if investors get scared that it 1.05
EUR/GBP
marks a series of downgrades, see New UK government faces massive fiscal 1.00
0.95
challenges - but GBP strengthens against EUR. 0.90
0.85
 The latest BoE inflation was quite dovish and it is important to remember that the 0.80
asset purchase programme is only paused. Fiscal tightening crowds out any degree of 0.75
0.70
monetary tightening. A BoE rate hike will come in H2 2011 at the earliest.
Jun Sep Dec Mar Jun Sep Dec Mar
09 10 11
 The UK banking sector is gaining momentum as the production of capital goods is 90 pct. region Spot (incl. DB forecast)
50 pct. region Forward
rising again, lending is picking up and surveys are promising. The UK banking sector
Source: Danske Markets
is a very important contributor to overall GDP.
 M&A flows have recently benefitted GBP and more might be in the pipeline.
 PMIs, the Bank of England Agent’s survey and other sentiment surveys are all EUR/GBP and PPP estimate (CPI-75)
indicating that 2010 probably won’t be as bad as seems to be the common perception. 1.0 1.0

We think that market participants will be taken by surprise by the UK’s economic 0.9 0.9

0.8 0.8
performance.
EUR/GBP spot
0.7 0.7
 According to PPP analysis, sterling is one of the most undervalued G10 currencies; in PPP estimate
0.6 0.6
contrast, the euro is the most overvalued. This misalignment could persist for some
0.5 0.5
time yet, but a ‘return to valuation’ could come into effect within our forecast horizon.
0.4 0.4

Key risks 0.3 0.3

80 85 90 95 00 05 10
 Tackling the government is the main task for the UK. Failure to resolve difficulties
could lead to a substantial GBP sell-off. Additional banking failures are adding to Source: Danske Markets

strained government finances.

 The crisis may have led to a permanent decline in potential GDP: if spare capacity is
lower than expected, inflation could pick up more quickly than projected by the BoE.
Things to look out for:
 Comments from rating agencies: S&P has the UK on negative outlook.
 The presentation of the ‘crisis budget’ from the new government. If the spending cuts
are smaller than anticipated in general, the risk premium on sterling can increase,
leading to a new pound sell-off. Senior Analyst
John Hydeskov
+45 45 12 84 97
johy@danskebank.dk

6| 17 May 2010
www.danskeresearch.com
FX Forecast Update

EUR/CHF – SNB lowering the floor

 The escalation of the Euroland debt crisis intensified downside pressure on EUR/CHF
EUR/CHF overview
to a point where the Swiss National Bank (SNB) on 6 May – after supposedly having
sold very large amounts of francs – allowed the cross to break below its April 1.4325 R ecent moves 1W 1M 3M
floor. A new floor has for now been established just above 1.40. Spot change -1.4% -2.3% -4.6%

Outlook Spot, high 1.433 1.439 1.469

Spot, low 1.399 1.399 1.399
 We project EUR/CHF at 1.38 in 3M, 1.37 in 6M, and 1.41 in 12M.
Outlook 1M 3M 6M 1Y
Key arguments Forecast 1.39 1.38 1.37 1.41

 Short term: The EUR relief rally following the announcement of the massive EU/ Forward 1.40 1.40 1.40 1.41
IMF/ECB crisis package, announced on 9 May, proved short-lived and EUR/CHF has Carry (pips) -8 -22 -43 -86

since corrected back to trade just above 1.40, where the SNB is allegedly intervening. Source: Danske Markets
As long as EUR is under pressure, CHF is likely to see strong demand. A break below
1.40 cannot be ruled out in the short term, although the SNB will probably seek to
EUR/CHF forecast and option implied
avoid an uncontrolled appreciation of the franc. Should the pressure on the EUR ease,
probabilities
a short-term spike higher in EUR/CHF could be triggered by position unwinding.
1.55 EUR/CHF
1.50
 Medium term: The recession in Switzerland has proven milder than first projected – 1.45
also by the SNB – and with the outlook of the economic recovery maturing further in 1.40
1.35
2010, the emergency setting of monetary policy is becoming gradually more 1.30
1.25
inappropriate. We expect the SNB to move further away from using intervention as a 1.20
1.15
monetary policy tool and hike rates before year-end – prior to the first expected ECB
Jun Sep Dec Mar Jun Sep Dec Mar
hike – adding to downside pressure on EUR/CHF. An earlier-than-expected SNB hike 09 10 11
90 pct. region Spot (incl. DB forecast)
in September (or even June) would be likely to take EUR/CHF below our 1.38 forecast. 50 pct. region Forward

 Longer term: The ECB is likely to tighten monetary policy more than the SNB (due to Source: Danske Markets

higher underlying price pressures and a more hawkish government council), which
should see underlying flows reverse and take EUR/CHF beyond the 12-month
EUR/CHF and PPP estimate
horizon. Also, current market expectations towards both economic performance and
3.25 3.25
relative monetary policy currently leave more potential for EUR positive ‘surprises’
3.00 3.00
than CHF positive ‘surprises’. We expect the Swiss franc to trade with a smaller 2.75 2.75

premium to the euro on a 12-month horizon. 2.50 2.50

2.25 2.25
Key risks 2.00 2.00

1.75 1.75
 A sooner-than-expected move away from interventions by the SNB coupled with still 1.50
PPP estimate
1.50
EUR/CHF spot
significant EUR risks could see EUR/CHF break meaningfully below 1.40. 1.25 1.25

1.00 1.00
 Escalation of Euroland debt crisis could trigger an uncontrolled drop in EUR/CHF. 80 85 90 95 00 05 10

 Uncertainties about the economic recovery remain significant, which coupled with
Source: Danske Markets
absent price pressures (deflation fears) could postpone a move further away from
intervention and secure a floor below EUR/CHF also longer term.
Things to look out for
 Speeches by the members of the SNB governing board. SNB Governing Board
member Jean-Pierre Danthine stated on 18 March that “…households and firms
should prepare themselves for a return, sometime in the future, to a world of higher
interest rates, with exchange rates being guided by market forces”. Comments like
this on SNB exit strategies are likely to drive franc demand.
 If the current economic momentum is sustained in Switzerland, the SNB could hike
interest rates at the September (or even the June) meeting – well before any signalled Senior Analyst
Kasper Kirkegaard
ECB hikes. This would probably see EUR/CHF move well below our current forecast. +45 4513 7018
kaki@danskebank.dk

7| 17 May 2010
www.danskeresearch.com
FX Forecast Update

EUR/SEK – summer volatility

 In the last couple of weeks, EUR/SEK has remained range bound, albeit with
increasing volatility, around our mid-May target. Downside pressure has come from EUR/SEK overview
strong macro data and somewhat hawkish comments from the Riksbank, whereas
Recent moves 1W 1M 3M
European debt concerns that weighed on global risk appetite pushed the pair
Spot change -0.5% -0.9% -2.1%
temporarily higher amid closing (profit taking) in short positions. The upside should
be limited given the beneficial medium-term outlook for the SEK, backed by relative Spot, high 9.88 9.88 9.89
growth, relative yields, relative fundamentals, outright EUR weakness and the krona's Spot, low 9.52 9.52 9.52
long-term cheapness. However, financial market turmoil runs a risk of delaying the
Outlook 1M 3M 6M 1Y
projected appreciation of the SEK. The summer weeks could be accompanied by
Forecast 9.60 9.50 9.40 9.20
rising EUR/SEK volatility and further temporary upward corrections.
Forward 9.60 9.60 9.59 9.57
Outlook:
Carry (pips) -10 -4 59 255
 We forecast EUR/SEK to trade around 9.50 in the next month and slide towards 9.40 Source: Danske Markets
in three to six months while we lower slightly the 12-month target to 9.20.

Key arguments: EUR/SEK forecast and option implied

probabilities
 Relative valuation, relative fundamentals, cyclical rebound and relative monetary
policy are key factors that back up our medium-term bullish view on the SEK.
11.5
EUR/SEK
 Medium-term macro models and PPP suggest the SEK is fundamentally undervalued. 11.0
10.5
 Stable public finances put Sweden in a favourable position with its small deficits and 10.0
low debt ratios. There is even room for further fiscal stimulus ahead of the September 9.5

general election. Meanwhile, debt consolidation will be the main economic-policy 9.0
8.5
issue in many other economies for years to come, especially in southern Europe, US
Jun Sep Dec Mar Jun Sep Dec Mar
and the UK. This is positive for the SEK. 09 10 11
90 pct. region Spot (incl. DB forecast)
50 pct. region Forward
 The global economic rebound is set to continue and a no growth-scenario is expected
to be replaced by a slow growth-ditto. This is basically supportive for the pro-cyclical Source: Danske Markets
Swedish currency.
 The export recovery will be weaker than normal but still compatible with increasing
commercial demand for SEK. EUR/SEK and PPP
12 12
 The Riksbank has with the slightest possible 3-3 majority (Stefan Ingves’ casting EUR/SEK spot
11 11
vote) signalled its intention to move away from crisis-mode monetary policy and raise
10 10
the repo rate to 0.5% on 1 July. In the period ahead of that decision we look, in 9 9
particular, for a much stronger first quarter GDP reading at 1.5% y/y (with an upside 8 PPP estimate 8
tilt) than the Riksbank’s 0.9% y/y forecast; domestic macro data in general supports a 7 7

July hike and that is our main scenario. The multi-facetted problems in southern 6 6

Europe and contagion effects might postpone the first rate hike and/or reduce the 5 5

amount of monetary tightening going forward though. That said, on a relative basis 4 4
80 85 90 95 00 05 10
the Riksbank will outhike the ECB and close the policy gap by year end. At the end of
the day, the SEK is the winner in the monetary policy game. Source: Danske Markets

 Early summer has historically been associated with rising EUR/SEK volatility. Note: The EUR/SEK PPP model deviates from the
other G10 PPP models, as we have added a trend
Key risks: to the SEK REER series

 Global risk aversion (might delay SEK rebound); softer Riksbank (delay SEK
rebound); sharp EUR sell-off (prompt faster SEK appreciation than forecast).

Things to look out for:

 GDP Q1 on 28 May
 Riksbank communication ahead of 1 July rate decision Senior Analyst
Stefan Mellin
 The general election (September) is not an issue yet but bears watching. +46 8 568 805 92
mell@danskebank.se

8| 17 May 2010
www.danskeresearch.com
FX Forecast Update

EUR/NOK – some downside remains

EUR/NOK has continued to trade lower during the last month and the cross has briefly
EUR/NOK overview
traded below 7.80 – a level not seen since May 2008. The NOK got another boost when
Norges Bank hiked rates by another 25bp to 2.0% on 5 May. The rate hike came despite Recent moves 1W 1M 3M
the growing concerns regarding Greece. Spot change -2.1% -3.2% -3.7%

Outlook Spot, high 8.038 8.038 8.134

Spot, low 7.692 7.692 7.692
 We forecast that the Norwegian krone will continue to perform going forward, albeit
Outlook 1M 3M 6M 1Y
at a significantly slower pace than seen in the past 16 months. We forecast that
Forecast 7.70 7.65 7.60 7.60
EUR/NOK will drop to 7.65 in 3 months, 7.60 in 6 months and 7.60 in 12 months.
Forward 7.69 7.67 7.63 7.57
Key arguments
Carry (pips) 132 370 736 1398
 Norges Bank hiked rates by 25bp on 5 May. Norges Bank repeated that that the Source: Danske Markets

interest rate should be gradually brought closer to a more normal level. Norges Bank
highlighted the strong housing market as an argument for hiking rates. However, EUR/NOK forecast and option implied
Norges Bank also said that developments in Europe may prove to be weaker than probabilities
expected, underlining that the European debt crisis has also impacted Norway.
9.25
 We expect that Norges Bank will continue to hike rates gradually for the next 12 9.00 EUR/NOK
8.75
months. Hence, with the ECB on hold, we forecast that relative rates will continue to 8.50
8.25
favour the NOK. That said, undoubtedly Norges Bank will not tolerate a too-strong 8.00
7.75
currency. 7.50
7.25
7.00
 The PMI indicator has finally moved above the 50 level and the enterprises in the 6.75

“Regional Network” expect moderate growth ahead. Real income growth is high, the Jun Sep Dec Mar Jun Sep Dec Mar
09 10 11
90 pct. region Spot (incl. DB forecast)
unemployment rate is low and the housing market is improving. The Norwegian 50 pct. region Forward

savings rate is very high, minimizing the risk of a new spike in savings. The revised Source: Danske Markets
budget for 2010 indicated that amid the marginally lower oil spending initially
planned the budget is still very expansive.
EUR/NOK and PPP
 Norwegian fundamentals are second to none with huge trade and public surpluses and
10.0 10.0
an outstanding credit rating. We believe investors will look for currencies with strong 9.5
EUR/NOK spot
9.5
9.0 9.0
fundamentals in 2010, not least because of the debt problems in many countries. But
8.5 8.5
note that EUR/NOK is now trading below fair value implied by a simple PPP model 8.0 8.0
7.5 7.5
underlining that the downside potential is limited despite strong fundamentals. PPP estimate
7.0 7.0
6.5 6.5
 The NOK is in general expected to get support from oil that is expected to trade in a 6.0 6.0

USD80-100 range for the rest of 2010. The higher oil price indicates that over the 5.5 5.5
5.0 5.0
coming months Norges Bank will once again start to purchase foreign currency on 80 85 90 95 00 05 10

behalf of the Pension Fund – Global (Petroleum fund).

Source: Danske Markets
Key risks
The market is speculatively long NOK, which could spark periods of profit taking. The
latest appreciation hurts competiveness and also poses a risk of too-low inflation that
inevitably would affect monetary policy going forward. A general setback in risk appetite,
or the oil price, is expected to weigh on the NOK. We do not consider the NOK as a safe-
haven currency. The latest ,ove lower in EUR/NOK is very much about euro-weakness. If
the euro once again gains credibility it might push EUR/NOK higher.
Things to look out for
 If Norges Bank start to purchase currency (sell NOK) in the market on a daily basis.
Comments from Norges Bank on the effect of the Euroland debt crisis. Chief Analyst
Arne Lohmann Rasmussen
+45 45128532
arr@danskebank.dk

9| 17 May 2010
www.danskeresearch.com
FX Forecast Update

EUR/DKK – in the very narrow range

EUR/DKK is trading just above 7.44 at the moment. A firm break of 7.44 is being
EUR/DKK overview
stopped by the Danish central bank while moves higher are being used by market players
R ecent moves 1W 1M 3M
to establish short EUR/DKK to exploit the still attractive DKK-EUR yield spread.
Spot change 0.0% 0.0% 0.0%
Outlook
Outlook 1M 3M 6M 1Y
 We believe the Danish central bank will aim to keep the krone on the strong side in Forecast 7.44 7.44 7.45 7.46

the coming months before drifting back toward central parity on a 12M horizon. We
Forward 7.44 7.44 7.43 7.43
project 7.44 at 3M, 7.45 at 6M, and 7.46 at 12M. Carry (pips) 12 36 65 132
Source: Danske Markets
 Our base case scenario is that the repo-rate spread between Denmark and Euroland
will stay at 5bp throughout our forecast horizon. In the event of additional inflow in
the short run, we expect the Danish central bank to cut the deposit rate and current
EUR/DKK spot rate
account rate by 10bp each, but leave both the lending and discount rate unchanged. In
7.480 EUR/DKK EUR/DKK 7.480
the event of a very rapid liquidity withdrawal in Euroland, independent Danish rate Higher 'de facto' fluctuation band (-0.5%)
7.470 7.470
hikes cannot be ruled out. Central parity
7.460 7.460

Key arguments 7.450 7.450

EUR/DKK
7.440 7.440
 EUR/DKK trades in a +/-2.25% band around a central parity of 7.46038 (7.29252- 7.430 7.430
Lower 'de facto' fluctuation band (-0.5%)
7.62824). In practice, the central bank has kept EUR/DKK within a much tighter band 7.420 7.420
of 7.423-7.468 (-0.1% - +0.5%). Most recently, the Danish central bank has shown a 07 08 09 10

strong dedication to keeping EUR/DKK very stable and preferably slightly lower than
the central parity. Source: Danske Markets

 EUR/DKK is still subject to some downward pressure as some investors find it

attractive to exploit the higher Danish yield, at least in the short term. This trick has, Record-high Danish currency reserve
however, lost some of its attractiveness as EUR/DKK upside risks are evident.
450 DKK bn 450
 EUR/DKK is likely to rise toward parity when the ECB starts draining liquidity and 400 400
350 350
Danish money market rates therefore tighten against euro rates. Central bank buying 300 300
of DKK certainly cannot be ruled out during this process. 250 Currency reserve 250
200 200

Key risks 150

100
150
100
50 50
 If the financial crisis accelerates, smaller currencies will naturally be at risk. 0 0
80 85 90 95 00 05 10
 The higher-than-necessary DKK/EUR rate spread has generated some inflows of “hot
money”. If everybody wants to get out of the same door at the same time, rapid
Source: Danske Markets
movements can occur.
Things to look out for Normalisation of policy rate spread
 Developments in money market spreads. The Danish central bank can only control 1.75 1.75
% %
one leg here, the Danish. If the ECB starts to withdraw liquidity, leading to higher 1.50 1.50
1.25 1.25
European money market rates, the positive carry on DKK will decline further and
1.00 1.00
EUR/DKK will climb higher. 0.75 0.75
0.50 0.50
 Currency reserve announcements (second bank day in the month). Central bank
0.25 0.25
comments regarding the desired size of the currency reserve. Governors Bernstein and 0.00
DKK - EUR policy rate spread
0.00
Nielsen have both said that “a larger reserve is required than what has been the case in 07 08 09 10

previous years.” Source: Danske Markets

 The Danish central bank does not have scheduled meetings and does not announce
rates at a specific time. Recently, normal procedure has been to cut rates on Thursdays
at 16.00 CET. Senior Analyst
John Hydeskov
+45 45 12 84 97
johy@danskebank.dk

10 | 17 May 2010
www.danskeresearch.com
FX Forecast Update

AUD/USD – higher, but no new high

 The recent sell-off in risky assets, due to the Euroland debt crisis, has weighed on
AUD/USD overview
AUD/USD, which dropped back below 0.90 and its 200-day moving average. The
intraday collapse to 0.87 on 7 May illustrates still high correlation with risk sentiment. Recent moves 1W 1M 3M
Spot change -2.8% -5.3% -2.7%
Outlook
Spot, high 0.908 0.934 0.939
 We expect to see renewed support for AUD/USD in the short term and project
Spot, low 0.873 0.872 0.872
AUD/USD at 0.92 in 3M, 0.94 in 6M and 0.90 in 12M.
Outlook 1M 3M 6M 1Y
Key arguments
Forecast 0.91 0.92 0.94 0.90
 The Reserve Bank of Australia has begun tightening monetary policy and we expect
Forward 0.88 0.88 0.89 0.91
the policy rate to reach 5.00% before end-2010. Rate hikes have been more front-
Carry (pips) -27 -86 -178 -357
loaded than previously expected and with the market having priced out expected rate
hikes during the recent market turmoil (the OIS market currently prices an expected Source: Danske Markets

50bp hikes in 12 months), we see potential for renewed AUD support from relative
rates in the short term. AUD/USD forecast and option implied
 The Fed is unlikely to raise the policy rate before early 2011. Hence, relative probabilities
monetary policy is expected to remain AUD-favourable on a 3-6 month horizon. 1.05 AUD/USD
1.00
0.95
 Australia has been among the economies most sheltered from the global recession and 0.90
0.85
we expect the cyclical position of the Australian economy to continue to justify an 0.80
0.75
0.70
overvalued level in AUD/USD throughout the forecast horizon. 0.65
0.60
 A continued improvement in the global growth outlook should support commodity 0.55

Jun Sep Dec Mar Jun Sep Dec Mar

prices further and secure an additional improvement in the Australian terms of trade. 09 10 11
90 pct. region Spot (incl. DB forecast)
50 pct. region Forward
 Close to half of Australia’s exports go to emerging Asia, which continues to lead the
global recovery. Source: Danske Markets

 Indications that the Fed will tighten monetary policy are likely to mark a turnaround
in the bullish AUD/USD trend. We expect a narrowing of the AUD/USD interest rate AUD/USD and PPP estimate
differential by late 2010 to put downside pressure on AUD/USD (just as in December 1.4 1.4
1.3 1.3
2009) and take the pair away from, by long-term measures, very overvalued territory. 1.2 1.2
1.1 1.1
Risks are that this could materialise sooner than expected. A key test will be the 1.0 1.0
0.9 PPP estimate 0.9
reaction once the Fed removes the ‘extended period’ phrase from its monetary policy 0.8 0.8
0.7 0.7
statement. 0.6 AUD/USD spot 0.6
0.5 0.5
Key risks 0.4
76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
0.4

 Risky assets should remain supported by the easy global monetary policy setting and Source: Danske Markets
improving economic data. However, should the Euroland debt crisis trigger a more
pronounced and longer-lasting sell-off, we would expect AUD/USD to move much
lower.
 Our China economists are looking for an imminent revaluation of the Chinese
Renminbi. Should this prove negative for global risk sentiment, we could see
AUD/USD move lower.
 More front-loaded hikes by the RBA, potentially coinciding with a more dovish-than-
expected Fed, could see AUD/USD move well above our current forecast and towards
parity.
Things to look out for
Senior Analyst
 AUD/USD is trading at highly overvalued levels when benchmarked against long- Kasper Kirkegaard
term valuation measures (PPP estimate stands at 0.75). +45 4513 7018
kaki@danskebank.dk

11 | 17 May 2010
www.danskeresearch.com
FX Forecast Update

NZD/USD – recovery expected

 NZD/USD has moved slightly lower during the recent sell-off in risky assets. NZD
NZD/USD overview
has, however, held up much better than both AUD and CAD, as the New Zealand
money market has not priced out expected hikes in New Zealand. Indeed, relative Recent moves 1W 1M 3M
interest rates currently justify AUD/NZD at 1.25. Spot change -3.0% -1.2% -0.7%

Outlook Spot, high 0.73 0.73 0.73

Spot, low 0.70 0.70 0.68
 We project NZD/USD at 0.73 in 3M, 0.76 in 6M and 0.72 in 12M.
Outlook 1M 3M 6M 1Y
Key arguments Forecast 0.72 0.73 0.76 0.72
 A sustained positive trend in global economic data combined with ample global
Forward 0.70 0.70 0.71 0.72
liquidity (secured by low policy rates) is expected to fuel a sustained demand for risky Carry (pips) -10 -39 -87 -200
assets and the New Zealand dollar. Source: Danske Markets

 Monetary policy tightening is coming closer in New Zealand and is likely to

materialise at the June or July meeting – well before any tightening from the Federal NZD/USD forecast and option implied
Reserve. probabilities
 Indications that the Federal Reserve will tighten monetary policy are likely to mark a
0.85
NZD/USD
turnaround in the upward NZD/USD trend. We expect a narrowing of the NZD/USD 0.80
0.75
interest rate differential by late 2010 to put downside pressure on NZD/USD and take 0.70
0.65
the pair away from, by long-term measures, very overvalued territory. 0.60
0.55
 NZD outperformance against AUD and to a lesser extent CAD could be sustained on 0.50
0.45
the 3-6 month horizon given that the RBNZ commences a hiking cycle during the
Jun Sep Dec Mar Jun Sep Dec Mar
coming months. However, we also believe that the potential for a relief rally in AUD 09
90 pct. region
10 11
Spot (incl. DB forecast)
50 pct. region Forward
and CAD is bigger than for NZD.
Source: Danske Markets
Key risks
 If interest rate hikes in New Zealand become more front-loaded than currently priced
in the market, NZD/USD is likely to rise more than factored into our forecast. NZD/USD and PPP estimate
1.4 1.4
 New Zealand’s large external imbalances will have to be addressed at some point. 1.3 1.3
1.2 1.2
Historically we often see large currency depreciation coinciding with a correction of a 1.1 1.1
1.0 1.0
current account deficit. This remains a key risk to NZD. 0.9 0.9
0.8 0.8
 Risky assets should remain supported by the easy global monetary policy setting and 0.7 NZD/USDspot 0.7
0.6 0.6
improving economic data. However, should the Euroland debt crisis trigger a more 0.5 PPPestimate 0.5
0.4 0.4
pronounced and longer-lasting sell-off we would expect NZD/USD to move much 0.3 0.3
76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
lower.
Source: Danske Markets
Things to look out for
 NZD/USD remains positively and highly correlated with global equity prices (proxy
for risk sentiment).

 NZD/USD is trading at highly overvalued levels when benchmarked against long-

term valuation measures (PPP estimate stands at 0.60).

Senior Analyst
Kasper Kirkegaard
+45 4513 7018
kaki@danskebank.dk

12 | 17 May 2010
www.danskeresearch.com
FX Forecast Update

USD/CAD – BoC hikes coming up

USD/CAD soared earlier this month as concern about Euroland sovereign debt took its
USD/CAD overview
toll on global risk appetite. As risk appetite and liquidity have since improved somewhat
on the back of the EU/IMF rescue package, and as the general backdrop for equities Recent moves 1W 1M 3M

remains positive, we look for USD/CAD downside to unfold further. Spot change 1.4% 2.7% -0.5%

Outlook Spot, high 1.044 1.073 1.073

Spot, low 1.011 0.993 0.993
 The CAD looks poised to retest parity versus the USD as (1) the Canadian economy
Outlook 1M 3M 6M 1Y
continues to perform, (2) a BoC hike on 1 June looks increasingly likely, and (3)
Forecast 1.01 1.00 1.02 1.10
sovereign debt problems in Euroland have put Canadian balances into an even more
favourable light. That said, the CAD is already trading at stretched levels and given Forward 1.04 1.04 1.04 1.04
the crowded positioning, a major push below parity will likely prove difficult. Also, if Carry (pips) -16 -14 -6 31
risk appetite continues to be under pressure, the cyclical CAD could face headwinds. Source: Danske Markets

 Our forecasts are unchanged: 1.00 (3M), 1.02 (6M) and 1.10 (12M).
Forecast and option implied
Key arguments confidence regions
 Given the strength of recent Canadian economic data (e.g. the April jobs report 1.30 USD/CAD

showing 109k jobs added), the removal of the conditional commitment for unchanged 1.20

rates and the fact that the latest BoC statement called for a lessening of the degree of 1.10

1.00
stimulus, a hike on 1 June seems highly likely. This is likely to be the first in a series
0.90
of rate hikes and even though pricing is already aggressive, we look for the
0.80
confirmation of the beginning of the hiking cycle to give further support to the CAD. Jun Sep Dec Mar Jun Sep Dec Mar
09 10 11
90 pct. region Spot (incl. DB forecast)
 There are other factors pointing to the CAD remaining strong in the coming months. 50 pct. region Forward

First, given the prospects of global central banks keeping rates low for some time to Source: Danske Markets
come, risky assets could have further upside potential, boding well for the cyclical
CAD. Second, the Canadian economy is in better shape than the US, with stronger
labour and housing markets and a less severely hit banking sector. Also, Canada has USD/CAD and PPP estimate
much healthier balances, despite the slight government budget deficit. 1.7 1.7
1.6 1.6

 A significant move below parity could prove difficult: positioning data (IMM) points 1.5
USD/CAD spot
1.5
1.4 1.4

to short USD/CAD being an increasingly crowded trade. Also, we see limited 1.3 1.3
1.2 1.2
potential for relative interest rates to move further in favour of the CAD, given that 1.1
PPP estimate
1.1
1.0 1.0
roughly 170bp of tightening has already been priced in on a one-year horizon. Finally, 0.9 0.9

the pair is trading at stretched levels relative to long-term valuation (PPP estimate: 0.8 0.8
76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
1.16).
Source: Danske Markets
Key risks
 As a pro-cyclical currency, CAD remains exposed to changes in general market
sentiment and usually suffers if equities are sold off.

 The pair will also be exposed to hints of an earlier-than-expected tightening of the Fed
monetary policy. However, the BoC will most likely move first.
Things to look out for
 BoC meeting on 1 June: The BoC has recently moved away from the previous
commitment to unchanged rates until Q3. While BoC Governor Carney has stressed
that “nothing is pre-ordained”, recent strong Canadian data should give the bank
plenty of reasons to hike on the next occasion.
 The outlook for the price of oil, given the close negative correlation with USD/CAD. Senior Analyst
Sverre Holbek
+45 45 14 88 82
holb@danskebank.dk

13 | 17 May 2010
www.danskeresearch.com
FX Forecast Update

FX and Commodities Research

Arne Lohmann Rasmussen Head of FX Research NOK, SEK +45 45 12 85 32 arr@danskebank.dk
John Hydeskov Senior Analyst G10 +45 45 12 84 97 johy@danskebank.dk
Kasper Kirkegaard Senior Analyst G10 +45 45 13 70 18 kaki@danskebank.dk
Stefan Mellin Senior Analyst SEK +46 8 568 805 92 mell@danskebank.se
Sverre Holbek Senior Analyst Option strategies, CAD +45 45 14 88 82 holb@danskebank.dk
Christin Kyrme Tuxen Senior Analyst Commodities +45 45 13 78 67 tux@danskebank.dk

14 | 17 May 2010
www.danskeresearch.com
FX Forecast Update

Disclosure
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Financial models and/or methodology used in this research report

Calculations and presentations in this research report are based on standard econometric tools and
methodology as well as publicly available statistics for each individual security, issuer and/or country.
Documentation can be obtained from the authors upon request.

Risk warning
Major risks connected with recommendations or opinions in this research report, including as
sensitivity analysis of relevant assumptions, are stated throughout the text.

First date of publication

Please see the front page of this research report for the first date of publication. Price-related data is
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