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Most-Accurate Forecasts Say Dollar Beats QE3, Euro Tops Yen

Published: October 9, 2012 | 8:05 am
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(Adds IMF growth forecast in sixth paragraph, updates currency prices in 11th and 12th paragraphs.)

The world’s most-accurate foreign- exchange strategists say the dollar will strengthen even as the Federal Reserve debases it, unlike the previous two rounds of economic stimulus, when cash injections weakened the currency.
Fed Chairman Ben S. Bernanke’s $40 billion-a-month of bond purchases will leave a stronger currency in 2013, say nine of the 10 forecasters with the lowest margins of error in the six quarters ended Sept. 28 as measured by Bloomberg. Wells Fargo & Co. and Westpac Banking Corp., which tied for most-accurate, expect little damage from efforts to stimulate the economy and the so-called fiscal cliff of spending cuts and tax increases scheduled for next year.
While the Dollar Index, which measures the currency against those of six major trading partners, fell 4.6 percent and 3.9 percent in the first two rounds of Fed stimulus that added $2.3 trillion to the banking system, this time will be different, forecasters say. Investors will demand the world’s reserve currency as U.S. growth outpaces its developed counterparts.
“If the U.S. economy keeps outperforming, then it shouldn’t cause the U.S. dollar much damage,” given that most of its trading partners are growing slowly or contracting, said Sean Callow, a senior currency strategist in Sydney at Westpac Banking Corp. Monetary easing is only “a short-term negative for the U.S. dollar.”

Relative Growth
Westpac, which matched Wells Fargo with a 3.34 percent margin of error in the Bloomberg analysis, expects the dollar to rally to $1.20 versus the euro from $1.3045 at the end of last week, and 80 yen from 78.67 by the third quarter of next year.
U.S. gross domestic product is forecast to expand 2.1 percent in 2013 after growing 2.2 percent this year, according to the median estimate of 80 analysts surveyed by Bloomberg. That compares with a predicted 0.4 percent expansion in the euro area and 1.2 percent for Japan. The International Monetary Fund projects growth of 2.1 percent in the U.S. economy next year, 0.2 percent in 17-nation currency bloc, and 1.2 percent expansion in Japan.
The forecasts of the most-accurate strategists showed they don’t expect the dollar strengthening to begin until 2013, and that the euro will benefit this quarter from reduced concern that the region’s debt crisis will worsen.

Emerging Markets
Seven out of the top 10 forecasters said that even as the dollar gains, investors should favor emerging markets, such as India, Russia and Mexico, where the domestic economies will allow currency appreciation to help control inflation without raising interest rates.
“We have entered a new frontier” of seemingly unlimited central-bank stimulus, Eimear Daly, a currency analyst in London at Monex Europe Ltd., the fifth most-accurate forecaster, said in an e-mailed response to questions on Oct. 2. “For returns, investors have to look to emerging market currencies.”
Interest rates in developing economies will likely remain above those in Group of 10 nations as central banks try to contain inflation. The cost of living in India, where the central bank’s benchmark rate is 7 percent, is forecast to surge 7.8 percent next year, according to a survey of 16 economists by Bloomberg News. Inflation in Mexico and Russia is forecast to reach 3.8 percent and 6.5 percent in 2013, above the projected increase of 2 percent in the U.S.

Dollar Index
IntercontinentalExchange Inc.’s Dollar Index, which tracks the U.S. currency against the euro, yen, pound, Swiss franc, Canadian dollar and Swedish krona, traded at 79.535 as of 1:55 p.m. in Tokyo from 79.540 yesterday. The gauge fell 0.8 percent last week as the U.S. unemployment rate dropped below 8 percent in September for the first time since January 2009. The Dollar Index is little changed since the Fed said Sept. 13 it will conduct a third round of bond purchases in a policy known as quantitative easing.

The dollar slid 0.1 percent to $1.2983 per euro after rising 0.6 percent yesterday. It gained 0.1 percent to 78.40 yen following a 0.4 percent slide yesterday.
While the most-accurate forecasters’ predictions for 2013 averaged $1.25 for the euro next year, six of the 10 said the shared currency is still the best buy in the next three months, rather than the yen or the dollar as the European Central Bank and President Mario Draghi step up efforts to fix the region’s debt crisis.

Reduced Risk
The ECB’s decision to buy bonds of indebted members that ask for aid reduced the risk that the group will splinter as turmoil that caused spiraling borrowing costs in European nations drags into its fourth year. The odds of a country leaving the currency bloc by the end of 2013 fell to 45.2 percent from 55 percent before the ECB said Sept. 6 that it would purchase debt, according to Intrade.com.
“In the near-term, we believe ECB policy actions could offer some support to the euro as the worst-case scenarios are priced out,” said Nick Bennenbroek, head of currency strategy at Wells Fargo in New York, who with Vassili Serebriakov, has either been the most-accurate forecaster or tied for the top spot for the fourth consecutive quarter. The dollar’s “weakness in late 2012 is temporary and related to near-term developments in the European debt crisis,” he said.

Best Performer
The euro rose 1.1 percent in the past month, making it the best performer among 10 developed-nation currencies, Bloomberg Correlation-Weighted Currency Indexes show. It had lost 5.1 percent this year through July 26, when Draghi pledged to do “whatever it takes” to save the euro.
Wells Fargo, also the No. 3 euro-dollar forecaster, expects the dollar to weaken to $1.31 per euro by the end of the year, and then gain to $1.24 in 2013. Four of the 10 most-accurate forecasters’ favorite trade for the fourth-quarter includes a bet the euro will rise.
That means the Dollar Index, which normally falls when the euro appreciates, should be weaker in the fourth quarter. National Australia Bank Ltd., the fourth most-accurate forecaster, expects that decline to continue.
“The dollar is probably the least favorite as the Fed cranks up its QE3 program,” said Ray Attrill, the Sydney-based global co-head of currency strategy at National Australia Bank.

Weaker Aussie
The firm’s favorite trade is a bet the euro will rise and the so-called Aussie dollar will fall. Attrill said he expects Australia’s currency to weaken to 75 euro cents by the end of the year from 78.09 cents last week. The Sydney-based bank forecasts the Dollar Index to fall to 76.75 by March.
America’s currency tumbled against all its major counterparts except the pound by at least 4.2 percent as the Fed purchased $1.7 trillion in Treasuries and mortgage-related debt between December 2008 and March 2010 under QE1. During QE2, when it bought $600 billion from November 2010 through June 2011, the dollar was 4.4 percent weaker against the euro, little changed versus the yen and 0.1 percent lower compared with the pound.
The open-ended nature of the QE3, where Bernanke said the Fed will buy $40 billion of bonds a month until policy makers see “ongoing, sustained improvement in the labor market,” makes the effect on the dollar different this time, according to Danske Bank A/S. The firm is the seventh-most-accurate forecaster.

‘Fed’s Resolve’
“The market can no longer underestimate the Fed’s resolve to boost growth,” Arne Rasmussen, the head of currency research at Danske Bank in Copenhagen, said in a phone interview on Oct. 4. “That will benefit the economy and the dollar. We see the dollar picking up from the second quarter next year.”
A stronger dollar makes it easier for the U.S. to finance a fourth straight year of budget deficits exceeding $1 trillion as the government borrows for programs designed to pull the economy out of the worst financial crisis since the Great Depression.
Now, the U.S. faces the fiscal cliff of $1.2 trillion in mandated spending cuts and tax increases starting Jan. 1 if Congress can’t agree by Dec. 31 on ways to reduce the deficit.
The Fed and ECB aren’t the only central banks boosting stimulus as global growth slows. The Bank of Japan increased its asset-purchase fund last month to 55 trillion yen ($702 billion) to counter deflation. The Bank of England plans to buy 375 billion pounds ($602 billion) of government bonds to boost growth after the U.K. economy contracted for three quarters.
“We do not believe that QE3 will have anywhere near the potency of QE1 and QE2,” Mitul Kotecha, Hong Kong-based head of foreign-exchange strategy at Credit Agricole, the eighth-most accurate overall and the top euro-dollar forecaster, said in an e-mailed response to questions on Oct 3. That will allow the dollar to appreciate amid “relatively stronger growth.”
Strategists were ranked according to the accuracy of their forecasts for 13 currency pairs in each of six quarters through September. To test long-term accuracy, Bloomberg Rankings added one annual estimate, which was made at the end of September 2011 for the end of September 2012.
Companies with at least eight forecasts for a particular currency pair were ranked, and only those that qualified in at least eight of 13 pairs were included in the ranking of best overall forecaster. Thirty-two qualified.


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