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11 Mar 2013
Forex Flash: USD will rise against G10 - Societe Generale
Sebastien Galy, Senior FX Strategist at Societe Generale notes believes that the US dollar will steadily rise against its G10 peers by year end.
Looking at EUR/USD, he feels that it will finish the year in the low 1.20´s and more broadly speaking, he expects the dollar to outperform GBP, AUD, and other G10 currencies off the back of higher US Treasury yields and an improvement in the US national balance sheet. He adds, “As US households, their employers and eventually the government reduce their reliance on debt, the credit quality of the country improves and particularly so as it evolves from being a large net importer of oil to eventually becoming an exporter.”
Galy continues to note that expectations of an eventual tightening of Fed policy will have an effect via several channels. Firstly, higher US Treasury yields make it less attractive for US or US-dollar based investors to buy riskier assets at home and abroad. He notes that those borrowing in US dollars find that their funding costs are rising, with the FX market generally trading as a function of 2-year interest rate swap differentials. Further, he feels that there would presumably be a decision by some to switch their funding away from the US dollar to the yen, sterling or the Swiss franc with their ultra-low interest rates and tendency to weaken from high values. He writes, “The natural tendency will be therefore for the US dollar to tend to rise relative to such currencies.”
Additionally, the reallocation of risk back into uSD is as valid for private investors as it is for foreign reserve managers. Galy believes that they will eventually find it less attractive to divest out of the US dollar and buy other currencies such as the Euro. AUD or CAD. More importantly, he believes that reserve managers have reduced the duration of their fixed income positions to historical lows, partly in anticipation of a move higher in the back end of US Treasuries. He feels that such as move would otherwise lead to substantial market-to-market business. He adds, “This duration positioning means that the demand for the back end of the US Treasury curve is weak from central banks. This matters for Japanese investors in particular.”
Galy finishes by commenting that a steepening US Treasury curve would create additional upward pressure on USD/JPY. He finishes by writing, “Japanese life insurance companies typically buy the back end of the curve if the differential between the 10-year and 2-year is large enough where the latter is a decent proxy for the cost of hedging the position back in yen using FX swaps of three months to two years.”
Looking at EUR/USD, he feels that it will finish the year in the low 1.20´s and more broadly speaking, he expects the dollar to outperform GBP, AUD, and other G10 currencies off the back of higher US Treasury yields and an improvement in the US national balance sheet. He adds, “As US households, their employers and eventually the government reduce their reliance on debt, the credit quality of the country improves and particularly so as it evolves from being a large net importer of oil to eventually becoming an exporter.”
Galy continues to note that expectations of an eventual tightening of Fed policy will have an effect via several channels. Firstly, higher US Treasury yields make it less attractive for US or US-dollar based investors to buy riskier assets at home and abroad. He notes that those borrowing in US dollars find that their funding costs are rising, with the FX market generally trading as a function of 2-year interest rate swap differentials. Further, he feels that there would presumably be a decision by some to switch their funding away from the US dollar to the yen, sterling or the Swiss franc with their ultra-low interest rates and tendency to weaken from high values. He writes, “The natural tendency will be therefore for the US dollar to tend to rise relative to such currencies.”
Additionally, the reallocation of risk back into uSD is as valid for private investors as it is for foreign reserve managers. Galy believes that they will eventually find it less attractive to divest out of the US dollar and buy other currencies such as the Euro. AUD or CAD. More importantly, he believes that reserve managers have reduced the duration of their fixed income positions to historical lows, partly in anticipation of a move higher in the back end of US Treasuries. He feels that such as move would otherwise lead to substantial market-to-market business. He adds, “This duration positioning means that the demand for the back end of the US Treasury curve is weak from central banks. This matters for Japanese investors in particular.”
Galy finishes by commenting that a steepening US Treasury curve would create additional upward pressure on USD/JPY. He finishes by writing, “Japanese life insurance companies typically buy the back end of the curve if the differential between the 10-year and 2-year is large enough where the latter is a decent proxy for the cost of hedging the position back in yen using FX swaps of three months to two years.”