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FX Forecast Update: Low Rates for Longer - Greek Impact on EUR Loses Momentum

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Key points

Low rates are here to stay - at least in the G4. It is becoming increasingly clear that central banks in Europe, the US, the UK and Japan are in no hurry to normalise monetary conditions. Fiscal tightening, needed to curb the soaring budget deficits, simply crowds out monetary tightening. For most currency pairs, relative rates as the dominant driver for can therefore be delayed for longer than previously projected. And equity prices - a proxy for risky behaviour, fuelled by lower rates - and commodity prices can thereby remain significant for future exchange rate movements.

The Greek debt problems have not been solved - but fears of a euro collapse are fading. We believe the fiscal situation in Greece is unsustainable and think it reasonable that financial markets have been concerned and reacted by selling Greek bonds and stocks. We do however think the euro sell-off is somewhat overdone. After all, Greece only constitutes 2-3% of Euroland GDP - much less than also debt-burdened California's 13% share of US GDP - and we think it very unlikely that the stronger Euroland countries won't join forces if the situation escalates further. We foresee that debt problems within Euroland will continue to pop up in the media, but that the risk premium currently attached to the euro will gradually decrease and weigh less on the single currency in the quarters to come.

The US is set to outpace Euroland, the UK and Japan in terms of economic growth in 2010. However, as we see it, it is growth on steroids; the US economy enjoys the tailwinds from the massive fiscal and monetary stimuli but the underlying trend might not be as strong as the last GDP numbers indicated. Even though it seems like something we have seen before - the US recovers first, Euroland and the UK lag behind and Japan is stuck in the mire, and currency implications perhaps therefore should be straightforward - we keep in mind the lessons from 2003-04. At that time, the world also recovered from recession, the Fed hiked rates one year before the ECB and despite that EUR/USD climbed higher. The same thing could happen again.

An 'A-team' and a 'B-team' among central banks are starting to be formed: The Ateam consists of the leaders in hiking rates: RBA, Norges Bank and probably also in 2010 RBNZ, BoC, Riksbanken and perhaps also the Fed and the SNB. As we have seen with the AUD and the NOK, central bank hikes lead to currency appreciation almost no matter how anticipated they may be. The B-team consists of BoJ, ECB and BoE, from which we can expect only very moderate monetary tightening.

What to buy? With interest rates low, leading indicators still pointing towards economic expansion and risk appetite back in the saddle, we prefer currencies with a tendency to strengthen in good times. These include AUD, NZD and SEK. The latter we also like due to sound fiscal balances, higher interest rates to come and a good starting point from a valuation point of view. The NOK and the CAD are attractive due to several rate hikes in the pipeline and higher oil prices while the CHF is becoming interesting as the SNB is set to accept a stronger franc without intervening. The GBP has still sound potential against the EUR but patience is a virtue as the UK economy only recovers slowly and the financial sector remains under water for now. The JPY faces a losing streak as we see it

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