Global Economic Outlook and Strategy - Kadin Indonesia

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February 28, 2008 Global Economic Outlook and Strategy Stephen Halmarick 011-612 8225-6043 stephen.halmarick @citi.com Currency Outlook With the depth of the near-term deceleration of the U.S. economy still in doubt, and financial conditions continuing to deteriorate, we expect downward pressure on the U.S. dollar to persist in coming months. The dollar downtrend should, however, remain modest. Aggressive action by the Federal Reserve should help to stabilize financial conditions and prospects for growth in coming quarters. In addition, the outlook for growth in the euro area appears to be deteriorating, and this change in cyclical outlooks should eventually turn the tide on USD/EUR. The USD will likely depreciate modestly relative to the Japanese yen in the first half of 2008. Japan appears to be the least affected by the money and credit market strains among the major economies and should benefit from any further heightened risk aversion. However, we expect the JPY to start weakening against the USD in the second half of the year. As global economic and financial risks wane, in part thanks to policy actions in major countries, Japanese households are likely to resume diversifying their portfolios into foreign currency denominated assets, weighing down the yen. We continue to expect the British pound to be one of the weakest of the G10 currencies in 2008. While markets currently are discounting an easing cycle, we expect growth is likely to undershoot MPC forecasts, thus opening up scope for an extended easing cycle, even with the short-term inflation worries. Led by the renminbi, emerging Asian currencies continued to gain ground during the past month. A broad pickup in inflation has generated incentives for central banks across the region to tolerate greater exchange rate flexibility — especially for the Taiwanese dollar and Vietnamese dong. We continue to expect emerging Asian currencies to lead the next leg of U.S. dollar weakness. However, we also warn against excessive optimism regarding the outlook of Asian currencies, given that the expected slowing in exports will likely add caution to currency policymaking. We maintain our expectation of 7.5% renminbi appreciation against the USD, which is less aggressive than market expectations. We continue to favor the AUD among commodity currencies. Markets could be surprised by the extent to which the Reserve Bank of Australia (RBA) tightens monetary policy in coming months. We project a tightening of at least 50 basis points by May. Indeed, further tightening beyond that could be required to ensure inflation returns to the 2%-3% target zone. Along with rising interest rates, gains in key Australian commodity prices, as indicated by the recent 65% price rise in iron ore exports to Japan for the coming financial year, should continue to provide the AUD with fundamental support. In the near term, the NZD should remain in a range, as the Reserve Bank of New Zealand (RBNZ) holds monetary policy steady, balancing the inflation risks from higher dairy prices and a tight labor market against clear signs of a slowdown in the housing sector. The CAD is also likely to remain range-bound in the near term, with some modest retreat from parity amid a slowing Canadian economy, ongoing financial market strains, and tighter credit conditions. While the BoC is now expected to lower policy rates by 100 basis points by midyear, this will only match the expected easing in the United States. As a result, continued commodity price strength and the weak U.S. economic outlook argue against a meaningful depreciation of the CAD. The Swiss franc (CHF) has been a star performer so far this year, rising about 4% in trade-weighted terms, and it is likely to remain strong. Markets have scaled back the amount of Swiss National Bank (SNB) easing priced in for the second and third quarters, as the economy holds up better than expected and inflation remains above the 14
February 28, 2008 Global Economic Outlook and Strategy SNB’s 2% target ceiling. Therefore, the SNB will likely keep rates on hold in coming months, unless the CHF rises more sharply. The outlook for the CHF also should be reinforced by the currency’s longstanding safe-haven status, with a strong and positive correlation between equity market volatility and the trade-weighted CHF. While the Norges Bank has recently expressed concerns about money market strains and heightened global economic uncertainty, we still expect further monetary policy tightening to combat inflation risks amid heightened capacity pressures and accelerating wages. Oil prices are a double-edged sword for the NOK. Recent high prices have supported the NOK, but the sharp rise over the past year also raises the risk of a correction. In Sweden, the Riksbank is expected to keep rates steady near term, following the surprise rate hike in February. The next move is likely to be a cut around yearend to offset the negative effects from the credit crisis and weakening U.S. and global economic growth. But interest rate spreads remain in the SEK’s favor. Also, while periods of financial instability normally do not favor the SEK, the SEK should strengthen again once the dust settles in financial markets. Currencies across CEEMEA continue to feel the effects of conflicting forces. Amid ongoing financing concerns, currencies of external deficit countries such as South Africa and Romania remain under pressure relative to the EUR. Inflationary pressures across the region, however, continue to put upward pressure on domestic interest rates, providing some support to currencies of countries with better economic prospects, including Poland, Israel, and Slovakia. Slovakia is also experiencing capital inflows in anticipation of a revaluation of the koruna’s central parity against the EUR next quarter as part of the euroadoption process. Hungary, by abandoning its band, reversed much of its January selloff. Latin American currencies have so far shown no vulnerability to deteriorating global prospects. In fact, with the United States cutting rates and commodity prices making new highs, Latin currencies have continued to appreciate. Inflationary challenges in Chile, Peru, and Colombia will likely keep those central banks vigilant, with a bias toward maintaining a hawkish discourse, and possibly even hiking rates. Rate cuts are likely in Mexico, but not until September, given the likelihood that yearly inflation will increase above the top of Banxico’s band during most of the second quarter. Figure 20. Currency Recommendations, as of Feb 28, 2008 Current 3-Month Forecast Annual Return vs FWD Implied Vol. 12-Month Forecast Annual Return vs FWD Implied Vol. United States NA NA NA NA NA NA NA Japan 106 105 1.9 10.7 112 -7.2 9.6 Euro Area 1.51 1.52 4.1 9.1 1.46 -2.1 8.8 Canada 0.98 1.02 -14.4 11.6 1.04 -5.2 10.9 Australia 0.94 0.94 3.5 13.1 0.89 -0.7 12.7 New Zealand 0.81 0.80 -6.3 14.8 0.74 -3.6 14.8 Norway 5.20 4.92 25.3 12.2 4.94 8.2 11.8 Sweden 6.20 6.02 13.0 11.8 6.35 -0.5 11.3 Switzerland 1.06 1.05 4.7 10.0 1.03 2.7 9.0 United Kingdom 1.98 1.96 -1.7 8.6 1.93 -0.4 8.5 China 7.11 7.02 -5.2 3.4 6.62 -2.2 4.9 India 39.9 38.7 12.7 6.0 37.2 7.7 6.4 Korea 938 960 -8.8 5.3 887 6.0 4.9 Poland 2.33 2.39 -7.6 11.0 2.43 -0.7 10.5 Russia 24.1 24.0 3.7 5.9 24.5 1.4 6.7 South Africa 7.56 7.83 -5.5 19.6 8.07 2.2 19.3 Turkey 1.18 1.23 -3.9 14.1 1.31 1.9 16.2 Brazil 1.67 1.80 -23.7 13.6 1.83 -2.6 14.6 Mexico 10.7 10.9 -2.3 5.3 11.0 1.6 6.6 Source: Citi. 15
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