Room For Additional Economic Stimulus Continues To Shrink, Stock Market Trend

Most analysts view the current correction on stock markets worldwide as unavoidable. Tensions in Europe linked to the public finances are on the rise, China is trying to restrict domestic credit supply, and the Fed faces a torrent of criticism at home and abroad regarding its policy to increase quantitative easing by $600bn with an option to draw down more. It is feared that further quantitative easing would only weaken the dollar further and push up commodity prices. As a result of the latter the rapidly growing Asian economies would come under additional inflationary pressures.

EUR/USD – On the way down

We think economic growth and interest rates will pick up in the US in the near future. Simultaneously, the eurozone economy is bound to cool, which will undoubtedly ratchet up the tensions within the Monetary Union. It increasingly remains to be seen if the Fed will be able to apply further quantitative easing whereas the ECB is under mounting pressure to ease its monetary policy additionally. EUR/USD could slide towards 1.15 over the coming months to quarters.

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European short-term interest rates and bond yields – Eurozone: One monetary union, very different economies

Owing to fiscal tightening in the eurozone we expect decelerating economic growth for the time being. The – temporary – bail-out of Ireland does not change a thing. Both Ireland and the eurozone are still facing the same problems. As the situation in the weak euro countries is quite desperate, long-term interest rates in these member states will likely continue to rise. Simultaneously, the spread between bond yields in the weak and the strong euro states could widen in the coming months. On top of this, the 3-month EURIBOR may be expected to rise in the coming period, whereas the EUR swap spread could continue to widen. The main reasons are slowing economic growth, mounting uncertainty on the financial markets, and fresh banking woes. The 3-month EURIBOR may climb from around 1.04% towards 1.50% as the EUR swap spread widens from near 30 bp to around 50 bp. In the coming months the German 10-year yield (now around 2.7%) could on balance rise towards 3% in the wake of rising US bond yields. Subsequently, it may fall quite sharply.

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EUR/CHF, USD/CHF Swiss Rates - Growing demand for francs

In the coming months we expect global economic growth to slow. This will create mounting tensions, within the EMU as well as wider afield. In response, we foresee a darkening mood on the markets as investors flee into safety. These developments will benefit the franc. EUR/CHF (now around 1.33) could gradually drop towards 1.20 over the next few months.

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EUR/USD - Months of dollar strength in the pipeline

The dollar is under downward pressure (for various reasons). However, we expect a marked appreciation in the US currency over the coming period, especially against the euro. Among others because US economic growth could start to accelerate somewhat over the coming months to quarters whereas there is little doubt that tensions within the eurozone will continue to mount. Over that period, EUR/USD (now around 1.38) may peak near 1.43 then fall towards 1.10.

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European short-term interest rates and bond yields – ECB is standing firm …for now

The ECB is pursuing a considerably more restrictve monetary policy than the Fed. In our view the trouble in the euro area will grow worse over the coming period. This could widen the spreads between bond yields in the weak and the strong euro countries. The 3-month EURIBOR may well rise from near 1.05% towards 1.5% in the coming months as the EUR swap spread widens from 32 towards 50 basis points. In the near future, the German 10-year yield (now around 2.4%) may drop slightly due to the flight to safety as a result of mounting problems in the struggling euro states.

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