Maraging Partners


FX Forecast for Q1 2013: EUR/USD, USD/RUB, EUR/RUB

Bos Taurus

Creating a currency forecast is akin to painting -- it all begins with grounding the canvas. Then one paints a background. Unlike a painter who needs an object or a topic, an analyst should not create topics where none is seen in reality. In foreign exchange analytics, long-range trends form the grounding and the background. In this release, we focus on these trends and take advantage of their predictive force in combination with correlation analysis. Bos taurus, the domestic bull, the most banal of the bovine, is exactly the kind of animal which looks natural within this approach while also reflecting our market view.

In our forecast for the fourth quarter of 2012 we dwelt on the Fiscal Cliff problems, the US sovereign debt ceiling of the year and the expected reaction of the credit rating agencies. In the course of the negotiations of the American legislators, the range of the politically acceptable solitions of the budget deficit problem became clear -- and that includes the numbers. Any kind of an "alarmist scenario" turned out to lie far outside the bounds of what emerged as the acceptable fairway of political maneuvering. Figurally speaking, the politicians argued not about kicking or not kicking the can down the road, but about what footwear to use in the process.

Now that the Federal Budget for 2013 has been signed and the relative consensus regarding The Can has become clear, the pending decisions of the rating agencies, of which the analysts focus on Moody's, whatever they come out to be, can hardly influence the expectations regarding the economic growth in 2013.

One long-range trend worth discussing is the inflationary process generating new money and new debt, denominated mostly in the USD, EUR, and JPY. This process unfolds in the developed economies. The capital infrustructure to support profit generation is being developed mostly in the emerging markets, where the said money is being invested and the said debts are being bought. Thus the slow migration of assets and influence from West to East proceeds. This process conditions the global risk appetite in the stock, commodity and currency markets and, among other things, it makes RUB relatively attractive compared to USD and EUR.


The Case-Shiller index, reflecting the residential real estate prices in the US, has been touching the bottom and has become positive in 2012. Shares of Home Depot, the largest retailer selling goods for home building and home improvement, have shown a nice growth. Lumber prices are climbing.

In this situation the US financial sector, not suffering from lack of liquidity and tied up to a considerable degree to the real estate financing, turned out to be the stock market growth leader for December, for the fourth quarter and for 2012. The growing business confidence ought to have started creating favorable conditions for financing small and medium companies in the US, which create jobs domestically.

In December 2012 the Fed stated that the interest rates would remain at the current low levels at least while the unemployment remains above 6.5%, and the while the inflation rate projected 1-2 years forward remains below 2.5%. The published minutes of that meeting showed that some FOMC members were in favor of stopping the QE well before the end of 2013. Obviously, Fed members respond to the good news, reevaluating the dosage of the monetary morphine critically.

Agaist this backdrop, we expect a reduction in the market demand for USD as a safe haven currency. When the barometer reading indicates clear skies, sailors are not that interested in safe havens.


Lack of confidence that the banks have towards each other and other businesses has been the cancer of European economies. Despite the OMT (Outright Monetary Transactions), economic growth in Europe is hampered by the continuing policy of austerity and by the varying degree of economic health among the Euroland members.

Within the framework of the OMT, which came to replace the SMP (Securities Markets Programme), the ECB buys up the bad debts of the governments which follow the path of austerity, from the banks. The banks meanwhile are encouraged to place the proceeds on the weekly deposits with the ECB. Thus, the proceeds are sterilized, or excluded from the credit multiplication mechanism. Unlike the SMP, OMT has no limits with regard to the time scale or amounts of these purchases. Like the SMP, the essence of OMT is the centralized control over the budgetary healing of the problem countries in exchange for taming of the market forces which otherwise would punish these goverments in the secondary markets of the sovereign debt.

As we noted in the past release, the global economic stimulation leads to increased demand for European goods and thus to increased demand for EUR, while the American QE3 increases the USD amount exported by the US to the world markets. Besides, European OMT decreases the systemic risks in the Euroland. The remaining interest rate differential in favor of EUR -- and we do not expect rate cuts from the ECB in the first quarter of 2013 -- increases the relative attractiveness of EUR under the conditions of QE3. The volume of EUR/USD currency swaps between the Fed and the ECB has dropped 8 times in 2012, indicating a reduction in the USD liquidity demand in Europe.

Therefore the background economic process is bullish for EUR/USD.

Russia and BRIC

The XVIIIth Congress of the Communist Party of China and the Central Economic Conference demonstrated that the new Chinese leaders shift the stress from engineering the so-called economic soft-landing to engineering the process known as decoupling. The "couple" implied by this term is the one formed by the Chinese producer and the Western consumer whose interests are thus entangled. The stated measures to stimulate credit and support urbanization are obviously meant to center the Chinese economy on the Chinese consumer. We expect an improvement in the investment climate in China. 2013 will quite possibly become the year of the emerging markets, which implies an increased demand for the currencies of these markets. The rise in the popularity of BRIC will indirectly enhance the market demand for RUB via theme and index investing under the BRIC brand.

The background economic process will support the price of the Russian commodity exports, while the exchange  of the export revenues will support RUB.

Correlation analysis: no sound of the Pied Piper's pipe yet

As usual, we have analyzed the inter-market correlations among the futures market instruments that reflect the basic macro factors for Russia: hourly data from the FORTS exchange, such as EUR/USD, USD/RUB, EUR/RUB, Brent oil and Russian stock market. We expected that QE would once again reduce the absolute magnitudes of the correlations. The data have confirmed this expectation.

Note that when strong feelings dominate the markets, correlations among financial instruments, either positive or negative, grow in the absolute magnitude, becoming strongly positive or strongly negative, while the multitude of the financial instuments degenerates, enabling their simplified classification into risk assets and safe haven assets. The very possibility of such classification testifies to the dominance of collective dynamics in these periods: the pack of enchanted rats follow the Pied Piper's pipe, and usually, towards a precipice.

The investment topic of return to fundamentals -- which, in effect, is what we called the "background process" -- manifests itself as the opposite of the scenario above, and as a result, asset diversification is more effective than usual. The behaviour of assets resembles that of cats, each of which walks by themselves, rather than that of enchanted rates. Such was the situation in the fourth quarter, and we expect the exit phase from this regime to last at least another quarter, while the Pied Piper's pipe would be either silent as now or play tunes conducive to investment in risky assets.

Probabilistic forecast of the spot quotes at the end of the Q1

Interval boundaries corresponds to quartiles of the distribution, built according to the efficient market hypothesis. Probabilities in the table take into account the expert opinion formulated in the text. When the work on the forecast was over (January 4th, 7pm Moscow time), the spot quotes were: EUR/USD: 1.3040; USD/RUB: 30.37; EUR/RUB: 39.60.

EUR/USD below 1.24 from 1.24 to 1.29 from 1.29 to 1.33 above 1.33
probability, % 16 22 27 35
USD/RUB below 28.80 from 28.80 to 29.94 from 29,94 to 31.11 above 31.11
probability, % 45 25 18 12
EUR/RUB below 37.77 from 37,77 to 38,88 from 38.88 to 40.06 above 40.06
probability, % 39 25 21 15