Maraging Partners


FX Forecast for Q2 2015: EUR/USD, USD/RUB, EUR/RUB

Ursus arctos horribilis

Among the animals frequently mentioned around the trading pits, mostly bears and bulls, one of which we choose to personify each quarter, a north american greezley bear Ursus arctos horribilis has never figured. We believe that his time has come.

The US dollar

A dove in hawkish feathers

The FOMC has disappointed those who expected that the interest rates will start rising in Q1. We still believe that under today's cratopolitical conditions, open statements of the "our currency, your problem" kind pose a PR problem, and FOMC will continue changing tacks, facing both the necessity of maintaining confidence in the global reserve currency, on the one hand (hawks), and the necessity of conducting financial repression, on the other (doves).

As a reminder, it is customary to use the term financial repression to denote the practice of goverments applying the instruments of economic regulation to keep interest rates below the real rate of inflation. By doing so, the contemporary debt-burdened governments forcibly lower the real value of their liabilities, stealing, in fact, from savers, senior citizens and risk-averse investors in general.

Seven out of twelve voting seats at FOMC belong to the FRS board members and five -- to the regional presidents. One of these five is permanently assigned to the new york Fed president. Obama's appointment of two board members to the two FOMC vacancies along with the rotation of two regional presidents -- hawkish dissidents Fisher and Plosser have left the committee -- can result in softer FOMC rhetoric in 2015.

Out of two alternatives -- dollar bursts first and the US stock market follows or the US stock market bursts first -- the first one is preferable. Otherwise, risk aversion amid falling stock market will strengthen the already strong dollar, creating an extra shock for the US economy.


Financial repressions

On March 9, 2015, the ECB started outright purchases of European government bonds and certain agencies totaling 60 billion Euro monthly. The official name of this program is EAPP and it is comparable to the American QE3 in volume and duration. It is planned that EAPP will continue till September 2016 or longer.

While the manner in which US economy is funded can be characterized as chiefly equity - based, in Europe banks, rather than stock exchanges, play the leading role in this process. For a number of reasons, the path from the ECB to the real economy is shorter than the path from the FRS to the real economy. Therefore, everything else being equal, EAPP will be more inflationary than QE, which inflated the US stock market in the first place.

For the EUR /USD exchange rate, EAPP will be more depressive, than QE was for any of the usd exchange rates, because the international role USD plays makes the eur/usd market a pivotal one for a number of investment opportunities related to the EAPP.

The financial repression of the EAPP will hit European retirees, a populous group which does not feel too bad so far under the present conditions of deflation. From the social stability standpoint, it is safer than hitting the immigrants or the young via unemployment.

European real estate prices will rise, which will make banks healthier, and which will help mitigate the negative effects of currency depreciation on retirees and long time residents.

Depreciation of the euro with respect to the national currencies of those who buy European export is good news for industrial "old" Europe, Germany and Italy in particular.

Finally, politically, EAPP compares favorably to the Marshall Plan by assuming more independence from the benevolent transatlantic strangers.

Speaking of the art of composing investment portfolios, the QE s, especially QE2 and QE3, saw decreased correlations among the various assets. It is possible that amid EAPP, the markets will again forget about the fundamental correlation between RUB and oil, like they did recently.

The value of all these factors, except for perhaps the last one, for the forecasting, is reduced by their obviousness, and they are likely already discounted by the eur/usd market. We do not think that the factor we referred to as dove in hawkish feather is equally obvious.


The collapse of "The Collapse" it is

In our Q1 forecast, we offered three scenarios for Rouble in Q1. Out of these three, the first one, The Collapse of the collapse, turned out to be the closest to the the actual events. In brief, the reason currencies weakened with respect to rouble, turned out to be the banal lack of demand at those elevated prices, and the lack of mechanisms able to generate demand.

We believe that the markets still underestimate the potential of the EAPP conducted by our European neighbors for strengthening a high interest -- and a high risk -- currency such as the Rouble. It is likely that they also overestimate the influence of police and beaurecracy measures such as "sanctions" on the currency markets of today.

Minsk 2 has placed the political blame for the possible continuation of violent military operations in Ukraine, in advance, on Kiev, in the eyes of the Paris - Berlin -Moscow troika. This turned out to be the unknown unknown of the quarter.

Effective February 2013, our correlation analysis of the Russian future market, called FORTS, has been expanded into a separate analytical product, Market Correlations, to which we refer the interested reader. The review is issued monthly, and since Q4 2013, in English.

In USD/RUB and EUR/RUB, the futures premium (the spread between the futures and spot quotes) makes the profit/loss of the position include (but not be limited to) the profit (if selling USD/RUB or EUR/RUB futures) or loss (if buying the same) caused by the interest rate differential. As time goes on and the contract's expiry date approaches, the futures premium narrows and the buyer of the RUB realizes the futures premium. We always take these facts into account when developing the hedging strategies: given the present level of the interest rate differential, one has to have very strong reasons to buy USD/RUB or EUR/RUB futures for three months. On the contrary, carry trade strategies, those based on the interest rate harvesting, in a combination with intra-day systematic position adjustment, within the constraints of the given risk quota, form the basis of our Active Management service.

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 (April 6, evening, Moscow time), the spot quotes were: EUR/USD: 1.10; USD/RUB: 55.23; EUR/RUB: 60.73.

A model position in each currency pair is proportional to the difference between probability sums of two right and two left fields of the table below. So, when the probability sum in the two right fields exceeds the sum in the two bottom ones, the futures contract is bought, in the opposite situation it is sold. The historical track record chart will be updated in the middle of the quarter.

EUR/USD below 1.04 from 1.04 to 1.09 from 1.09 to 1.15 above 1.15
probability, % 21 24 26 29
USD/RUB below 52.20 from 52.20 to 54.90 from 54.90 to 57.90 above 57.90
probability, % 34 26 21 18
EUR/RUB below 57.20 from 57.20 to 60.20 from 60.20 to 63.30 above 63.30
probability, % 30 26 23 21