david woo presentation May 1108

USD: Vicious CircleDavid WooHead of Global FX Strategy, Barclays Capital

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America is running both expansionary monetary and loose fiscal policies

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Real Fed Funds rate Budget balance as a share of GDP

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Periods of such policy stance were always characterized by a weak USD

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periods of negative real Fed Funds rate and budget balance<-3% of GDPreal trade-weighted USD index against major currencies

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Eurozone exporters may be suffering from the strengthening euro….

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US export to eurozone (USD, 6m/ 6m, SA, AR)eurozone export to US (EUR, 6m/ 6m, SA, AR)

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…but euro’s rise against the USD has been supported by evolving relative fundamentals

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EUR/USD uptrend and oil uptrend are becoming mutually reinforcing

52 week rolling correlation between EUR/ USD and Brent futures

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EUR/ USD (left axis)Brent crude 6-month futures (right axis)

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USD’s vicious circle

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This is the first time in twenty years that Eurozone inflation is rising while the Fed is cutting rates

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Fed rate cut cycle eurozone inflation (y/ y)

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Increase in oil prices has prevented an improvement of US trade deficit, despite US slowdown and USD weakness

Breakdown of US trade balance

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Capital goods Industrial supplies, excl petroleum goodsConsumer goods Auto and partsFood, feeds, and beverages Other goodspetroleum goods

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Preconditions for a sustainable USD recovery•Sharp slowdown in China: such an event would dampen global marginal demand for oil, and, by triggering a correction of oil prices, break the vicious circle.

•Big correction of the US equity market: there are no signs of any decoupling of ROW from US financial markets. Synchronized equity sell-off would be followed by synchronized global economic slowdown

•Visible negative knock-on effect of USD decline on US asset prices: If further USD decline were to reduce appetite for US assets and drive down US asset prices, then US policy makers may be forced to change their ways

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But if China is slowing at all, it is slowing very gradually

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China's crude oil imports (y/ y)

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sales of vehicles (y/ y, 3-m MA)

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Meanwhile, global oil inventory remains tight

US crude inventory

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US gasoline stock

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Bond vigilantes are suppressed by inelastic demand from reserve managers

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Foreign official sector accumulation of USDassets (4Q-MA, left axis)Foreign official sector accumulation of USDassets/ Current account (4Q-MA, right axis)

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Positioning and sentiment indicate scope for further USD rally in the short-term is limited

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