BNP Paribas has a forecast of euro to dollar exchange rate to go to 1.07 by the end of Q1. Holy Toledo!

Foreign Exchange Outlook: The rest of the world is falling into recession faster and bigger than the US, which is to blame for the trigger events that started the recession in the first place. (Talking-head TV pundits said over the weekend that a lot of fingers were pointing blame at the US at the G-20 meeting.) The National Association for Business Economics says the US will still put in growth of 1.4% in 2008, sliding to a contraction of 0.2% in 2009. Compare to the UK with a peak-to-trough of 2.5%. On the quarterly basis, Q4 will contract at an annual pace of 2.6% and in Q1, by 1.3%-but then the US will resume growth of 0.5% in Q2. This improvement will mirror recovery in real estate/housing. Really? This implies the worst is nearly over. We'd have only 4 months to go (to Q2 next year). This must assume GM doesn’t blow up and that the Obama stimulus/rescue plan is really big and really successful (whatever it is) and that oil prices remain low and a few other assumptions that are probably unrealistic.

We get a dose of cold water today with the Empire State index from the New York Fed, probably a drop to -26 from -24.6 in Sept, according to the Bloomberg survey.

But again, conditions elsewhere are worse than in the US. The ECB next meets on Dec 4, with opinion wildly divided on whether itthe ECB will cut interest rates. IMF managing director Strauss-Kahn said the ECB has room to cut rates. He told the BBC "In some parts of the world--Japan, the United States--interest rates have been cut very much, but it can be done more aggressively in other parts. I think now [the ECB has] room to decrease the interest rate, but nevertheless the stress has to be put on fiscal policy." This presumably means each country has to give up fiscal prudence. But we thought that was already a given--?

With the market seeing rate cuts as the right thing to do and not a currency-negative, we are faced with the perverse idea that if the ECB doesn’t cut in Dec, the euro exchange rate will be punished. This seems backwards of the usual response to rate cuts but it has justification today. Cuts are virtuous and refusing to cut is pig-headed. So did Strauss-Kahn give us a clue? Yes, maybe, that Trichet and/or the policy board are reluctant to cut a second time in as many months out of fear of looking panicky or some other reason. Watch for additional news about the ECB attitude toward a cut. If the policy board is looking reluctant, the euro rate can drop another 500 points. In fact, general sluggishness on the European front is inspiring some wild forecasts of a crashing euro. BNP Paribas has a forecast of euro to dollar exchange rate to go to 1.07 by the end of Q1. Holy Toledo!

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Barbara Rockefeller

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