Strong support for the Euro and weak factors for cyclical currencies.

THE INTEREST RATE DIFFERENTIAL IS STILL SUPPORTING THE EURO AGAINST THE DOLLAR.

The European currency approached the 1.50 threshold following the rise in base rates announced in April. The trend was rapidly inversed however, on account of the Greek crisis, with the euro falling back to 1.40. The ECB seems determined to pursue the normalisation of monetary policy with a hike in the main base rate likely in July, and undoubtedly a further rate increase before year end. Base rates should therefore reach 1.75% in December. On the other hand, measures providing liquidity are still being pursued, illustrating the difficulties experienced by certain establishments which are only able to access liquidity through the ECB or national central banks.

In the US, the federal reserve is still biding its time. The Treasury securities buy-back programme will close at the end of June as scheduled. It is highly unlikely that quantitative easing will be prolonged beyond this date: the recovery is underway, albeit fragile for the time being, and a further liquidity injection would boost inflationary expectations without having any significant impact on the economy. However, as the federal reserve has repeatedly stated, it intends to reinvest the proceeds of its maturing securities, undoubtedly until towards the end of the year, and will stabilise in so doing the size of its balance sheet commitments. No increase in the Fed funds rate is therefore to be expected before mid 2012 or even the end of the same year, as the recovery has experienced several downward blips.

In this context, the euro will remain firm against the dollar and possibly break through the 1.50 threshold if the Greek debt crisis appears to be under control. We are anticipating a euro at 1.45/USD on a 6-month horizon. On a 12-month horizon, we are expecting the euro to slip back slightly to 1.40/USD once the interest rate differential has begun to diminish.

INCREASED RISK AVERSION IS WEIGHING ON EMERGING AND CYCLICAL CURRENCIES

Cyclicals (AUD, CAD, NZD) have rallied sharply against the dollar over the past two years, reaching levels which are now higher than before the Lehman bankruptcy in 2008. We are expecting these currencies to fall back slightly against the dollar essentially on account of the downturn in commodity prices. However, with oil prices likely to remain high, outlook is more optimistic for the Canadian dollar. Although we consider emerging currencies to be on a structurally bullish trend, the current context and the situation over coming months appears less favourable.

Firstly, many countries have adopted macro-prudential measures aiming to discourage portfolio investments and limit recourse to external borrowing. Secondly, rising inflation dissuades foreign investors from setting up large positions in these markets. Finally, many countries are pursuing monetary policies which are not restrictive enough, particularly in Asia where base rates are still well below 2008 levels, despite current economic overheating.

We believe that emerging currencies are unlikely to rise sharply in the short term. By the end of the year however, the Chinese yuan should continue to trend upwards against the dollar, especially if inflationary pressure remains strong, which will mean that the authorities are more likely to favour a steep rise in the yuan to combat inflation.