Kiran Kowshik, Currency Strategist at BNP Paribas, on the U.S. economy and outlook for the Dollar

As Ben S. Bernanke mentioned, it is not only the headline employment, which is important, but it is also quality of improvement in employment. Currently the Fed is looking at two metrics: namely, inflation to remain close to around 2% and jobless rate to fall towards the target of 6.5%. The fact is that the decline in jobless rate has to come because of an underlying improvement. Nevertheless, the problem right now is that the downtick we are seeing in the jobless rate for the past year has been on the account of falling participation rate, i.e. more people moving out of the labour force, which means that they have permanently stopped looking for jobs. That is actually a negative development, and on that basis the Fed is quite far from ending its quantitative easing. In fact, we look for continued balance sheet expansion into the end of next year with tapering probably starting next year.

I believe the way to think about the budget is the implication it has on growth and what that means for monetary policy. From my perspective, projected fiscal tightening will probably shave 1.2 percentage points of growth this year, thus the U.S. economy will probably weaken in the second and third quarter of 2013. That means the Fed would probably move further away from stopping its balance sheet expansion policy. Clearly from FX point of view, it means further Dollar weakness against high-yielding commodity currencies. 

At the end of April EUR/USD would probably move up to 1.32-1.33 region. However, for the end of the second quarter we are looking for 1.35 on EUR/USD. We expect the Cable to see at 1.53 at the end of second quarter, whereas at the end of April we will probably observe a little bit of upside in the pair, due to a lack of dovish catalysts. Moreover, I think there would be a little bit of Dollar weakness, which should help the Cable to perform around 1.53. As to USD/JPY, our forecast is 101 for the end of April.