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To: Haim R. Branisteanu who wrote (132607)	11/2/2001 2:29:56 PM
From: patron_anejo_por_favor	Read Replies (2) \| Respond to of 436258

Euro: Climbing a stairway to (money) heaven? morganstanley.com Currencies: Stairway to Heaven Joachim Fels (London) [This is an excerpt from FX Pulse: Fed Up Yet? 1 November 2001] I still see the euro on a stairway to heaven. My definition of heaven for the euro is a level between 0.95 and parity against the US dollar. Within this range, the euro would be neither too weak nor too strong, as judged by our fair value model. As before (see "EUR/USD: Sideways for Now, Higher Next Year" FX Pulse 27 September 2001), I expect the euro to bump sideways between now and year-end before making its next big move up. True, based on current and prospective growth differentials between the US and Europe and the level of oil prices, EUR/USD should trade higher as I write. However, there are good reasons why the EUR is undervalued against the USD for now. First, as we have pointed out many times in the past, the overvalued USD is currently supported by safe-haven flows and by market expectations of a V-shaped US recovery in response to aggressive policy stimulus. Second, the EUR has suffered from the lack of major policy stimulus so far and from the apparent tensions about the proper policy course between politicians and central bankers. This environment is likely to keep the EUR trapped in a range against the USD for a while, and I remain happy with our long-standing year-end forecast of 0.91. However, there are several factors that are likely to elevate the EUR into heaven in the first half of next year. Right now, markets are taking it almost for granted that the massive policy stimulus in the US will underwrite a V-shaped recovery next year. This consensus is likely to be challenged severely at some stage over the next several months, in my view. Monetary easing may not be successful in an environment where the corporate sector has built up massive excess capacity in the previous boom that hasn't been fully corrected. Also, an important part of the transmission from monetary easing to investment and consumer spending runs via equity markets. Without a significant and sustained equity rally, monetary easing won't have much effect. And, while it is true that lower long-term interest rates help consumers, as they can refinance their mortgages, the bulk of the refi bonanza has probably already occurred this year (see Stephen Roach, "An Empty Pipeline?" 30 October 2001). This leaves us with the fiscal stimulus, which should amount to some 2% of GDP. My worry is that this will be largely absorbed by an upward adjustment in the personal savings rate. Just as the accumulation of fiscal surpluses in the late 1990s had its mirror image in a sharp reduction in the private sector's savings rate, the private sector may now well neutralise fiscal easing by building up savings balances. All it takes to neutralise a 2% swing in the fiscal balance is an increase in the household savings rate of approximately 3 percentage points. Note that between May and August alone, the savings rate jumped by approximately that amount. Emerging doubts about the V-shaped recovery are likely to weigh on the USD as we move into next year. Meanwhile in Europe, the economic picture remains less bleak than in the US. True, the economy is slowing very sharply, underpinning our forecast of an outright contraction of GDP in Q4. However, the main case for Europe still remains that this will be a mini-recession, not a maxi-recession like the one in the early 90s or early 80s. Compared to back then, there simply hasn't been the same amount of monetary tightening ahead of the slowdown, and compared to the US today, Europe hasn't had an investment bubble or the consumer spending excesses. What is missing so far in Europe is a major policy stimulus. But, in our view, the ECB will cut rates by no less than 100 bp over the next 3-6 months, on top of the 100 bp of easing that has already happened. As there are no major imbalances in the European economy, this should underwrite a recovery in the course of next year. Therefore, the euro should benefit from accelerated ECB easing. Here's the bottom line: The euro is currently held back by safe haven flows into the greenback, hopes for a V-shaped US recovery in response to major policy stimulus, and a lack of major policy action in Europe. We continue to expect EUR/USD to bump broadly sideways in this environment, and our year-end forecast remains at 0.91. However, the safe haven flows should be temporary, and markets are likely to start to doubt the effectiveness of monetary and fiscal policy stimulus in the US at some stage during the first half of next year. Coupled with more decisive policy action from the ECB (which, in the absence of major imbalances in Europe, should help to simulate the economy), we expect EUR/USD to move into the 0.95 to parity range some time early next year. But for now, heaven can wait.