Chew Soon Gek, Portfolio Manager Asia Pacific at Deutsche Bank Private Wealth Management discusses risk aversion, and the importance of maintaining a current account surplus.

What are your predictions for the world economy over the course of 2009, and what impact will this have on investors' immediate attitudes towards risk?

In 2009, we expect a severe global recession which has not been seen in decades. World growth is expected to contract by 0.1%. We anticipate further bad news ahead of us, even with the rapid deterioration in financial markets and the real economy in the last few months.

Our forecasts for short-term rates continue to be revised downwards to Japanese-like levels which are close to zero. The slump in demand and falling commodity prices have led to a sharp fall in inflation. We expect the European Central Bank (ECB) to end its rate-cutting cycle at 0.75%, slightly above the Fed at 0%.

The demand for US denominated safe-haven assets like short-dated Treasury bills should still stay, as safety of principal is paramount.

We expect risk aversion to continue and do not expect a reversal of foreign exchange (FX) trends observed since mid 2008 in the next few months. Investors should be defensively positioned. The US Dollar (USD) and Japanese Yen are expected to stay supported for a while.

We advise clients to hedge FX exposure in non-base currency assets with hedging costs low as they are. This is especially in the context of G4 rates. Trading clients should consider taking profits at shorter time intervals in view of higher volatility and significant headline risks.

What is your view on the Yen, will it stay strong in the short to medium term?

The Japanese Yen is expected to stay strong in the short and medium term. Carry trades were potentially a key factor influencing yen weakness until mid 2008. With global short rates converging, relative nominal rates are becoming less important a driver of exchange rates. Differentials have shrunk globally and should lead to continued carry trade underperformance. We prefer currencies of current account surplus countries to deficit countries. In 2009, we expect Japan to record a current account surplus of more than 4.4% of gross domestic product (GDP), versus a deficit of 3.5% in the US. Markets reward favorable fundamental strength in times of high volatility and uncertainty.

In the short term, the Yen may take a breather after its rapid ascent in the fourth quarter of last year. With Japan firmly in recession again and with deflationary risks till 2010, the odds of intervention have increased. In the medium term, the case for broad yen strength is intact, benefiting from de-leveraging, repatriation by Japanese investors and a valuation overshoot. Our expectation is for the Yen to trade at 90 Yen in three months and higher to 85 Yen in 12 months.

How important is a current account surplus for countries at the moment?

Fairly important at this stage of the business cycle. Based on data over 40 years, DB's FX strategist concludes that as a group, countries with current account surpluses tend to outperform deficit countries in recession, the exception being the shallow recession of 2001. Many current account surplus currencies also enjoy sound net foreign asset positions. Going into this recession, a basket of the Japanese Yen, Swiss Franc, Norwegian Krone and Swedish Krona potentially looks attractive, as they have the strongest current account balances and net foreign asset positions in the G10 countries.

What are the short and long term outlook for the USD?

The USD is likely to be constructive in the next few months, but is vulnerable further out. Our forecasts look for a modest appreciation of the dollar against the Euro (EUR) as it continues to correct for its undervaluation in the short term. Euroland prospects in the near term are not encouraging, with a recession more prolonged than first thought and with peripheral countries impacted by rising credit spreads. These currency concerns may be overstated, as the weak Economic and Monetary Union (EMU) countries have little incentive to leave the EMU as exit costs are huge. Our forecast is for EUR at 1.25 in three months and 1.4 in 12 months.

Beyond the short-term, the USD on a trade-weighted basis may enter a longer than anticipated multi-year bottoming phase (ie continue with its longer term downtrend) as in the 1990s, following the Savings and Loans Crisis. Main areas of vulnerability include a weak banking system, low rates and a high fiscal and trade deficit. The much larger reflation efforts in the US compared to Europe, growing monetary base and continued low growth is expected to drive the USD lower later on. Of crucial importance is US policy response and continued confidence in US financial markets.

What are your predictions for commodity currencies over 2009?

Should the global business cycle turn up later in the second half of 2009, commodity currencies should rank among the first to recover. Our expectation is for the Australian dollar at 65 against the USD in three months, with potential upside later.