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Currency speak

Since the middle of July there has been a huge change of sentiment in the currency markets towards the US Dollar which has allowed the US currency to appreciate between 12% and 20% against other major currencies.  The Euro has fallen from 1.60 to 1.40, Sterling has fallen from just above 2.00 to 1.75, the New Zealand Dollar has fallen from 0.77 to 0.65 and worst of all, the Australian Dollar has declined from 0.98 to 0.79.

Before mid-July there had been a belief in the markets that the problems in the US economy stemming from the implosion of the US housing and mortgage markets would be contained largely within the United States and that growth in the economies of other countries would continue regardless. Over the past two months there has been a dramatic reversal in this perception. The view now seems to be that the rest of the world is slowing down but that the pro-active approach taken by the US Treasury and Federal Reserve may allow the US economy to be the first to emerge from the period of sub-par growth.  There is some evidence to support this view. Certainly economic growth is slowing in much of the world, including the Euro-zone, the UK and Japan. The Reserve (central) Banks of  Australia and New Zealand have already responded by cutting interest rates and there have been calls for the European Central Bank and the Bank of England to follow suit.

However, the recent moves in the currency markets may have been exaggerated by massive de-leveraging which could be taking place as financial institutions unwind positions to cut risk and reduce the liabilities on their balance sheets and as currency investors are forced out of positions such as the carry trade (where they buy high yielding currencies such as the AUD or NZD and sell low yielding currencies such as the JPY or USD).

In my opinion, the US remains the epicentre of the current turmoil in global markets as can be seen from the need to bail out the US mortgage giants Fannie Mae and Freddie Mac last week and the near bankruptcy of US investment bank Lehman Brothers this week. At the same time unemployment in the US continues to rise (to 6.1% of the workforce according to the latest figures) and house prices continue to decline, albeit at a slower pace. As a result it may be that once the current de-leveraging comes to an end that the US Dollar will give up at least some of its recent gains.

Please let me know if you would like to discuss this further or if you have any questions

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