Last month's currency report seemed to be going so well until the US banking system imploded, and at...
Last month's currency report seemed to be going so well until the US banking system imploded, and at the time of writing the US Treasury rescue package is waiting for approval from Congress, which is highly unlikely to challenge it. This would make Mr Paulson the world's biggest fund manager.
The immediate response to this news has been a sell-off in the US dollar, which is understandable as the global economy becomes awash with dollars trying to heal the toxic debt problem. However, looking through the short term no-one can say for sure how this once-in-a-lifetime collapse will eventually affect both the global currency and equity markets. Once the market digests and looks further into the future, the US dollar could continue its upward path. The US Treasury has hit the problem head-on and despite letting Bear Stearns and Lehmans go to the wall, the saving of AIG has bought the banks time to recapitalise their balance sheets.
Moving across the Pond, the forced marriage of HBOS and Lloyds TSB has seen sterling rally against both the US dollar and euro. However, this rally may be short-lived as the problem of short-term funding between banks remains and the BoE will probably start a series of interest rate cuts, which if you take a poll of analysts could see rates down to 3.5% during 2009, something that will be sterling negative and could see the pound move back down against the dollar to retest $1.7500.
The outlook for the euro remains negative; it still is overvalued against a basket of currencies. During the current crisis the ECB has rejected calls to cut interest rates, instead preferring to flood the market with short-term liquidity, but while this will stop the credit markets from seizing up it does little to encourage growth at the consumer level.
Again expect rate cuts from the ECB during 2009, which should see the euro move below $1.40, targeting $1.30, and against sterling we should see a move back above EUR1.30.
The main beneficiary from the recent turmoil has been the Japanese yen. Its low yield has made it an ideal proxy to enter the US equity markets and also to take positions in high-yielding currencies like the Australian and New Zealand dollars. Expect to see continued volatility as the equity markets yo-yo as risk gets put on and taken off on a daily basis. The Swiss franc has also gained as again the safe haven currencies come to the fore.
Keep one eye on Asian currencies, as it was from here that this banking crisis had its roots. The trillions of US dollars these export-led countries produced as a result of keeping their currencies artificially low needed a home to go to. They found this in both US treasuries and products sold by the investment banks, namely sub-prime debt. Even the Chinese renminbi is weakening as the growth in China slows. One thing I can promise you is increased volatility in the currency markets. The liquidity in these markets makes them ideal to liquidate positions no matter how large, and as the equity markets become even harder to navigate, expect volumes to pick up in the major currency pairs.
- Mark O'Sullivan is director, dealing, at Currencies Direct.
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