Forex Investment and Currency Trading

Despite numerous downside risks to the US economy and the likelihood of yet more Fed rate cuts before year end owing to the rapid deterioration of the domestic economy, USD has managed to shed its six-year bear market, a trend that is likely to continue. USD gained as the economic outlook elsewhere deteriorated as, if not more, quickly. This suggests policy rate spreads will narrow as the Fed was far ahead in creating stimulative monetary conditions in cutting rates by 375bp. The Fed does face pressure to lower rates further before year-end, but its easing cycle is close to the end, while other are just starting.

With what the Federal Reserve has called a “structural dollar funding shortfall outside the United States,” there is a systemic demand for USD in global capital markets. This was clear in the acute demand for USD at the end of Q3 and the spike in the 3m USD Libor-OIS spread. The USD funding shortfall and the collapse of interbank lending prompted the Fed to dramatically expand swap lines with foreign central banks (the ECB, BoE, SNB, BoC, BoJ, Norway, Sweden, Denmark and Australia) from US$290bn to US$620bn. The swap lines will remain in place through April 30, 2009. Apparently, global central banks foresee ongoing intense USD funding concerns through year end, and 2009 Q1.

A belaboured process turned a simple, though vague, 3-page proposal into a pork-laden 451-page behemoth, but US Treasury Secretary Paulson got his US$700bn bailout package through Congress. Now the hard work can start. The initial cash infusion will be from foreign investors, who hold 56.8% of Treasuries, and have been the primary buyers of new Treasury issuance for the past few years.