Forex Investment and Currency Trading

Four stages to the dollar
There have been four stages to the strong recovery of the U.S. dollar in the last few weeks.

• Signs of weakness in the European economy
• Risk aversion – which resulted in an unwinding of short U.S. dollar positions
• Counterparty risk – more recently when borrowers found it increasingly difficult to rollover U.S. dollar and were forced to sell currency to obtain the necessary dollars.
• Panic sales of foreign currency/purchases of U.S. dollars – which is perhaps the best description of this week.

The first stage was largely irrelevant for Mexico. This was far from the case, however, with the second stage insofar as the large interest rate differential between Mexican and the United States had been reflected in a gradual accumulation of long peso/short-U.S. dollar positions, which then needed to be
unwound. It should be stressed that it was not the case that long dollar positions were being established; rather, that short positions were being closed.

There is an obvious overlap between the four stages. Since the collapse of Lehman Brothers, concerns about counterparty risk have dominated financial markets. It has not been an issue of the state of a country’s economic fundamentals but rather an issue of the country’s exposure to short-term debt. The Brazilian real has depreciated even more dramatically than the peso as the even larger interest rate differential had resulted in even more dependence on external financing. The Russian rouble has been
under downward pressure despite Russia’s record current account surplus. The consistent interest rate differential if favor of rouble over the U.S. dollar and the euro had resulted in massive short-term borrowing in the euro-markets by Russian corporations and banks – borrowings that they then faced difficulty in rolling.

Mark-to-market losses
Companies with large U.S. dollar loans are now facing large marto-market losses. Comerci (Comercial Mexicana), a large Mexican retailer warned today that it was facing trouble servicing its foreign debt due to the peso’s depreciation and that it was in talks with creditors.

Economic spillover?
The strong economic linkages between Mexico and the United States are well-known. Earlier in the year, Mexican authorities had attempted to downplay the impact of a U.S. slowdown, arguing that the Mexican economy was in much better shape to resist such pressures. Increasingly, however, there are signs that the U.S. recession is feeding through into Mexico – whether sluggish industrial production or declining remittances. In today’s release of its semi-annual World Economic Outlook, the IMF
lowered its forecast of Mexican GDP growth in 2009 from 2.3% to 1.8% (and 2.1% in 2008)