Forex Investment and Currency Trading

Global market conditions remained extraordinary in October with implied volatility skyrocketing. Strength in the US dollar was driven by four factors: global de-leveraging, repatriation, liquidity shortage and downside surprises outside of the US. Of these, the series of measures by the US authorities have dealt with the liquidity shortage. US short-term deposit and borrowing rates have come down sharply, although from 3M out they remain elevated compared to the Fed Funds Target Rate (FFTR). Lower interest rates have removed some of the support from the USD. In addition, global investors are sitting on very large cash levels and will have to at some stage re-invest in higher-yielding assets, which should weigh on the USD to some degree. However, global leverage levels in 2008 hit the highest on record, much of it in the G10 and much of it financed in USD. The global de-leveraging process has some way to run, albeit in a more orderly fashion and should last well into 2009. Moreover, downside economic surprises will remain focused for the most part in Europe and Asia. A recession is already widely factored into US markets, but Europe in particular has further downside potential. The UK recession is likely to be the worst in many decades and that in the Eurozone not much better. Asia will slow sharply, but still record positive growth as a region. Some time in H1-09, markets will normalize fully, economic expectations will bottom out and investors will refocus on nominal interest rate spreads. When that happens, the USD is likely to come under renewed and more sustained pressure, albeit in gradual fashion. Of course, by that time, interest rates in Europe and Asia should be much lower than they are currently, reducing the spread to the US. Nevertheless, market looks thereafter for the start of a major USD downtrend, which will likely accelerate into 2010.