Forex Investment and Currency Trading

One of the key features of recent weeks is the continued normalization of global risk conditions. This is most evident in global stock markets – where we enter January at multi-week highs and volatility (as measured by VIX) at a 3-month low.

Global monetary policy

In the G10, the big policy moves over the past two weeks have come from the Norgesbank (-175bp to 3%, with expectations of -100bp) and the BOJ (the central bank cut the OCR rate to 10bps for the first time since 2006). More interestingly, relative market expectations have shifted markedly over this time. In the US, for instance, 2-year interest rates have actually risen 10bp, despite the Fed’s adoption of a zero interest rate policy and continued weak US data. Aussie and New Zealand rates are also generally flat to up. In the mean time, European rates have dropped sharply, led by the UK (-70bp), the Euro zone and Sweden (both -50bp). These rate shifts are likely one reason behind the dollar’s recent stabilization (and should provide support in the early part of 2009).

In emerging markets, the general trend continues to be central banks cutting more aggressively than market expectations.

Global manufacturing remains disappointingly weak

Despite the generally positive tone in financial markets, the actual news flow has been very weak - this was especially notable in most data on global manufacturing growth, including the latest PMIs. The notably weak PMIs were the US (ISM at 32.4 from 36.2), Euro zone, Japan and Russia. On the flip side, we saw upside surprises in the UK, Australia and most EM economies apart from Russia. Either way, the message continues to be weakness.

• Despite some pockets of strength (notably, the weekly mortgage refinancing data), the US remains weak, especially in the core parts of the economic decline - housing activity, house prices and the labour market.
• Japanese manufacturing data have been unbelievably weak lately: for instance, alongside the plunge in the PMI report, the Shoko Chukin small enterprise survey fell below 30 for the first time ever.
• Somewhat surprisingly, the UK data have actually been better than most expectations. We have seen a similar pattern in Australia. 
• In EM, Brazil appears to be holding up reasonably well, especially in the household sector, where retail sales growth has remained near 10% throughout the past few months. Russia looks to be in the worst shape of the major EM economies - with plunging growth and still reasonably high inflation.

Some FX ideas for the early part of 2009

• With risk conditions beginning to normalize, perhaps selling EUR/USD volatility might make sense in the coming weeks.
• As risk stabilizes, many of the relative value stories in the G10 look attractive, especially with the recent data flow and market moves looking supportive.

                - Trade Recommendation: Buy AUD against CAD (and probably NZD). AUD rates have significantly outperformed, the AUD economy has weathered the storm reasonably well and AUD valuation has overshot to the downside.

                -Buy NOK (vs CAD or EUR): NOK is well placed from a fiscal policy point of view, interest rates have outperformed and oil is bouncing a bit.

                - CHF looks expensive given the normalization in risk and very dovish SNB. 
                - Buy BRL, as the economy performs well and the currency weakness since September looks excessive.

                - And for the contrarian, the plunge in sterling is consistent with the shifting expectations of BoE rate policy, but it does look a little suspicious relative to the actual data flow in the UK. Perhaps EUR/GBP is ready for a more meaningful correction to the downside.