Forex Investment and Currency Trading

Risk aversion is back with lower stocks and Euro/yen fell to new 7 year lows, again dragging down Euro/dollar and dollar/yen.  The yen trade-weighted index is near historic highs and Japan’s MoF Vice Chairman warned against abrupt excessive FX moves, a veiled intervention threat which has helped stabilize things so far today.  But Sterling remains on the hot seat, sold to a 23 year low vs USD on talk of UK nationalizing the banks.  Russia widened the upper end of the RUB trading band to 41 against the Euro basket, equates to 36 vs USD, not letting it float nor devalue. 

Forex Updates:

• The recent gains for the USD appear less sustainable and more reflective of weakness in the EUR (and other European currencies) than fundamental, sustainable support for the USD. In the near term the excess of Fed-supplied USD liquidity and relative stability of ECB policy should help the EUR regain the 6 cent loss versus the USD and 8 big-figure loss versus the JPY since the beginning of the week.
• Emerging Markets (EM) will likely remain volatile with sentiment swinging from relief provided by the potential for swift and sizable policy responses offset by periodic collapses in confidence. Despite large exchange rate fluctuations, currency correlations are behaving more normally and USD ceilings are presenting in major EM currency pairs. A partial normalization of correlation coefficients suggests that relative value trades should begin to react more in line with fundamentals. The presence of reasonably firm USD ceilings and lower correlations suggest modest moves toward select risk-seeking trades may be rewarded. In this environment, short USD/KRW, short USD/BRL, and long PLN/CZK will likely perform well.
• The UK is unlikely to move towards a “pure QE regime” with a targeted level of bank reserves, at least in the near term. Revise market forecast for end-2Q 2009 EUR/GBP is 0.9800, up from 0.9600 and end-2009 forecast is 1.0000, up from 0.9700 as the UK economic recovery somewhat lags that of the Eurozone. However, a global economic recovery should put EUR/GBP on a sustainable decline in 2010.
• In both Australia and New Zealand, hopes for a flat to slightly positive economic performance in 1H 2009 have diminished, increasing FX downside risk. While analysts still do not expect a terminal RBA cash target as low as 2.25%, they do acknowledge that the risk of a deeper decline in the economy and attendant rate cuts have increased. In New Zealand, the two deficits and the possibility that the recent stabilization of the economy was only a pause in a more extended recession keeps downside risk to the NZD TWI intact.
• The stepwise devaluation of the RUB against the 55%USD/ 45%EUR basket targeted by the Central Bank of Russia (CBR) continued in the first weeks of trading this year. Expect further devaluation in small steps for a total of about 10%. The RUB thus could reach a justifiable level by end-January, although there is a risk of undershooting due to negative sentiment.