[achiever]

The fall in USD has continued, consistent with the views that we would see additional weakening through the end of 2009. Market continues to target 1.50 for end-of-year EUR-USD. In general, the same dynamic of continued positive risksentiment and normalization of financial markets driving the drop in USD continues to play out. Normalization remains a near-term theme not only in terms of the investment and macro outlook, but also policy, with the Reserve Bank of Australia becoming the first central bank in G10 to hike rates (by 25bp to 3.25%). Markets now expect the Norges Bank to become the next central bank to hike rates, by 25bp to 1.50% on October 28.

Traders look for the current trend of risk “on” related USD weakness to continue in the near term, encouraged by a strengthening of the growth outlook. But over the longer term in 2010, USD weakness is not expected to go much further against other G10 currencies.

[achiever]

Even current levels of foreign currency strength are starting to generate policymaker chatter. We are beginning to see movement on comments about the impact of strong foreign currencies in economies overseas. What made the RBA decision so powerful for FX markets was not just their hike, but their only modest concern about the impact of the stronger currency on the Australian economy. New Japanese Finance Minister Hirohisa Fujii’s many statements have implied that the authorities are prepared to let JPY continue to rise without any policy action, helping to push JPY even higher relative to rate spreads.

[achiever]

However, comments effectively supporting USD weakness are becoming balanced by discussion supporting a strong USD. Treasury Secretary Geithner has reiterated the strong dollar mantra, although the impact of that pronouncement has been fading. Comments backstopping USD weakness by both finance ministers and central bankers about starting to backstop USD weakness have grown, especially after an anticlimactic G7 statement that did not produce any additional defensive rhetoric around the USD. The main substantive comments have largely been the ECB’s Trichet not only reiterating how excess volatility in FX markets is unwelcome, but referring to how policymakers will “cooperate as appropriate” when it comes to the currency. Officials in Canada and New Zealand have added to the chorus against USD weakness.

[achiever]

At the moment the current level of rhetoric is still fairly tame. In the near term USD-positive rhetoric might result in perverse USD-negative reactions as currency markets dare policymakers to take stronger positions or even take outright policy actions that would influence the currency, most likely through a more aggressive reduction of the Fed’s balance sheet or slower than expected pace of rate normalization in G10 outside the US. Still, this shift in rhetoric matches well with expectations of a USD-positive turn that begins next year. It is still too early to lay down more substantial verbal markers against USD weakness, but these comments are consistent with policymakers establishing a base of comments by which to escalate their verbal interventions into next year.