Forex's blog

The USD is officially trending upwards, having appreciated over 7% against the Euro in only a few weeks. Of course, hindsight is 20/20, and some analysts now claim that support for the Dollar had been building for several months. They point out that the first break for the Greenback came in March when the Fed stopped lowering interest rates. Then, at a meeting of the G8 nations, several high-ranking officials indicated that they were unhappy with the recent decline of the Dollar and suggested that coordinated intervention should be effected in order to prevent a further collapse of confidence. While this "verbal intervention" was ultimately not backed by any kind of substantive action, investors apparently took the hint.

While not yet in the same league as other popular emerging market currencies, the Brazilian Real and Mexican Peso are sure to join their ranks soon; both currencies have risen markedly over the last few years, and have performed especially well in the year-to-date. They have been propelled by interest rates that are generously high, especially compared to those of the US and EU. Brazil's benchmark rate currently stands at 13%, while Mexico's equivelent rate is slightly lower, at 8%. In fact, interest rates are quite high throughout the region, including in Peru and in Chile.

In historical periods of financial crisis, where did investors turn?

The Canadian Dollar continues to lose its luster. Falling natural resource prices and the credit crunch have combined to exact a devastating blow on the Canadian economy, causing it to actually contract in the most recent month for which data is available. Now, the Central Bank is predicting that the economy will expand by only 1% in 2008. Most economists expect that Canadian Monetary Policy will soon lag US policy, especially if the Fed raises interest rates to combat inflation. Based on these developments, the consensus is that the Canadian Loonie is significantly overvalued, and will lose some of its value over the next few years, falling to a more sustainable level against the US Dollar. Bloomberg News reports:

As the Chinese Yuan has appreciated over the last three years, and even in the decade leading up to the sudden revaluation, a tremendous amount of speculative "hot money" poured into China. Periodically, the government and Central bank have attempted to stem some of these inflows by creating deliberately unfavorable conditions for foreigners to invest in China. Witness the unnaturally low interest rates and the one-way convertibility of the Chinese Yuan. Now, with inflation running at a 10-year high, the government is becoming more serious in its efforts to clamp down on some of the factors that are driving demand. As a result, it altered its system for governing forex and will increase its oversight over the entities and businesses that import capital into China.

The parallels between the Australian Dollar and the Canadian Dollar are remarkable! Both currencies are backed by economies highly dependent on natural resources. Both countries' Central Banks are considering rate cuts in response to slowing growth. Finally, both currencies have slipped well below parity with the US Dollar. Unlike the Canadian Loonie, the AUD had never quite breached the mythical 1:1 level with the USD. Furthermore, given the deteriorating economic picture in Australia, parity is off the table for a long time.

2007 was a momentous year for the Canadian Loonie, which rose 17.5% and even reached parity against the US Dollar. 2008 has been somewhat less kind to the Loonie; it has been battered repeatedly from falling commodity prices and the global credit crunch. Actually, even before the price of oil peaked near $140, the link between the Canadian Dollar and natural resources had begun to break down. The rationale among investors had shifted such that expensive commodities were now seen as a drag on global economic growth, and hence, bad for Canada in the long-term. Using this logic, the currency should have received a reprieve from falling prices, but this was interpreted as bad for Canada in the short-term. In other words, a lose-lose situation.

Last week, the Forex Blog covered an IMF report that claimed the period of Dollar hegemony is nowhere near finished. This view appears to be widely held, and an American economist argued in a recent op-ed piece that the Euro still trails the Dollar in terms of global prominence. Certainly, he acknowledged the collapse in confidence that has sent the Dollar spiraling downward over the last few years. Central Banks are holding an ever-increasing portion of their reserves in alternative currencies, namely Euros. Many new bond and stock issues are denominated in Euros. But ultimately, the Dollar is still Numero Uno.

The exchange rate between Zimbabwe's local currency and the US Dollar is currently 110 Billion:1, give or take a few zeroes. This complete collapse in confidence surrounding the currency is redolent of post-war Germany, when a wheelbarrow full of Deutsch Mark was required to buy a loaf of bread. The same hyperinflation, estimated at 100,000,000% on an annualized basis, has gripped Zimbabwe, causing prices to skyrocket and the local currency to plummet. As a result, the Central Bank has announced a plan to redenominate the currency by removing 10 zeroes from notes currently in circulation.

By one measure, the US Dollar has lost 33.8% of its value under President George Bush, its worst performance by far under any one administration. The burgeoning twin deficits, lackluster economic performance, as well as the current environment of stagflation have all contributed to a dramatic and unprecedented loss of confidence in the Dollar. While investors are understandably optimistic about the prospect of a new President, come January, they are ambivalent as to whether it is Barack Obama or instead John McCain that is ultimately elected. Since the Dollar seems to have bottomed out anyway, the new President stands to preside over a recovery of the Dollar. Reuters reports: