Chinese Yuan: Further Appreciation is Inevitable

Relatively speaking, the Chinese Yuan has been on a tear, appreciating ~1% in a little more than a month. One has to wonder whether this is a concession by the People’s Bank of China (PBOC) that its exchange rate regime is not viable or whether its instead a political sop. The question on everyone’s minds, of course, <br /><a name='more'></a>is, <em>will it continue? </em><br /> <a href="http://www.forexblog.org/wp-content/uploads/2011/02/CNY-USD-3-month-chart.png"><img alt="" class="aligncenter size-full wp-image-3715" height="288" src="http://www.forexblog.org/wp-content/uploads/2011/02/CNY-USD-3-month-chart.png" title="CNY USD 3 month chart" width="512" /></a><br />Countries around the world have continued to criticize China for its unwillingness to allow the Yuan to appreciate. At last week’s G20 meeting, US Treasury Secretary Timothy Geithner and Fed Chairman Ben Bernanke separately took aim. “They’re still <a href="http://www.bloomberg.com/news/2011-02-19/china-still-resisting-yuan-appreciation-geithner-tells-bbc.html">heavily leaning against</a> the forces trying to push their currency up,” complained Geithner. “The maintenance of undervalued currencies by some countries has contributed to a pattern of global spending that is <a href="http://www.bloomberg.com/news/2011-02-18/bernanke-criticizes-china-s-policy-of-keeping-yuan-low-amid-trade-surplus.html">unbalanced and unsustainable</a>,” intimated Bernanke.<br /> However, it was only when fellow emerging market economies – namely Brazil – voiced similar concerns, that China was finally forced to concede partial defeat. It signed on to an <a href="http://www.marketwatch.com/story/china-yuan-reform-to-move-gradually-pboc-chief-2011-02-21?reflink=MW_news_stmp">official G20 communique</a> that declared that exchange rates and current account balances would be used to determine whether a particular country’s policies were contributing to global economic imbalances. Alas, the Communique (and the G20, for that matter) is deliberately vague and unenforceable; it’s more symbolic than anything else.<br /> Still, China is not one to take its cues – especially on issues as important as the Yuan – from the international community. That the Yuan is now appreciating at a steady clip (~5% in annualized terms) is almost certainly being <a href="http://www.forexblog.org/2011/01/chinese-yuan-continues-to-tick-up.html">driven more by pragmatism than politics</a>. Specifically, it represents the most effective tool to combat inflation, which has already breached 5% and continues to tick higher.<br /> <a href="http://www.forexblog.org/wp-content/uploads/2011/02/China-Inflation-Rate-2000-2011.jpg"><img alt="" class="aligncenter size-full wp-image-3716" height="297" src="http://www.forexblog.org/wp-content/uploads/2011/02/China-Inflation-Rate-2000-2011.jpg" title="China Inflation Rate 2000 - 2011" width="632" /></a><br /> China critics forget that China’s fixed exchange rate regime is not a free lunch. While it almost certainly gives the export sector a competitive advantage, it also deprives the PBOC of the ability to conduct monetary policy and is inherently inflationary. That’s because the policy necessitates soaking up all of the foreign currency that enters the country (hence the <a href="http://www.forexblog.org/2010/10/china-diversifies-forex-reserves.html">~$3 Trillion in forex reserves</a>) and instead printing new Chinese Yuan and putting into circulation. When you combine a 15% annual increase in the money supply with soaring economic growth, a surge in bank lending, real estate boom, and rising commodity prices, the inevitable result is inflation. The country’s economic officials have responded by <a href="http://www.businessweek.com/news/2011-02-08/china-raises-rates-to-counter-accelerating-inflation.html">tightening credit and raising interest rates</a>, but these will ultimately fail as long as the Fed’s QE2 program continues to send US Dollars into China.<br /> In addition to allowing the Yuan to slowly appreciate, China has also moved to <a href="http://www.marketwatch.com/story/china-adds-to-steps-to-internationalize-yuan-2011-02-16?pagenumber=2">make the Yuan more convertible</a>. This has the dual advantages of making China less reliant on the US Dollar and on relieving upward pressure on the Yuan. More of its trade is being settled directly in Chinese Yuan. Chinese companies are being encouraged to invest outside of China, and foreign companies inside of China are gradually being permitted to issue Yuan-denominated bonds, rather than import Dollars to fund new investments.<br /> It appears that all of these measures are actually starting to have some impact. China’s <a href="http://www.nytimes.com/2011/02/15/business/global/15yuan.html?_r=1">trade surplus is shrinking.</a> The IMF <a href="http://www.rttnews.com/Content/AsianEconomicNews.aspx?Id=1557338&SM=1">has suggested</a> that the Chinese Yuan could one day be an international reserve currency and could be a component of its Special Drawing Rights (SDR) currency. Less hot money (distinct from investment inflows) is finding its way into China.<br /> Unfortunately, most analysts are skeptical that it will last. Futures markets reflect a modest 2.5% appreciation against the Dollar over the next 12 months. I’m personally anticipating a rise of 4-5%, though I think it will ultimately be tweaked depending on inflation.<br /> <div style="text-align: center;"><a href="http://www.forexblog.org/wp-content/uploads/2011/02/USD-CNY-March-2012-Futures.jpg"><img alt="" class="aligncenter size-full wp-image-3717" height="259" src="http://www.forexblog.org/wp-content/uploads/2011/02/USD-CNY-March-2012-Futures.jpg" title="USD CNY March 2012 Futures" width="528" /></a></div>

Chinese Yuan: Further Appreciation is Inevitable

Relatively speaking, the Chinese Yuan has been on a tear, appreciating ~1% in a little more than a month. One has to wonder whether this ...

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CAD/USD Parity: Reality or Illusion?

In January, the Canadian Dollar (aka Loonie) registered its worst monthly performance since June. Many analysts pointed to this as proof that its run was over, after coming tantalizingly close to parity. Others insisted that the decline was only a temporary correction, a mere squaring of positions before the Loonie’s next big run. Who’s right? <em>Both</em>!<br /><a name='more'></a><br /> <img alt="cad1" class="aligncenter size-full wp-image-2479" height="288" src="http://www.forexblog.org/wp-content/uploads/2010/02/cad1.png" width="512" /><br /> There are (at least) two separate narratives presently weighing on the Loonie. The first is causing it to decline against its arch-rival, the US Dollar, for reasons that essentially have nothing to do with the Canadian Dollar and everything to do with the US Dollar. Specifically, the mini-crisis that is playing out in Greece and the EU has caused risk aversion to resurface, such that investors are now returning capital to the US. <a href="http://www.bloomberg.com/apps/news?pid=20601082&sid=a8Cj8q4Ao5X0">One analyst</a> explains the impact of this seemingly tangential development on the Loonie as follows: “When you get any sort of ‘risk-off’ type of environment like we’ve had over the past week or so, currencies like the Canadian dollar and the Australian dollar will come under pressure.”<br /> The second narrative explains why the Canadian Dollar continues to hold its own against most other currencies. Specifically, Canada’s economic recovery continues to gain momentum as commodity prices continue their rally. In the latest month for which figures are available, the economy added about 80,000 jobs, more than five times what forecasters were expecting. This turn of events is helping to <a href="http://www.canadianbusiness.com/managing/strategy/article.jsp?content=20100113_10033_10033">quash the “view</a> that the Canadian trade sector is incapable of growth with a strong currency,” and making traders less nervous about sending the Loonie up even higher.<br /> Going forward, there is tremendous uncertainty. Both short-term (determined by the Bank of Canada) and long-term (determined by investors) interest rates remain quite low, such that the Loonie is not really a candidate for the carry trade. In addition, the Bank of Canada hasn’t completely ruled out the possibility of intervention on behalf of the Loonie; it may simply leave its benchmark interest rate on hold (at the current record low of .25%) for longer than it otherwise would have. In addition, a series of recent tightening measures by the government in China threatens to crimp demand for commodities and weigh on prices. Finally, the market turmoil in Greece is causing investors to look afresh at the balance sheets (in order to weigh the likelihood of default) of other economies. This probably won’t help Canada, which continues to run large deficits and whose debt level once earned it the dubious distinction of “honorary member of the Third World.”<br /> Still, Canada’s capital markets are among the most liquid and stable in the industrialized world, and if risk-aversion really picks up, it won’t suffer as much as some other economies. “<a href="http://www.marketwatch.com/story/canadas-loonie-on-bumpy-path-to-us-parity-2010-01-26?dist=afterbell">The Canadian economy</a> is not as structurally impaired as the U.S. or the U.K. It creates a sense that Canada is less exposed to the fickleness of foreign investors that are causing uncertainty in other locations.” In fact, the Central Bank of Russia just announced that it will switch some of its foreign exchange reserves into Canadian Dollars, and other Central Banks could follow suit.<br /> <img alt="cad2" class="aligncenter size-full wp-image-2480" height="288" src="http://www.forexblog.org/wp-content/uploads/2010/02/cad2.png" width="512" /><br /> While the Canadian Dollar should continue to hold its own against other currencies, the same cannot necessarily be said for its relationship to the US Dollar. “Options traders are the most bearish on the Canadian dollar in 13 months…The three-month options showed a premium today of as much as 1.34 percentage points in favor of Canadian dollar puts.” In other words, the price of insurance against a sudden decline in the CAD/USD is rising as investors move to cushion their portfolios against such a possibility. While this trend could ease slightly in the coming weeks, I personally don’t expect it to disappear altogether. All else being equal, given a choice between owning Loonies or Greenbacks, I think most investors would choose Greenbacks.

CAD/USD Parity: Reality or Illusion?

In January, the Canadian Dollar (aka Loonie) registered its worst monthly performance since June. Many analysts pointed to this as proof t...

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New Zealand Dollar Rise Threatens Economic Recovery

Having risen nearly 30% against the US Dollar since March, the New Zealand Dollar (NZD or Kiwi) is now close to a 9 1/2 month high. While still far from the record highs of 2008, the currency is already erased a large portion of the losses it racked up since the credit crisis gave way to economic recession.<br /><a name='more'></a><br /> As part of last <a href="http://www.forexblog.org/2009/07/japanese-yen-exports-versus-carry.html">Friday’s coverage of the Japanese Yen</a>, we included a chart which compared the performance of the AUD/JPY cross to the S&P 500. Even without calculating the correlation coefficient, a cursory review of the chart revealed an uncanny relationship! Unsurprisingly, it turns out the same relationship also applies to the New Zealand Dollar, whose recent performance closely mirrors US equities.<br /> <img alt="nzd" class="aligncenter size-full wp-image-1946" height="288" src="http://www.forexblog.org/wp-content/uploads/2009/07/nzd.png" width="512" /><br /> In other words, the interplay between risk appetite and risk aversion continues to dominate the forex markets, as traders move to calibrate the split of funds between so-called safe haven currencies and the riskier alternatives, among which the New Zealand Dollar is certainly counted. Much of the rally in the Kiwi, then, represents a correction, as investors acknowledge that the near 50% slide from-peak-to-trough was an overreaction.<br /> Going forward, however, the Kiwi will have to rest on its own feet, as new themes move to the fore of investors’ minds. Specifically, they will begin to look more closely at the New Zealand economy, and demand evidence of a recovery. “<a href="http://online.wsj.com/article/BT-CO-20090714-700029.html" target="_blank">Reserve Bank of New Zealand Governor Alan Bollard</a> told a business audience the world has ‘avoided a repeat of the Great Depression. Now, we and the world, appear to be on our way to recovery. New Zealand looks likely to start recovering ahead of the pack.’ ”<br /> At the same time, the most recent economic data showed an economy in freefall, as “New Zealand’s economy shrank for a <a href="http://www.ft.com/cms/s/0/dad55046-61f4-11de-9e03-00144feabdc0.html">fifth straight quarter</a>…The economy contracted 2.7 per cent in the January-March quarter.” While forecasts vary, GDP is expected to fall by at least 2.1% in 2009, with a modest pickup expected in 2010. Investors are betting that the recovery will be driven by rising demand for commodities, which will help to buoy New Zealand exports. Once again, this conflicts with the data, which shows an annualized <a href="http://www.forexblog.org/category/$3%20Billion" target="_blank">trade deficit of $3 Billion</a>. Despite a fall in imports, the country is still importing more than its exporting. This could be a product of the stronger currency, which all stakeholders agree is not conducive to economic growth. In the end, the economy’s best chance for recovery lies in a resumption of debt-induced consumption and residential construction, the very forces which caused the current downturn. Says Mr. Bollard, “Reliance on past experience of strong house price inflation and easy credit will be untenable.”<br /> Given the uncertain prospects for growth, combined with moderating price inflation, the RBNZ can be expected to hold interest rates at current levels for the near-term. “Bollard will leave the benchmark interest rate unchanged at a record low 2.5 percent on <a href="http://www.bloomberg.com/apps/news?pid=20601081&sid=ajBITvArkefw">July 30</a>, according to all 10 economists surveyed by Bloomberg.” Based on <a href="http://news.alibaba.com/article/detail/markets/100143654-1-poll-new-zealand-central-bank-set.html">swap rates</a>, the markets feel similarly, and are pricing a mere 25 basis point hike over the next twelve months. With such a dubious prognosis, one has to wonder whether the Kiwi’s rally is really sustainable.<br /> <img alt="new-zealand-cpi-inflation2" class="aligncenter size-full wp-image-1949" height="267" src="http://www.forexblog.org/wp-content/uploads/2009/07/new-zealand-cpi-inflation2.jpg" width="230" />

New Zealand Dollar Rise Threatens Economic Recovery

Having risen nearly 30% against the US Dollar since March, the New Zealand Dollar (NZD or Kiwi) is now close to a 9 1/2 month high. While ...

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Canadian Dollar Slated to Outperform Other Commodity Currencies

In the same vein as <a href="http://www.forexblog.org/2009/07/new-zealand-dollar-rise-threatens-economic-recovery.html">Monday’s</a> and <a href="http://www.forexblog.org/2009/07/reserve-bank-of-australia-could-be-the-first-to-hike-rates.html">Tuesday’s</a> posts (covering the New Zealand Dollar and Australian Dollar, respectively), I’d like to use today’s post to look at another commodity currency – the Canadian Dollar. The Loonie, it turns out, has also benefited from the a recovery in risk appetite and concomitant boom in commodity prices; it has appreciated by 7% against the USD in the last month alone, en route to a ten-month high. “All in all, with almost everything going its way these days (besides the crummy weather and the impact on tourism), a <a href="http://www.theglobeandmail.com/globe-investor/soaring-loonie-fuels-parity-speculation/article1233238/">return trip to parity</a> – last visited nearly one year ago – doesn’t seem far fetched,” chimes one optimistic analyst.<br /><a name='more'></a><br /> <img alt="cad-usd" class="aligncenter size-full wp-image-1977" height="288" src="http://www.forexblog.org/wp-content/uploads/2009/07/cad-usd.png" width="512" /><br />Like Australia and New Zealand, Canada’s economic fate is tied closely to commodity prices. Simply, as oil and other natural resources have inched closer to last year’s record highs, the Loonie has rebounded proportionately. “Raw materials account for <a href="http://www.bloomberg.com/apps/news?pid=20601082&sid=a1tRPcEP0mrw" target="_blank">more than 50 percent</a> of Canada’s export revenue. Crude is the nation’s largest export.” Of course, this relationship works both ways. Any indication that the global economic recovery is stalling, and commodities prices would likely tumble, bringing commodity currencies down likewise.<br /> Unlike the Australian Dollar and New Zealand Dollar, the Loonie has never really held much appeal as a carry trade currency. Even at their peak, Canadian interest rates were mediocre, from the standpoint of yield. The current rate is a measly .25%, compared to 2.5% in New Zealand and 3% in Australia. Moreover, while Australia may begin tightening as soon as the fall, “The Bank of Canada committed to keep its key policy rate at the <a href="http://www.forbes.com/feeds/ap/2009/07/21/ap6680008.html">lowest possible level</a> until the spring of 2010,” after voting to hold rates at yesterday’s rate setting meeting. This interest differential could explain why the Aussie has outpaced the Loonie of late.<br /><img alt="cad-aud" class="aligncenter size-full wp-image-1978" height="288" src="http://www.forexblog.org/wp-content/uploads/2009/07/cad-aud.png" width="512" /><br />Another key difference – and potential explanation for the currencies’ recent divergence – is that Australia is considered part of the Asian economic zone, while Canada’s economic fortunes are closely aligned with those of its main trading partner, the US. China, alone, is helping to lift Australia out of recession. The US, meanwhile, is still struggling to find its feet. Hence, it is projected that Canadian GDP will <a href="http://www.forbes.com/feeds/ap/2009/07/21/ap6680008.html">contract by 2.3% in 2009</a>, while Australian GDP may fall by a modest .5%. “<a href="http://www.theglobeandmail.com/report-on-business/central-bank-likely-to-eye-runup-in-loonies-value/article1224296/">When things look bad</a>, you are more likely to sell Canada than the Australian dollar because its economy is moderated by Asian growth,” explains one analyst.<br /> Going forward, this regional differentiation could actually work to the advantage of Canada, which is forecast to grow by an impressive 3% in 2010, compared to 1% growth in Australia. Accordingly, one analyst advises that “Investors should sell Australia’s dollar against Canada’s as a ‘relative commodity play’ because an attempt by China to reign in bank lending on concern it may be creating asset-price bubbles could slow Asian growth…’The Canadian dollar <a href="http://www.bloomberg.com/apps/news?pid=20601082&sid=a1tRPcEP0mrw" target="_blank">should outperform </a>because it is much more closely linked to a recovery in the U.S.’ “

Canadian Dollar Slated to Outperform Other Commodity Currencies

In the same vein as Monday’s and Tuesday’s posts (covering the New Zealand Dollar and Australian Dollar, respectively), I’d like to use t...

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Risk Aversion Hits Australian Dollar

<div>These days, I feel like you could take that title and substitute pretty much any currency for the <em>Australian Dollar.</em> Let’s face it- the EU sovereign debt crisis has hit a number of currencies extremely hard, as investors have fled anything and everything risky, in favor of the US Dollar, Swiss Franc, Japanese Yen, and Gold.<a name='more'></a></div><div> Still, the Australian Dollar merits special attention, because in the forex markets, it has come to be a symbol of risk-taking. For veritable years, every credit expansion and economic boom has been accompanied by a surge in the value of the Aussie, and 2009 was no exception. As the global economy recovered and risk aversion ebbed, the Australian Dollar rose by more than 40% against the USD. It has been helped in its upward course by Chinese demand for its natural resources and strong interest rates, especially compared to the rest of the industrialized world. </div><div><img alt="AUD USD 2 Year Chart" class="aligncenter size-full wp-image-2791" height="230" src="http://www.forexblog.org/wp-content/uploads/2010/06/AUD-USD-2-Year-Chart.bmp" width="410" /></div><div> </div><div>That the Australian Dollar has already fallen 14% (from peak to trough) against the US Dollar over the last month is less due to economic and monetary factors, however, and more the result of an ebb in risk-taking. “The Australian dollar is considered a barometer of global <a href="http://www.google.com/url?sa=t&source=web&cd=4&ved=0CA8QFjAD&url=http%3A%2F%2Fwww.cmemarkets.com%2Fv3%2F2010%2F05%2F20%2Fwsj-update-investor-worries-push-australian">risk appetite</a>. Its fall reflects the quick change in mood, as Europe’s debt problems and China’s monetary tightening plans cloud expectations for the global economic growth,” summarized one analyst.</div><div> </div><div>Specifically, investors are growing increasingly nervous about the viability of the carry trade, of which the Australian Dollar has been one of the primary beneficiaries. Uncertainty surrounding the fiscal problems of the Eurozone has catalyzed a spike in volatility, and investors have responded by rapidly unwinding their carry trade positions. Ironically, this caused a temporary upswing in the Euro, at the expense of the Aussie: ” ‘The euro rally isn’t that people like the euro. Investors have decided they want out of risk.’ The way to remove that risk from portfolios is to pay back the euro loans by selling the Australian dollar.”</div><div> </div><div>From another standpoint, the yield advantage associated with holding Australian Dollars is no longer enough to compensate investors for the added risk. After adjusting for inflation, real interest rates in Australia are only about 2.5% (the nominal benchmark rate is 4.5%). This is still 2.5% higher than the benchmark US Federal Funds Rate, but not very attractive if you consider that the Australian Dollar has fallen by more than 2.5% against the US Dollar in several individual trading sessions in May. Moreover, the Reserve Bank of Australia (RBA) is signalling a pause in its rate hikes. If futures contracts are any indication, the Fed and the ECB will raise their respective interest rates before the RBA moves again.</div><div> </div><div>Going forward, the consensus is that a sustainable level for the Australian Dollar based on current fundamentals is probably around .75 AUD/USD. However, the Aussie rallied 5% against the US Dollar last week, which suggests that investors still aren’t ready to give up completely: ” ‘The environment is not yet ripe to get truly bearish on the Australian dollar,’ said Commonwealth Bank Strategist Richard Grace. There are positives on the horizon, namely a better outlook for the U.S. and a calming of the Greek crisis, he said. He’s forecasting a return to $0.87.” Personally, I could see the Aussie going either way. Parity probably isn’t on the table anymore, but virtually everything else still is.</div>

Risk Aversion Hits Australian Dollar

These days, I feel like you could take that title and substitute pretty much any currency for the Australian Dollar. Let’s face it- the EU ...

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New Zealand Dollar Thriving in Obscurity

It’s understandable that forex investors basically ignore New Zealand. Its economy is around 10% the size of its neighbor Australia, its currency is less liquid, and spreads are higher. Given that its performance closely tracks the Australian Dollar, meanwhile, why pay it any attention?<br /><a name='more'></a><br /> <img alt="NZD AUD 1 year" class="size-full wp-image-2849 alignnone" height="288" src="http://www.forexblog.org/wp-content/uploads/2010/07/NZD-AUD-1-year1.png" width="512" /><br /> To be sure, the new currencies from Down Under trade in virtual lockstep, having strayed by only a few cents in either direction from their trading mean over the last year. Since the beginning of May, however, the Kiwi has staged an impressive rally, rising 8% against the Aussie in a matter of weeks. Perhaps, there is something worth analyzing after all!<br /> According to most analysts, the sudden rise is largely a product of risk-appetite. Specifically, as the EU sovereign debt crisis stalls, investors are relaxing, and gradually moving capital back into growth currencies, like the New Zealand Dollar. In fact, the Kiwi recently rose to a one-month high on the same day that Spain successfully completed a bond auction.<br /> For proof of this phenomenon, one need look no further than the close relationship between the NZD/USD rate and US stocks, as proxied by the S&P 500. You can see from the chart below that they have largely tracked each other over the last 12 months. This relationship seems to have intensified over the last few weeks, as the New Zealand Dollar sometimes takes its cues directly from releases of US economic data.<br /> <img alt="NZD USD 1 year" class="size-full wp-image-2850 alignnone" height="288" src="http://www.forexblog.org/wp-content/uploads/2010/07/NZD-USD-1-year1.png" width="512" /><br /> However, New Zealand economic fundamentals are also playing a role, perhaps even the dominant role. According to one analyst, “The NZ dollar had now recovered nearly all its losses of late May…<a href="http://www.stuff.co.nz/business/market-data/currencies/3860948/NZ-dollar-rises-on-risk-appetite">Domestic fundamentals </a>had contributed relatively more to the NZ dollar’s recent recovery than had the mild improvement in the global backdrop.” Unlike Australia, which has been racked by political disruptions and concerns over an economic slowdown by its largest trade partner (China), New Zealand continues to coast at a healthy pace.<br /> <a href="http://www.stuff.co.nz/business/3897923/Moodys-cautiously-upbeat-about-NZ">Moody’s forecasts</a> that New Zealand’s economy will expand by 2.4% in 2010, and “assuming a healthy global economy, New Zealand’s recovery should evolve into a self-sustaining expansion during 2011 and 2012.” This should set the stage for near-term rate hikes, beginning with an expected 25 basis point hike on July 29. Analysts project that the benchmark rate will reach 3.75% by the end of 2010, and 5% in 2011. Widening interest rate differentials, combined with the ongoing recovery in risk appetite, could turn the Kiwi into a popular carry trade currency.<br /> Given that the Central Bank of Australia is also projected to further hike rates, it seems the Aussie will join the Kiwi in its upward march, and that the two currencies will continue to trade in lockstep. Options traders might try to construct a low volatility strategy, such as a short straddle or selling covered calls against the pair. For currency traders that prefer the Aussie, meanwhile, the New Zealand Dollar could serve as an attractive hedge.<br /> Then again, it’s possible that both currencies could fade, especially if the EU debt crisis intensifies, and/or the global economic recovery stalls. In short, “<a href="http://www.businessspectator.com.au/bs.nsf/Article/POLL-Aussie-NZ-dlrs-in-steady-cruise-for-rest-of-2-7676K?OpenDocument">The near-term outlook</a> is…uncertain due to prevailing risk aversion that may weigh on the commodity currency universe.”

New Zealand Dollar Thriving in Obscurity

It’s understandable that forex investors basically ignore New Zealand. Its economy is around 10% the size of its neighbor Australia, its c...

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Pound Surges to 15-Year High

<div class="entrytext"> Since 1992, two macroeconomic events had not occurred in Britain: price inflation has no exceeded 3% annually and the British Pound has not surpassed the $2 barrier.  Both events were realized today, however, as an early-morning release of economic data indicated inflation in Britain was hovering around 3.1% and the British Pound quickly rose above 2 USD/Pound.  Interest rate futures also witnessed an immediate correction, to the extent that the markets are now pricing in a British benchmark interest rate of 5.75% 6 months from now, .5% above the current rate.  Meanwhile, US inflation statistics were dovish, suggesting the gap between British and US interest rates is set to widen, which should propel the Pound further upwards.  The Financial Times reports: <br /> <blockquote>There is little that is inevitable about currencies moving in line with expected interest rates and nothing in long-term trends that allows people to predict currency movements in connection with inflation and other variables. But on Tuesday, the currencies moved exactly as if they were linked to the inflation figures by an umbilical cord. <br /> </blockquote>Read More: <a href="http://www.ft.com/cms/s/66614a84-ed1c-11db-9520-000b5df10621.html">Pound rises on prices and rates fears</a> <br /> <a class="st-taf" href="http://tellafriend.socialtwist.com/" style="border: 0; margin: 0; padding: 0;"><img alt="SocialTwist Tell-a-Friend" src="http://images.socialtwist.com/2009021910542/button.png" style="border: 0; margin: 0; padding: 0;" /></a> </div>

Pound Surges to 15-Year High

Since 1992, two macroeconomic events had not occurred in Britain: price inflation has no exceeded 3% annually and the British Pound has...

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Aussie May Have Peaked in 2010

When offering forecasts for 2011, I feel like I can just take the stock phrase “______ is due for a correction” and apply it to one of any number of currencies. But let’s face it: 2009 – 2010 were banner years for commodity currencies and emerging market currencies, as investors shook off the credit crisis and piled back into risky assets. As a result, a widespread correction might be just what the doctor ordered, starting with the Australian Dollar.<br /> By any measure, the Aussie was a standout in the forex markets in 2010. After getting off to a slow start, it rose a whopping 25% against the US Dollar, and breached parity (1:1) for the first time since it was launched in 1983. Just like with every currency, there is a narrative that can be used to explain the Aussie’s rise. High interest rates. Strong economic growth. In the end, though, it comes down to commodities.<br /><a name='more'></a><br /> <div style="text-align: center;"><a href="http://www.forexblog.org/wp-content/uploads/2011/01/Australian-Dollar-Vs.-Commodities-Prices-2010-2011.jpg"><img alt="" class="size-full wp-image-3640 aligncenter" height="315" src="http://www.forexblog.org/wp-content/uploads/2011/01/Australian-Dollar-Vs.-Commodities-Prices-2010-2011.jpg" title="Australian Dollar Vs. Commodities Prices 2010-2011" width="567" /></a></div>If you chart the recent performance of the Australian Dollar, you will notice that it almost perfectly tracks the movement of commodities prices. (In fact, if not for the fact that commodities are more volatile than currencies, the two charts might line up perfectly!) By no coincidence, the structure of Australia’s economy is increasingly tilted towards the extraction, processing, and export of raw materials. As prices for these commodities have risen (tripling over the last decade), so, too, has demand for Australian currency.<br /> To take this line of reasoning one step further, China represents the primary market for Australian commodities. “China, <a href="http://www.smh.com.au/business/markets/a-parity-party-might-be-over-in-2011-20101231-19bk4.html">according to the Reserve Bank of Australia</a>, accounts for around two-thirds of world iron ore demand, about one-third of aluminium ore demand and more than 45 per cent of global demand for coal.” In other words, saying that the Australian Dollar closely mirrors commodities prices is really an indirect way of saying that the Australian Dollar is simply a function of Chinese economic growth.<br /> Going forward, there are many analysts who are trying to forecast the Aussie based on interest rates and risk appetite and the impact of this fall’s <a href="http://www.theaustralian.com.au/business/flood-fears-weigh-down-australian-dollar/story-e6frg8zx-1225986571679">catastrophic floods</a>. (For the record, the former will gradually rise from the current level of 4.75%, and the latter will shave .5% or so from Australian GDP, while it’s unclear to what extent the EU sovereign debt crisis will curtail risk appetite…but this is all beside the point.) What we should be focusing on is commodity prices, and more importantly, the Chinese economy.<br /> Chinese GDP probably grew 10% in 2010, exceeding both economists’ forecasts and the goals of Chinese policymakers. The concern, however, is that the Chinese economic steamer is now <a href="http://www.theaustralian.com.au/business/fears-of-overheating-as-chinas-runaway-growth-defies-efforts-to-slow-it-down/story-e6frg8zx-1225991941824">powering forward at an uncontrollable speed</a>, leaving asset bubbles and inflation in its wake. The People’s Bank of China has begun to cautiously lift interest rates, raise reserve ratios, and tighten the supply of credit. This should gradually trickle down in the form of price stability and more sustainable growth.<br /> Some analysts don’t expect the Chinese economic juggernaut to slow down: “While <a href="http://www.investordaily.com/cps/rde/xchg/id/style/10814.htm?rdeCOQ=SID-0A3D9633-DEF269AE">there is always a chance of a slowdown in China</a>, the authorities there have proved remarkably adept at getting that economy going again should it falter.” But remember- the issue is not whether its economy will suddenly <em>falter</em>, but whether those same “authorities” will deliberately engineer a slowdown, in order to prevent consumer prices and asset prices from rising inexorably.<br /> <div style="text-align: center;"><a href="http://www.forexblog.org/wp-content/uploads/2011/01/AUD-USD-2006-2011-5-Year-Chart.jpg"><img alt="" class="aligncenter size-full wp-image-3643" height="247" src="http://www.forexblog.org/wp-content/uploads/2011/01/AUD-USD-2006-2011-5-Year-Chart.jpg" title="AUD USD 2006 - 2011 5 Year Chart" width="566" /></a></div>The impact on the Aussie would be devastating. “A <a href="http://www.telegraph.co.uk/finance/china-business/8261740/Hedge-funds-bet-China-is-a-bubble-close-to-bursting.html">recent study by Fitch</a> concluded that if China’s growth falls to 5pc this year rather than the expected 10pc, global commodity prices would plunge by as much as 20pc.” [According to that same article, the number of hedge funds that is betting on a Chinese economic slowdown is increasing dramatically]. If the Aussie maintains its close correlation with commodity prices, then we can expect it to decline proportionately if/when China’s economy finally slows down.

Aussie May Have Peaked in 2010

When offering forecasts for 2011, I feel like I can just take the stock phrase “______ is due for a correction” and apply it to one of any ...

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CAD: Steady as She Goes

The Canadian Dollar was supposed to be one of the “hot” currencies of 2010. Given that it’s now exactly where it started the year, I think it’s safe to say that this isn’t the case. On the one hand, it would seem that the markets are still confused about how much the CAD should be worth, as Adam <a href="http://www.forexblog.org/2010/07/markets-confused-about-canadian-dollar.html">recently pointed out</a>. An alternative interpretation is that investors believe the Loonie should trade near parity with the US Dollar; it has hovered just above that mark since breaching it in April.<br /><a name='more'></a><br /> <img alt="CAD USD 1 Year" class="aligncenter size-full wp-image-2957" height="288" src="http://www.forexblog.org/wp-content/uploads/2010/08/1y1.png" title="CAD USD 1 Year" width="512" /><br />The Canadian Dollar has benefited from strong fundamentals, especially compared to the US. Inflation is low and the economy is stable. “<a href="http://moneymorning.com/2010/08/19/double-dip-recession-6/">The International Monetary Fund (IMF)</a> recently said that Canada is likely to be the first of the seven major industrialized democracies to return to a budgetary surplus status by 2015.” 2010 GDP growth is <a href="http://www.google.com/url?sa=t&source=web&cd=3&ved=0CBwQFjAC&url=http%3A%2F%2Fwww.scotiacapital.com%2FEnglish%2Fbns_econ%2Fforecast.pdf&ei=aUZvTLuhHIWglAff3O2cDg&usg=AFQjCNH8srFRVwnyBMvtZawLdhclwCG8Pw&sig2=FSMncoWKcjK5U2HvfvjMMg">projected at 3.3%</a>, compared to around 2.5% in the US.<br /> <div style="text-align: center;"><img alt="Canada-GDP-Growth-Rate-Chart-2006-2010" class="aligncenter size-full wp-image-2958" height="240" src="http://www.forexblog.org/wp-content/uploads/2010/08/Canada-GDP-Growth-Rate-Chart-2006-2010.png" title="Canada-GDP-Growth-Rate-Chart-2006-2010" width="560" /></div>For this reason, “Pacific Investment Management Co. founder <a href="http://www.bloomberg.com/news/2010-08-12/canadian-dollar-touches-three-week-low-on-concern-global-economy-slowing.html">Bill Gross said he favors Canada</a>…he’s ‘in awe’ of countries such as Canada that have a low debt-to-gross-domestic- product ratio and solvent financial institutions. ‘North of the border’ has become a ‘preferable destination’ to what he sees in the U.S.” As a result, analysts have started to look beyond commodities, historically seen as the cornerstone of Canada’s economy. When the price of oil collapsed in May, the Loonie hardly budged. Given that Canada’s balance of trade is negative in spite of its commodity exports, maybe in focus is justified.<br /> <img alt="CAD Versus Oil Prices 2010" class="aligncenter size-full wp-image-2959" height="288" src="http://www.forexblog.org/wp-content/uploads/2010/08/z1.png" title="CAD Versus Oil Prices 2010" width="512" /><br />The Loonie is also benefiting from a positive interest rate differential with the US. Thanks to two consecutive rate hikes by the Bank of Canada (BOC) – which was the first G7 Central bank to tighten – Canada’s benchmark rate now exceeds the Federal Funds Rate by .5%. If the BOC fulfills expectations and hikes rates again at its meeting on September 8, this differential will widen further. In fact, it could continue expanding well into 2011, since the BOC is well ahead of the Fed in its monetary policy cycle. Here, again, the contrast with the US is self-evident: “The Canadian central bank has been raising interest rates, and has signaled that it will continue to raise interest rates. And with the Fed’s decision today reaffirming its dovish position, the interest rate differential will continue to favor increasingly Canada, and higher interest rates in Canada will continue to favor Canadian dollar strength.”<br /> <img alt="Bank of Canada 2000-2010 Interest Rate Hike Forecast" class="aligncenter size-full wp-image-2963" height="369" src="http://www.forexblog.org/wp-content/uploads/2010/08/Bank-of-Canada-2000-2010-Interest-Rate-Hike-Forecast1.jpg" title="Bank of Canada 2000-2010 Interest Rate Hike Forecast" width="600" /><br /> Throughout the rest of the summer, the Loonie will likely remain rangebound. Most traders are on vacation and trading volume is low. Besides, risk appetite is currently weak. When the markets return to full swing in September, I expect the Loonie will experience in a surge in volatility. In fact, investors are already starting to adjust their positions, with the most recent <a href="http://www.reuters.com/article/idUSN2013863520100820">Commitment of Traders report</a> showing an increase in Net Longs, bringing the total to $4.2 Billion.<br /> There is certainly a basis for predicting continued strength, but I think much depends on how commodity prices perform. As I pointed out above, the Loonie remains somewhat decoupled from commodities. That it nonetheless got a boost from strong wheat prices and the $40 Billion takeover bid for Potash Corp by mining giant BHP Biliton shows that investors still view Canada as a resource economy. If the global economy avoids a double-dip recession, commodities prices will probably recover and the Loonie will probably rise slowly towards parity. On the flip-side, the Loonie would be one of the big losers of a global slide back into recession.

CAD: Steady as She Goes

The Canadian Dollar was supposed to be one of the “hot” currencies of 2010. Given that it’s now exactly where it started the year, I think ...

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Loonie and Aussie Share Downward Bond

In yesterday’s post (<a href="http://www.forexblog.org/2011/06/tide-is-turning-for-the-aussie.html"><em>Tide is Turning for the Aussie</em></a>), I explained how a prevailing sense of uncertainty in the markets has manifested itself in the form of a declining Australian Dollar. With today’s post, I’d like to carry that argument forward to the Canadian Dollar.<br /><a name='more'></a><br /> <div style="text-align: left;"><img alt="" class="aligncenter size-full wp-image-4241" height="208" src="http://www.forexblog.org/wp-content/uploads/2011/06/CAD-AUD-Commodities-2010-2011.jpg" title="CAD AUD Commodities 2010 - 2011" width="536" /><br />As it turns out, the forex markets are currently treating the Loonie and the Aussie as inseparable. According to <a href="http://www.mataf.net/en/tools/01-01-correlation">Mataf.net</a>, the AUD/USD and CAD/USD are trading with a 92.5% correlation, the second highest in forex (behind only the CHFUSD and AUDUSD). The fact that the two have been numerically correlated (see chart below) for the better part of 2011 can also be discerned with a cursory glance at the charts above.</div><div style="text-align: left;"><img alt="" class="aligncenter size-full wp-image-4242" height="155" src="http://www.forexblog.org/wp-content/uploads/2011/06/Currency-Correlations-June-2011.jpg" title="Currency Correlations June 2011" width="578" /><br /><em>Why is this the case?</em> As it turns out, there are a handful of reasons. First of all, both have earned the dubious characterization of “commodity currency,” which basically means that a rise in commodity prices is matched by a proportionate appreciation in the Aussie and Loonie, relative to the US dollar. You can see from the chart above that the year-long commodities boom and sudden drop corresponded with similar movement in commodity currencies. Likewise, yesterday’s rally coincided with the biggest one-day rise in the Canadian Dollar in the year-to-date.</div>Beyond this, both currencies are seen as attractive proxies for risk. Even though the chaos in the eurozone has very little actual connection to the Loonie and Aussie (which are fiscally sound, geographically distinct, and economically insulated from the crisis), the two currencies have recently taken their cues from political developments in Greece, of all things. Given the heightened sensitivity to risk that has arisen both from the sovereign debt crisis and global economic slowdown, it’s no surprise that investors have responded cautiously by unwinding bets on the Canadian dollar.<br /> <div style="text-align: left;"><img alt="" class="aligncenter size-full wp-image-4246" height="266" src="http://www.forexblog.org/wp-content/uploads/2011/06/Canada-inflation-rate-2008-2011.jpg" title="Canada inflation rate 2008 - 2011" width="579" /><br />Finally, the Bank of Canada is in a very similar position to the Reserve Bank of Australia (RBA). Both central banks embarked on a cycle of monetary tightening in 2010, only to suspend rate hikes in 2011, due to uncertainty over near-term growth prospects. While GDP growth has indeed moderated in both countries, price inflation has not. In fact, the most recent reading of Canadian CPI was 3.7%, which is well above the BOC’s comfort zone. Further complicating the picture is the fact that the Loonie is near a record high, and the BOC remains wary of further stoking the fires of appreciation by making it more attractive to carry traders.</div>In the near-term, then, the prospects for further appreciation are not good. The currency’s rise was so solid in 2009-2010 that it now seems the forex markets may have gotten ahead of themselves. A pullback towards parity – and beyond – seems like the only realistic possibility. If/when the global economy stabilizes, central banks resume heightening, and risk appetite increases, you can be sure that the Loonie (and the Aussie) will pick up where they left off.

Loonie and Aussie Share Downward Bond

In yesterday’s post ( Tide is Turning for the Aussie ), I explained how a prevailing sense of uncertainty in the markets has manifested ...

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Archive for the 'Australian Dollar' Category

<h3 class="entry-header">Tide is Turning for the Aussie</h3>“Australia is about to enter a boom that should last decades…The Australian dollar is unlikely to go back to where it was, and manufacturing will shrink in importance to the economy, perhaps even faster than it has been.” This, according to <a href="http://www.smh.com.au/business/australia-entering-decades-of-boom-20110602-1fiwp.html">Martin Parkinson, Treasury Minister of Australia</a>. While 30 years from now, Mr. Parkinson’s prognosis might probe to be accurate, I’m not so sure it applies to the period 3 months from now. Here’s why:<br />First of all, the putative economic boom that is taking place in Australia is being driven entirely by high commodity prices and surging production and exports. Since peaking at the end of April, commodity prices have fallen mightily. You can see from the chart above that there continues to exist a tight correlation between the AUD/USD and commodities prices. As commodities prices have fallen over the last two months, so has the Australian Dollar.<br /><a name='more'></a><br /><div style="text-align: left;"><img alt="" class="aligncenter size-full wp-image-4235" height="209" src="http://www.forexblog.org/wp-content/uploads/2011/06/Australian-Dollar-Vs-Commodities-Prices-2010-2011.jpg" title="Australian Dollar Vs Commodities Prices 2010 - 2011" width="536" /><br />In addition, while demand will probably remain strong over the long-term, it may very well slacken over the short-term, due to declining economic growth across the industrialized world.  Consider also that Australia’s largest market for commodity exports – China – may have difficulty sustaining a GDP growth rate of 10%, and at the very least, new fixed-asset investment (which necessitates demand for raw materials) will temporarily peak in the immediate future.</div>Finally, the mining sector directly accounts for only 8% of Australia’s economy, which means that only to a limited extent to high commodities prices contribute to the bottom line of Australian GDP. This notion is reinforced by the 1.2% economic contraction in the second quarter – the biggest decline in 20 years – and the fact that GDP is basically flat over the last three quarters. Many non-mining economic indicators are sagging, and the number of <a href="http://news.smh.com.au/breaking-news-business/more-australian-companies-collapsing-data-20110606-1fou2.html">corporate bankruptcies is 10% higher</a> than in 2010. In the end, then, the ebb and flow of Australia’s fortune depends less on commodities, and more on other sectors.<br /><div style="text-align: left;"><img alt="" class="aligncenter size-full wp-image-4237" height="231" src="http://www.forexblog.org/wp-content/uploads/2011/06/Australia-GDP-Growth-Rate-2007-2011.jpg" title="Australia GDP Growth Rate 2007 - 2011" width="506" /><br />Mr. Parkinson’s optimistic forecasts might also be undermined in the short-term by a looser-than-expected monetary policy. The Reserve Bank of Australia last hiked its benchmark interest rate in November 2010, and <a href="http://www.theaustralian.com.au/business-old/rba-signals-rates-will-rise-this-year-barring-disaster-in-europe/story-e6frg8zx-1226079509278">may not hike again for a few more months</a> due to moderating economic growth and proportionally moderate inflation. Given that an attractive interest rate differential may be driving some of the speculative activity that has girded the Aussie’s rise, a decline in this differential could likewise propel it downward.</div>That’s because anecdotal reports suggest that the Australian Dollar remains a popular long currency for carry traders, funded by shorting the US Dollar, and to a lesser extent, Japanese Yen. Given that many of these carry trades are heavily leveraged, it wouldn’t take much to trigger a short squeeze and a rapid decline in the AUD/USD. For evidence of this phenomenon, one has to look no further back than May 2010, when the Aussie fell 10-15% in only three weeks.<br /><div style="text-align: left;"><img alt="" class="aligncenter size-full wp-image-4236" height="208" src="http://www.forexblog.org/wp-content/uploads/2011/06/Australian-Dollar-Short-Squeeze-May-2010.jpg" title="Australian Dollar Short Squeeze May 2010" width="536" /><br />Ultimately, as <a href="http://www.businessinsider.com/sea-change-for-the-australian-dollar-2011-6">one commentator</a> recently pointed out, the Aussie’s 70% rise since 2008 might better be seen as US Dollar weakness (which also catalyzed the rise in commodity prices). The <a href="http://www.forexblog.org/2011/06/no-qe3-what-are-the-implications-for-the-dollar.html">apparent stabilizing of the dollar</a>, then, might let some air out of the currency down under.</div><h3 class="entry-header"> </h3>

Archive for the 'Australian Dollar' Category

Tide is Turning for the Aussie “Australia is about to enter a boom that should last decades…The Australian dollar is unlikely to go back to...

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Pound Stagnates, Lacking Direction

The British Pound has struggled to find direction in 2011. After getting off to a solid start – rising 4% against the US dollar in less than a month -  the Pound has since stagnated. At 1.625 GBP/USD, it is now at the same level that it was at five months ago. Given the paltry state of UK fundamentals, the fact that it still has any gains to hold on to is itself something of a miracle.<br /><a name='more'></a><br /> <div style="text-align: left;"><a href="http://www.forexblog.org/wp-content/uploads/2011/06/GBP-USD-2011-Chart.jpg"><img alt="" class="aligncenter size-full wp-image-4172" height="209" src="http://www.forexblog.org/wp-content/uploads/2011/06/GBP-USD-2011-Chart.jpg" title="GBP USD 2011 Chart" width="537" /></a><br />The Pound’s failure to make any additional headway shouldn’t come as a surprise. First of all, the Pound is not a safe haven currency. That means that the only chance it has to rise is when risk is “on.” Unfortunately, the Pound also scores pretty low in this regard. Annual GDP growth is currently a pathetic .5%, and is projected at only 1.8% for the entire year. Inflation is high, and both the trade balance and the current account balance are in deficit. Deficit spending has caused a surge in government debt, and there is a possibility that the UK <a href="http://www.indiainfoline.com/Markets/News/UK-may-lose-its-AAA-rating;-Moodys-warns/5173695912">could lose its AAA credit rating</a>.</div><div style="text-align: left;"><a href="http://www.forexblog.org/wp-content/uploads/2011/06/UK-inflation-rate.png"><img alt="" class="aligncenter size-full wp-image-4178" height="262" src="http://www.forexblog.org/wp-content/uploads/2011/06/UK-inflation-rate.png" title="UK inflation rate" width="585" /></a></div><div style="text-align: left;">Investors might be willing to overlook all of this if interest rates were at an attractive level. Alas, at .5%, the Bank of England’s (BOE) benchmark rate is among the lowest in the world. Moreover, it isn’t expected to begin hiking rates for many months, and even then, the pace will be slow. Simply, the economy is too fragile to support a serious tightening of monetary policy. Interest rate futures reflect a consensus expectation that rates will be only 75 basis points higher one year from now.</div><div style="text-align: left;">If that’s the case, why hasn’t the Pound crashed entirely? To be fair, the Pound is losing groroundround against both the euro and the franc, the former of which has it bested in economic grounds while the latter is cashing in on its status as a safe haven currency. On the other hand, the Pound is still up for the year against the US dollar and Japanese Yen, both of which are also safe haven currencies.</div><div style="text-align: center;"><a href="http://www.forexblog.org/wp-content/uploads/2011/06/GBP-versus-other-currencies-YTD-2011.jpg"><img alt="" class="aligncenter size-full wp-image-4175" height="209" src="http://www.forexblog.org/wp-content/uploads/2011/06/GBP-versus-other-currencies-YTD-2011.jpg" title="GBP versus other currencies YTD 2011" width="533" /></a></div><div style="text-align: left;">It could be the case that the Pound is simply not the ugliest currency, since all of the charges that can be leveled against it can similarly be leveled against the dollar. Head-to-head, it’s actually quite possible that the Pound still wins, if only because its interest rates are slightly higher than the US. Or, it could be the case that investors still believe the BOE will come around and begin hiking rates. After all, <a href="http://www.forexblog.org/2011/02/forex-markets-look-to-interest-rates-for-guidance.html">at the beginning of the year</a> (when by no coincidence, the Pound was still rising), expectations were that the BOE would have already hiked twice by this time, bringing the benchmark to a level that would make the Pound attractive to carry traders. While the BOE hasn’t followed through, carry traders may be sticking around, since the opportunity cost of holding the Pound is basically nil.</div>As for whether the Pound correction (<a href="http://www.forexblog.org/2011/05/pound-correction-is-already-underway.html">that I first observed last month</a>) will continue, that depends entirely on the BOE. Unfortunately, there is very little reason to believe that the UK economy will suddenly pick up, and hence very little reason to expect the BOE to suddenly tighten. At some point, earning .5% interest on Pounds will become unattractive to investors. Until that day comes, that might stick with the Pound out of sheer inertia. While the Pound may hold its value for this reason, I don’t think it has any hope of appreciating further this year.

Pound Stagnates, Lacking Direction

The British Pound has struggled to find direction in 2011. After getting off to a solid start – rising 4% against the US dollar in less ...

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USD Gets Double Kick

<div style="background-color: white; color: #333333; font-family: Verdana, Arial, sans-serif; font-size: small; line-height: 19.5px; margin-bottom: 10px; margin-top: 10px;">Over the last couple months, a raft of positive economic developments has driven the USD steadily to its highest level in months. These developments include GDP data, retail sales data, and housing data have all shown signs of strength after an all-encompassing slump in the first quarter. However, it was not until last week that the markets fully removed the possibility of</div><a name='more'></a> near-term rate cuts out of the markets, sending US benchmark interest rates to their highest levels in years. As a result, the USD received a second bump, as higher yields sucked in a risk-averse capital from other parts of the world.  The delay between positive economic data and the subsequent rise in yields that took place here is rare, but Dollar bulls were probably happy to ride the wave upwards.  Dow Jones News reports:<br /><blockquote style="background-color: white; color: #333333; font-family: Verdana, Arial, sans-serif; font-size: small; line-height: 19.5px; margin-bottom: 10px; margin-top: 10px;"><div class="MsoNormal" style="margin-bottom: 10px; margin-top: 10px;">Amid soaring rates, the dollar’s rally got a second lease of life, confounding those who had been calling for a reversal in the greenback’s fortunes. Contrast that with late April, when the euro hit a record high of $1.3682 – and analysts were forecasting a run to $1.40.</div></blockquote><div class="MsoNormal" style="background-color: white; color: #333333; font-family: Verdana, Arial, sans-serif; font-size: small; line-height: 19.5px; margin-bottom: 10px; margin-top: 10px;">Read More: <a href="http://biznes.onet.pl/5,1553133,wiadomosci.html" style="color: #003366;">Dollar Perhaps Undeserving Of Recent Rally</a></div>

USD Gets Double Kick

Over the last couple months, a raft of positive economic developments has driven the USD steadily to its highest level in months. These deve...

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Emerging Market Currencies Still Look Good for the Long-Term

<div style="background-color: white; color: #333333; font-family: Verdana, Arial, sans-serif; font-size: small; line-height: 19.5px; margin-bottom: 10px; margin-top: 10px;">In my <a href="http://www.forexblog.org/2011/04/emerging-market-currency-correlations-break-down.html" style="color: #003366;">previous update on emerging market currencies</a>, I wrote that in the short-term, it’s important not to lump them all together; high-yielding currencies must be distinguished from low-yielding ones. In this post, I’m going to backpedal a bit and argue that over the medium-term and long-term, emerging market currencies as an asset class are still a good bet.<br /><a name='more'></a></div><div style="background-color: white; color: #333333; font-family: Verdana, Arial, sans-serif; font-size: small; line-height: 19.5px; margin-bottom: 10px; margin-top: 10px;"><a href="http://www.forexblog.org/wp-content/uploads/2011/06/World-Central-Bank-Interest-Rates-2011.jpg" style="color: #003366;"><img alt="" class="aligncenter size-full wp-image-4156" height="308" src="http://www.forexblog.org/wp-content/uploads/2011/06/World-Central-Bank-Interest-Rates-2011.jpg" style="border: 0px; display: block; margin: 0px auto 5px;" title="World Central Bank Interest Rates 2011" width="552" /></a><br />Most emerging market central banks have already begun to tighten monetary policy in order to mitigate against runaway inflation, overheating economies, and asset bubbles. You can see from the chart above (where a dark shade of green signifies a higher benchmark interest rate) that the overwhelming majority of high-yielding currencies belong to emerging market economies. (In fact, if not for Australia, it would be possible to say <em>all </em>high-yielding currencies).</div><div style="background-color: white; color: #333333; font-family: Verdana, Arial, sans-serif; font-size: small; line-height: 19.5px; margin-bottom: 10px; margin-top: 10px;">While industrialized central banks are also expected to begin tightening, the timetable is much less certain, due to slowing growth, high unemployment, and low inflation. If current trends continue, then, interest rate differentials should only widen further between industrialized currencies and emerging currencies. Without taking risk into account, the most profitable carry trade will involve shorting the lowest-yielding currency against the highest-yielding currency(s). Alas, liquidity must also be taken in account, and the Angolan Kwanza – with an interest rate of 20% – is probably not a viable candidate. As <a href="http://gulfnews.com/business/markets/bonding-with-emerging-markets-1.817757" style="color: #003366;">one fund manager summarized</a>, “[If] we feel like it’s a country where if we exit we are sort of going to shoot ourselves in the foot [due to lack of liquidity], then we won’t go in the first place.</div><div style="background-color: white; color: #333333; font-family: Verdana, Arial, sans-serif; font-size: small; line-height: 19.5px; margin-bottom: 10px; margin-top: 10px;">Over the long-term, meanwhile, emerging market currencies will receive a boost from two related forces: strong fundamentals and capital inflows. With regard to the former, emerging market economies already account for the lion’s share of global GDP growth. The <a href="http://www.reuters.com/article/2011/05/17/businesspro-us-worldbank-emerging-idUSTRE74G5PJ20110517" style="color: #003366;">World Bank</a> projects that over the next 15 years, emerging market economies will collectively expand by 4.7%, compared to 2.3% in the developed world. As a result of this strong growth, combined with fiscal prudence, debt levels across the developing world are generally falling. It marks a significant reversal that none of the current sovereign debt crises involves an emerging market country. What is more amazing is that some emerging market economies (Mexico, Russia, and Brazil) that struggled with bankruptcy less than a decade ago now have investment-grade credit ratings!</div><div style="background-color: white; color: #333333; font-family: Verdana, Arial, sans-serif; font-size: small; line-height: 19.5px; margin-bottom: 10px; margin-top: 10px;"><a href="http://www.forexblog.org/wp-content/uploads/2011/06/Emerging-Market-Currencies-Chart-2011.jpg" style="color: #003366;"><img alt="" class="aligncenter" height="209" src="http://www.forexblog.org/wp-content/uploads/2011/06/Emerging-Market-Currencies-Chart-2011.jpg" style="border: 0px; display: block; margin: 0px auto 5px;" title="Emerging Market Currencies Chart 2011" width="536" /></a><br />As a result, capital flows into emerging markets should continue to surge. Even though emerging market equity and bond funds have witnessed <a href="http://online.wsj.com/article/BT-CO-20110603-710053.html" style="color: #003366;">record inflows</a> over the last few years, portfolio allocations still remain extremely low. For example, “<a href="http://www.moneycontrol.com/news/world-news/imf-forum-no-easy-fixes-for-hot-emerging-markets_547429.html" style="color: #003366;">U.S. defined-contribution pension plans</a> only have 2.1% of their funds allocated to developing economies, which make up nearly 50% of global GDP.” Emerging market bonds, meanwhile, account for an estimated 1% of total assets under management. This trend will be further reinforced by domestic investors, which will probably opt to keep more capital in-country.</div><div style="background-color: white; color: #333333; font-family: Verdana, Arial, sans-serif; font-size: small; line-height: 19.5px; margin-bottom: 10px; margin-top: 10px;">Of course, the risks are manifold. First of all, there is a risk that these capital inflows will provoke a backlash. “Emerging countries have adopted a broad range of measures to regulate inflows and stem currency rises, increasingly resorting to<a href="http://www.moneycontrol.com/news/world-news/imf-forum-no-easy-fixes-for-hot-emerging-markets_547429.html" style="color: #003366;">capital controls and so-called macro-prudential measures</a> such as credit curbs.” Now that they have the blessing of the IMF, emerging market currencies might conceivably be more audacious in trying to limit currency appreciation. On a related note, there is also the possibility that emerging market central banks will fall behind the curve, perhaps deliberately. Lower-than-expected interest rates and hyperinflation would certainly dent the attractiveness of going long such currencies.</div><div style="background-color: white; color: #333333; font-family: Verdana, Arial, sans-serif; font-size: small; line-height: 19.5px; margin-bottom: 10px; margin-top: 10px; text-align: center;"><a href="http://www.forexblog.org/wp-content/uploads/2011/06/MSCI-Emering-Markets-Index-2006-2011.jpg" style="color: #003366;"><img alt="" class="aligncenter" height="416" src="http://www.forexblog.org/wp-content/uploads/2011/06/MSCI-Emering-Markets-Index-2006-2011.jpg" style="border: 0px; display: block; margin: 0px auto 5px;" title="MSCI Emering Markets Index 2006 - 2011" width="574" /></a></div><div style="background-color: white; color: #333333; font-family: Verdana, Arial, sans-serif; font-size: small; line-height: 19.5px; margin-bottom: 10px; margin-top: 10px;">Finally, it is possible that in all of their excitement, investors are bidding up emerging market assets to <a href="http://online.wsj.com/article/BT-CO-20110608-709573.html" style="color: #003366;">bubble levels</a>. The <a href="http://online.wsj.com/article/BT-CO-20110601-714327.html" style="color: #003366;">Wall Street Journal recently reported</a>, for instance, that commodity prices and emerging market currency returns have become strongly correlated. Given that many of these countries are in fact net importers of energy and raw materials, this shows that emerging market currencies are rising more in proportion to risk appetite than to economic fundamentals. If when this risk appetite ebbs, then, this could send emerging market currencies crashing.</div>

Emerging Market Currencies Still Look Good for the Long-Term

In my  previous update on emerging market currencies , I wrote that in the short-term, it’s important not to lump them all together; high-yi...

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Currency Correlations, Part II: Canadian Dollar Begins its Decline

In April, I wrote a post entitled, “<a href="http://www.forexblog.org/2011/04/economic-theory-implies-canadian-dollar-will-fall.html">Economic Theory Implies Canadian Dollar will Fall</a>,” in which I argued that the currency’s impressive rise was belied by fundamentals. It seems the gods of forex read that post; since then, the Loonie has fallen 3% against the US dollar alone. Based on my reading of the tea leaves, the loonie will fall further over the coming months, and finish the year below parity.<br /><a name='more'></a><br /> <div style="text-align: left;"><a href="http://www.forexblog.org/wp-content/uploads/2011/06/CADUSD-Chart-2010-2011.jpg"><img alt="" class="aligncenter size-full wp-image-4149" height="208" src="http://www.forexblog.org/wp-content/uploads/2011/06/CADUSD-Chart-2010-2011.jpg" title="CADUSD Chart 2010 - 2011" width="536" /></a><br />My contention is basically that investors are falsely treating the Loonie is a high-yield growth currency, and hence, bidding up its value. There are a few reasons why I believe this viewpoint is completely erroneous. First of all, Canada’s economy is both plain and mature. While it is indeed rich in natural resources would seem to make it stand-out, commodities exports account for only a small portion of GDP. Given that the US absorbs 75% of its exports, it’s no accident that Canada’s economic fortunes are tied closely to the US. Finally, Canadian interest rates are pretty mediocre, which means there is neither a strong monetary nor an economic impetus for buying the Loonie against the dollar.</div>While Canadian GDP and inflation have exceeded analysts’ predictions, the <a href="http://www.theglobeandmail.com/globe-investor/markets/markets-blog/bank-of-canada-rate-hikes-are-coming/article2041135/">consensus expectation</a> is still for the Bank of Canada to hold off on tightening until September or so. Even the most bullish forecasts show a benchmark interest rate of only 1.75% by the end of 2011 and perhaps 3% at the end of 2012. In other words, it will be a long time before the Loonie becomes a viable target currency for the carry trade.<br /> According to <a href="http://stats.oecd.org/Index.aspx?DataSetCode=PPPGDP">OECD models</a>, the Canadian dollar is overvalued by 17% against the Dollar on a purchasing power parity (ppp). While it is generally dubious to apply this concept to currency markets, I think it’s reasonable to invoke it when analyzing the USD/CAD. The two economies share more than just a border. As I said, their economies are closely intertwined, and goods, services (and people!) move freely between the two. Thus, you would expect that large discrepancies in prices should disappear over the medium-term. In fact, the Canadian trade balance recently slipped into deficit for the first time in 40 years (corresponding with the Loonie’s record high level), which shows just how quickly consumers can shift their attention south of the border. That means that either Canadian prices have to decline (something which retailers are always reluctant to effect) or the Loonie must drop further against the Dollar.<br /> <div style="text-align: center;"><a href="http://www.forexblog.org/wp-content/uploads/2011/06/Canadian-Dollar-currency-correlations-20111.jpg"><img alt="" class="aligncenter size-full wp-image-4148" height="147" src="http://www.forexblog.org/wp-content/uploads/2011/06/Canadian-Dollar-currency-correlations-20111.jpg" title="Canadian Dollar currency correlations 2011" width="540" /></a></div>Of course, there is a mitigating factor: the US dollar may fall even faster than the loonie. While it would seem impossible to tease apart the loonie’s rise from the dollar’s fall (since a rise in CADUSD inherently reflects both), we can still make an educated guess. For example, consider that the Canadian dollar is strongly correlated (i.e. greater than 80 or less than -80 in the chart above) with almost every other major currency, relative to the US dollar. If the correlation was low, than it would imply that the Canadian dollar is fluctuating (in this case falling) for endemic reasons. In this case, however, the almost perfect correlation with the majors shows that it is almost definitely a US dollar spike rather than a Canadian dollar correction.<br /> Whether this trend continues then, depends more on the health of the US dollar and less on what investors think about the loonie.

Currency Correlations, Part II: Canadian Dollar Begins its Decline

In April, I wrote a post entitled, “ Economic Theory Implies Canadian Dollar will Fall ,” in which I argued that the currency’s impressiv...

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