Clues on Currencies

Investors are running for the doors and it is not easy anymore to get the direction right for currencies in this market environment. What I am attempting to do here is to find some clues of what’s happening in stocks and commodities to predict what next for currencies.

The relief rally of these two markets over the past four months appear to have run its course, which resulting in currencies like Euro, AUD, Pound and emerging market currencies to start falling as well. The tight correlation between these markets is because all of the risks that drove these correlations still loom, especially housing market is still a major problem with no relief in sight.

The bottom line – the global economy is mired by risks that could easily divert recovery and send things into further depths of contraction, which makes the risk-taking interest of recent months merely opportunism.

When crisis strikes, investors are in favour for safety of US dollar-denominated assets. However, this trend gradually retracted over the past four months as risk appetite rising.

Now, risk aversion is coming back. Stocks are breaking down again and crude oil has fallen nearly 20% in six trading days. The commodity rally looks exhausted too and China’s import of iron ore is subsiding. The Baltic Dry Index, a good gauge of global demand, has been falling for seven straight days.

Evidently, the Euro, Pound, AUD have all breached key technical support and are now in decline. And higher risk carry trades, funded by the favoured Japanese yen, are being reversed aggressively. The Russian rubble experienced its biggest fall in five months. The last time the ruble was falling at this rate, the Russian central bank was in the process of exhausting 220 billion dollars in foreign exchange reserve to defend the value of the currency.

With risk aversion picking up, the US dollar’s least ugly status comes back into focus and the dollar benefits. Despite all the recent debate about the future of its reserve currency status, viable dollar alternatives don’t exist, particularly in a highly fragile global economic recession.