In the year-to-date, the respective currencies of Southeast Asia have been among the strongest in the world. The Indonesian Rupiah and the Thai Baht have appreciated 8% and 5%, respectively, in less than three months. While the politics in these countries has been unstable at best, their economies have served as models for other developing nations to emulate.In addition, the region’s governments have reined in spending and loosened monetary policy, moves which have attracted foreign investment. However, these same government s are now taking steps to prevent their currencies from rising further. The Economist reports:

The Philippines’ central bank says that the peso floats freely and it will intervene only to smooth volatility. However, Thailand’s and Malaysia’s central banks have been buying dollars to slow the rises in the baht and ringgit.

Read More: Perky pesos, rallying rupiah

Jean Claude Trichet, President of the European Central Bank (ECB) recently cautioned investors to expect EU interest rates to remain at historically low levels in the near-term. Nonetheless, analysts still expect the ECB to raise its benchmark interest rate next month. In fact, interest rate futures, which reflect investors’ collective expectations for future monetary policy, have three rate hikes priced into them. In addition, the last few weeks have seen heightened speculation that Asian and OPEC Central Banks will soon diversify some of their reserves into Euros. Many analysts have opined that the prospective combination of narrowing interest rate differentials and reserve diversification will soon send the dollar on a downward spiral. The Financial Times reports:

The debate was kickstarted by…the central bank of the United Arab Emirates, which may increase the share of its reserves held in euros from 2 to 10 per cent on valuation grounds.

Read More: Dollar dips on narrowing yield gap

It was probably inevitable: China’s foreign exchange reserves are now the largest in the world, having recently surpassed $850 Billion. The reserves are both a product of China’s massive current account surplus and the $100 Billion+ that the nation attracts in foreign investment each year. Further, experts do not expect China to slow its accumulation of reserves, which may reach $1 Trillion by the end of the year. As the majority of China’s forex reserves are held in USD-denominated assets, any slight appreciation of the Yuan causes a relative depreciation in the value of its reserves. Rediff.com reports:

China’s forex reserves maintained an upward growing trend and would be beneficial to maintain the nation’s and its enterprises’ external credit and the stability of financial structure and to prevent and resolve international financial risks.

Read More: China’s forex reserves = $853.7 billion!

As expected, America’s Federal Reserve Bank today raised the benchmark federal funds rates for the 15th consecutive time, to 4.75%. Prior to the announcement, the USD had traded downward, as traders braced for the possibility that this would be the last rate hike for a while. Ben Bernanke, Chairman of the Fed, soon allayed their anxiety by suggesting “some further policy firming may be needed.” In fact, some of the most hawkish analysts are now predicting the Fed will continue raising rates to 5.5% in the coming months.

Read More: Dollar rollercoasters on Fed statement

The most recent data on Japanese capital flows paints a picture of increasing repatriation of Japanese capital. In other words, Japanese people and businesses are divesting from overseas assets and parking their money in Japanese securities. Analysts have offered a couple explanations for this trend. First, yields on Japanese bonds have been growing as the Central Bank prepares to lift interest rates, and Japanese equities are approaching valuations left unseen for years. Perhaps, notoriously conservative Japanese investors are growing more confident in the strength of domestic asset markets. Second, and equally plausible, is that Japanese companies are repatriating profits earned overseas for tax purposes. Either way, the Yen will benefit. The Financial Times reports:

Data released on Friday by Japan’s Ministry of Finance revealed that Japanese investors sold a net Y1,480bn of foreign assets in the week to March 17, a six-fold increase on the week before.

Read More: Yen rallies on year-end repatriation flows

Next Tuesday, America’s Federal Reserve Bank will likely raise its benchmark federal funds rate by 25 basis points to 4.75%. When the Fed embarked on its current cycle of monetary tightening, most economists predicted it would stop raising rates at this level. Now, supported by a recent spate of hawkish economic data, analysts have revised their models to take into account an additional 25 basis point hike. In fact, interest rate futures currently reflect a net 76% probability that such a rate hike will take place at the Fed’s next meeting in April. This should come as great news to USD bulls, as the dollar’s day of reckoning has surely been postponed by many months, at the very least. The Financial Times reports:

The bulk of the economic numbers that did emerge largely played into the hands of the rate hawks, with core producer price inflation exceeding expectations and strong existing home sales data attesting to the continued robustness of the housing sector.

Read More: Dollar bounces as rate expectations rise

Earlier this week, US Senators Charles Schumer and Lindsey Graham concluded a trip to China, during which they met with top-level Chinese officials to discuss economic issues. The most important item on their agenda, naturally, was to press China to further revalue the Yuan. In less than a week, in fact, the Senate is set to vote on whether Schumer’s bill, which calls for a 27.5% tariff to be levied on all Chinese imports, should be advanced. Evidently, Senators Schumer and Graham left the talks satisfied, indicating that the Yuan should likely break through a level of psychological importance in the near future. The China Daily reports:

Premier Wen Jiabao said eight days ago that the range for the yuan’s fluctuation would be widen. But there will not be a one-off revaluation like the one in July, he said.

Read More: US must grasp reality of China forex policy

In a recent speech, Ben Bernanke, Chairman of the US Federal Reserve Bank, indicated the Fed would continue to raise interest rates in the near-term in order to rein in inflation. His words were supported by producer price data, which were released earlier in the day. The data suggested that prices of raw materials are rising, and, thus, the economy would benefit from additional rate hikes. For dollar bulls, this announcement provided a windfall, as the USD has become dependent on a wide interest rate differential to sustain the US current account deficit. The Wall Street Journal reports:

During the New York morning, the dollar…rebounded as the market factored that the core rate, which excludes volatile food and energy prices, rose more than expected. It climbed 0.3%, well above the 0.1% that economists had anticipated.

Read More: Dollar Posts Gains On Signs That Rates May Be Pushed Up

Over the last 12 months, the Brazilian Real has strengthened 32% against the USD, earning the distinction of strongest currency in the world. Analysts expect 2006 to be another strong year for the Real, as US interest rates peak, and investors shift funds to emerging markets in order to capture higher returns. Despite recent interest rate cuts totaling 3%, Brazil has not had difficulty attracting foreign capital. It recently auctioned off $1 Billion worth of Brazilian bonds, and is planning similar auctions in the near future, which should spur additional inflows of foreign capital. Bloomberg News reports:

“The contained inflation in the U.S. signals that flows will continue coming to Brazil. The most important thing nowadays for the currency markets is to pay attention to U.S. bonds to see how it will affect flows to emerging markets.”

Read More: Brazilian Currency Strengthens to 5-Year High on Rate Outlook

In January, a credit rating agency pronounced Iceland’s current account deficit unsustainable, arguing Iceland’s currency, the Krona, would need to depreciate significantly in order to shift the balance of trade back in favor of Iceland. In a follow-up report, the rating agency provided more context for its earlier comments, by identifying growing levels of Icelandic debt and surging imports. Economists have been quick to point out that similar crises in Turkey and Thailand ultimately drove 50-60% decreases in the value of their respective currencies. The Financial Times reports:

Two notable sell-offs in the krona in the last month have presaged wobbles in other emerging currencies and there were signs again of weakness…in the currencies of countries with large current account deficits.

Read More: Dollar gains weigh on emerging market FX

This week will end the second consecutive year in which Japan’s Ministry of Finance has abstained from intervening in forex markets. This is noteworthy, perhaps, in light of the fact that the Yen is poised to begin appreciating, on the heels of Japanese rate hikes. Most analysts do not expect the Bank of Japan to intervene if the Yen does begin to rise, because Japan’s economy appears to be in good shape. Several years ago, when the Bank of Japan spent over $300 Billion to prevent the Yen from rising, Japan’s economy was still fragile and forex intervention could be more easily justified. The Standard reports:

Japanese officials say there is no change in their standard refrain that currencies should stay in line with economic fundamentals, and movements should not become too volatile.

Read More: Tokyo tipped to let yen rise

The consensus among economists is that Japan has clearly emerged from a decade-long recession, which is a conclusion predicated on a bevy of economic data. The Bank of Japan is now in the unenviable position of having to raise interest rates to head off possible inflation, without shocking the economy back into recession. In a recent poll, a majority of economists indicated their belief that the rate hikes will be effected before the end of the year. While the Yen may not derive direct support from the rate hikes, it will likely benefit from an inevitable decline in carry trades, in which currency traders borrow Japanese Yen to finance purchases of other currencies. Reuters reports:

“Japanese rates are still going to remain extremely low – below 2 percent next year — and it will still be the lowest, notwithstanding the Swiss franc.”

Read More: BoJ change to ripple, not rock, through markets

As global debt and equity markets have stalled, many institutional and retail investors have turned to currency trading. In fact, forex trading volume typically exceeds $50 Billion per day among retail investors. At the rate at which it has been growing, it will not be long before forex volume surpasses turnover on the New York Stock Exchange, which averages just over $60 Billion daily. In addition, investment banks have identified retail currency trading as a key driver of revenue growth. Retail investors have been drawn in by such factors as low commissions and the ability to leverage. CNN reports:

“If you look at retail trading platforms, significant trading volumes are being put through. It’s a new market and a new clientele. I think they are having an impact on volume,” said Roger Hawes, global head of spot FX trading at Royal Bank of Scotland.

Read More: Risky business: Currency trading gets popular

Last week, the United Arab Emirates (UAE) was pressured into withdrawing from a deal that would have given it control over several US ports. Later in the week, the UAE announced that it would convert 10% of its foreign exchange reserves from dollars to Euros. While the timing of the announcement is open to debate, its impact is clear. Several other oil exporters have announced similar intentions to diversify their reserves. Some analysts think the moves are largely political. Other analysts think these nations are simply responding to narrowing interest differentials between the US and the rest of the developed world. Either way, dollar bulls should beware. Reuters reports:

The prospect of Middle Eastern oil exporters shunning the dollar sent ripples through currency markets on Monday, but analysts said any shift looks set to be gradual, marginal and driven by economic considerations.

Read More: Markets may be jumping gun over Gulf dollar sales

Last week, the USD registered solid gains against all of the major currencies, a feat that is not likely to be repeated this week. On one hand, currency traders continue to expect the USD to benefit from rate hikes and an increase in long-term treasury yields. On the other hand, a cascade of economic indicators are slated to be released this week, most of which are dollar-neutral or dollar-negative. Of primary importance is retail sales data, which serve as proxy for the consumption component of GDP and are expected to be lukewarm. Current account data will also be released, and will serve as a reminder to currency traders of the growing dependence of the US on inward foreign investment. In short, the USD is being pulled in multiple directions, and will likely remain range-bound in the near-term. The Wall Street Journal reports:

Recently, markets have ignored the ballooning U.S. trade deficit, focusing instead on the growing U.S. interest-rate advantage. However, Bank of America’s Mr. Sinche said the massive expected deficit could help refocus the market’s attention.

Read More: Slowdown in Dollar’s Gains Is Seen

In a recent interview, the always-coy Chairman of China’s Central Bank hinted that China may widen of the band in which the Chinese Yuan is permitted to move. The current band allows the Yuan to fluctuate +/- .3% per day, although in practice, the currency rarely moves by more than .01% per day. The Chairman was adamant, however, that China would not execute another one-off revaluation of the Yuan, like it did last summer. Rather, the RMB will continue to appreciate gradually, so as not to shock the global economy. Reuters reports:

Chinese officials have recently pledged to gradually increase the yuan’s flexibility by making better use of its daily trading band rather than doing another one-off revaluation.

Read More: China c. bank says it might widen yuan trading band

Later this month, Iran will inaugurate its much-anticipated oil bourse, whereby it will begin accepting payment for its oil in Euros, instead of in USD. Many analysts are already predicting that the bourse will mark the beginning of the end of the Dollar’s status as the world’s reserve currency. If other oil exporting nations follow the example of Iran, the demand for USD to settle oil purchases will decline. The central banks of these countries could conceivably begin to hold Euros instead of dollars in their foreign exchange reserves, which would deal a major blow to the dollar. FXStreet reports:

[Iran] has declared war on the U.S. Dollar’s world reserve status. That starts on March 20th, 2006 with their new Petro-euro oil bourse. The Fed will stop revealing M-3 on March 23rd, 2006. Coincidence?

Read More: Is the Federal Reserve Preparing for Iran?

Yesterday, as expected, the European Central Bank (ECB) hiked its benchmark short-term interest rate to 2.5%. It’s hard to believe that only six months ago, the ECB was drawing the ire of all of Europe for not acceding to political pressure to lower interest rates. In contrast, most economists now reckon Europe’s Central Bank will raise rates two or three more times in as many months. The economies of the European Union are showing signs of growth, and inflation is alive and well. As a result, many currency traders are now predicting the Euro will get a nice kick, as foreigners begin to move funds into the Euro-zone to take advantage of higher returns. The Financial Times reports:

“US cyclical support is probably close to a peak, and Trichet’s comments have bolstered a trend that was already in place,” said one analyst, who was sticking by his forecast that the euro would hit $1.25 in three months’ time.

Read More: Red letter day for Euro

One of the most popular types of investments among forex traders is the so-called ‘carry trade,’ in which investors borrow one currency that charges a low interest rate and purchase a different currency that offers a high interest rate. The goal is to profit from the interest rate differential (the gains from lending minus the cost of borrowing). In times of loose monetary policy and simultaneous forex stability, carry traders can extract enormous profits. However, as the current situation in Iceland underscores, when things go wrong, they often go very wrong. Most carry traders buy the currencies of developing countries, such as Brazil, New Zealand, and Iceland, because they offer higher interest rates. However, these currencies are often far less liquid than those of developed countries, which means it can be very difficult to exit quickly and safely from a losing position. Capuchinomics.com reports:

In an environment of rising interest rates, carry trades using the Dollar, Euro and Yen will come under severe pressure.

Read More: Krona crisis drama prelude to carry trade tragedy

In the last few months, a whole host of economic indicators have confirmed both that the Japanese economy is on solid footing and that the era of deflation has finally passed. Accordingly, many economists and analysts predicted that Japan would soon end its ultra loose monetary policy where real interest rates where kept below zero. In the last few days, however, currency traders have been working overtime to rid their models lofty rate hike expectations. The cause of the uncertainty has been the Bank of Japan, itself, which has insisted that it will continue to hold short term interest rates to below .1%, and long term rates to a proportionately low level. The Financial Times reports:

Reports suggested the BoJ will continue to pump liquidity into the economy by buying Y1,200bn worth of government bonds a month to keep long-term rates capped. “This would help…reduce market turmoil, including speculative yen buying.”

Read More: Yen falls on dovish rate talk