The Canadian Dollar is making a run at forex history, having reached a 30-year high against the USD this week.  The currency has appreciated by over 50% since 2002, and is up 9.4% this year alone.  The Loonie is surging on a combination of high commodity prices and attractive interest rates.  It is no coincidence that the price of oil has more than tripled over the five year period that the Loonie also appreciated in value.  In addition, the Bank of Canada is expected to raise interest rates two more times in the near-term which would bring its interest rate levels close to parity with US rates. The last time the Canadian currency, itself, stood at parity with the USD was in 1976. While it now seems inevitable that the currency will soon return to that marker, there are still hurdles that need to be cleared.  Bloomberg News reports:

“A strengthening currency has started to adversely affect the country’s growth, especially the manufacturing sector, which may raise concern the BOC needs to keep rates on hold.”

Read More: Canada Dollar Reaches 30-Year High on Outlook for Rate Increase

The Indian Rupee has been tightly controlled by the country’s Central Bank, which has not allowed the currency to fluctuate much.  A few months ago, however, the Rupee suddenly and rapidly began appreciating against all of the world’s major currencies.  Now, the Rupee stands at a 9-year high against the USD.  It turns out that India’s Central Bank deliberately allowed the Rupee to appreciate in order to combat inflation.  The reasoning is that a more expensive currency would make imports less expensive and exports more expensive from the standpoint of foreigners, which would hopefully lead Indian exporters to release more supply domestically, thus lowering prices.  While it remains to be seen whether the strategy was successful in reducing inflation, you can be sure India’s Central Bank will continue to aggressively pursue a policy of Rupee appreciation, until it inflation has decisively been held in check. 

Read More: Rising rupee: The causes and consequences

The US Federal Reserve Bank is scheduled to conclude its monthly meeting tomorrow at which point it will announce that interest rates will be maintained at current levels.  A few weeks ago, economists had actually been wavering in their expectations between a rate hike and rate cut which would be justified respectively by rising inflation and a sagging economy.  However, as the last couple weeks have witnessed a spate of releases of positive economic data, the consensus expectation is now that the Fed will leave rates unchanged.  The announcement is unlikely to affect the Dollar, whish is being driven by a rise in long-term interest rates that are determined by the markets, rather than the Fed.

Read More: The Short View: Fed Funds rate

With the US government doggedly clinging to the notion that China is manipulating its currency and insisting that the communist country be punished accordingly, it bears asking “how can we determine that a currency (in this case the Yuan) is in fact undervalued, and if so, by how much.  One notable economist has laid out three general techniques for “valuing a currency,” which may prove useful to all of you amateur economists.

First, there is the concept known as “purchasing power parity,” which suggests that a pair of currencies should fluctuate in value relative to each other based on changes in their respective interest rates and inflation. Second, there is the notion of a “sustainable” or “fundamental equilibrium” exchange rate which brings a country’s current account into balance- neither deficit nor surplus.  Third, historical exchange rate data can be regressed against various economic indicators (productivity, employment, etc.) in order to distill the select few that had the most direct effect on the currency in the past. The most current economic data can then be plugged into the resulting equation and tested against actual exchange rates.  However, while economists agree that these techniques are the most theoretically sound, they ignore the fact that currencies today seem less tied to the laws of plain economics than they do to financial economics- capital flows.

Read More: Misleading misalignments

This week, the President of the Central Bank of Japan essentially ruled out the possibility of a near-term rate hike, which was exactly the kind of reassuring news forex carry traders wanted to hear. As a result, the Yen quickly dropped to record lows against the Euro, British Pound and Australian Dollar, as well to a four-year low against the USD.  Surprisingly, the Swiss Franc, would seem an excellent candidate to fund the carry trade, is also surging. Now that any near-term volatility-which is the bane of carry traders-has been removed, the carry trade is likely to thrive. High-yielding currencies, such as the New Zealand Kiwi, will likely attract continued attention from speculators. At this point, it seems the only thing that could possibly slow the carry trade is a Japanese rate hike, or the mere threat of one.

Read More: Carry trades hit yen but Swiss franc surges

Most American traders know that a majority of stock market investments have become global over the past quarter century. Even homegrown companies have expanded with overseas offices or, at the minimum, overseas clients have come on board through the Internet. Currency traders aren’t immune to global trading, as the Forex market has opened to any interested trader with money to invest. While investors can look forward to portfolio growth with market expansions, they can also begin to measure how terrorism has affected their trades since 9/11.

The events on 11 September 2001 seem to provide the baseline for many analysts on how terrorism can affect trading. The day before the Twin Towers fell, the Dow Jones Industrial Average (DJIA) closed at $9,605.51. One week later, when the markets reopened on September 17, 2001, the DIJA hit an intraday low of $8,755.46 and the market didn’t recover for about another month. But, terrorist attacks – even the threat of an attack – can affect any market beyond Wall Street. Forex is especially susceptible to terrorism, since many targets focus on financial institutions or on major industries that represent wealthier countries.

According to one study [PDF] conducted by Ohio State University, exchanges, banks, and oil companies aren’t the only facilities that terrorists target. This study reveals that 75 terrorist-related attacks between 1995 and 2002 were focused on publicly traded firms and that the average loss per firm per attack was $401 million in market capitalization.

After watching the New Zealand Dollar (“Kiwi”) rise to a 22-year high in trade-weighted terms, the Bank of New Zealand decided it had had enough and intervened directly in forex markets to hold down the value of the currency.  Last week, the Bank was forced to raise interest rates due to soaring inflation.  Strong commodity prices and a commensurately strong economy have ushered in a surge of foreign capital, which in turn, have driven the Bank to hike rates, which in turn has made New Zealand more attractive to foreign investors.  This vicious cycle proved frustrating enough that the country’s Central Bank evidently felt the only way to curb the currency’s rise was to actively hold it down.  The Economist reports:

A strong currency can be a curse for exporters, however. In New Zealand’s case, the carry trade has given the kiwi dollar an extra upward push. With the yen nearing five-year lows against the American dollar this week, such trades may well continue.

Read More: A Warning Shot

The International Monetary Fund (“IMF”) today announced it will change the way it monitors the foreign exchange policies of its member nations. Previously, the IMF primarily focused on the internal effects of exchange rate policies, by looking at how the currency’s host country was either harmed or benefited from the policy.  The IMF’s new mandate, in contrast, extends to the evaluation these policies from an external standpoint: that is, how these policies affect other countries.  In the past, the IMF would only advise a country to alter its exchange rate regime if it was fostering economic instability in that particular country.  Now, however, the IMF would theoretically be justified in advising against currency policies that engender global economic standpoint.  Predictably, Iran, Egypt and Chin all voiced disapproval of the policy. Reuters reports:

The changes were meant to address exchange currency-related problems that developed since 1977, mainly caused by overvalued or undervalued exchange rate pegs and, more recently, capital account vulnerabilities.

Read More: IMF sharpens focus of forex monitoring

Since the beginning of 2007, the Bank of England has raised Britain’s benchmark interest rate by 50 basis points, to 5.50%.  While the Bank voted earlier this month to maintain rates at current levels, many analysts are speculating that it will resume hiking rates again in July.  A recent spate of economic data has supported the notion that Britain’s economy is on stable ground.  As a result, the specter of inflation is once again looming, and the Bank, which has a reputation for monetary hawkishness, will be quick to act if inflation stays above the Bank’s comfort level.  While the rate hike could certainly put a damper on Britain’s economy, it is likely to feed continued short-term interest in the Pound, is a viable risk-free alternative to the USD.

Read More: King comments send sterling climbing

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 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:

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.

Read More: Dollar Perhaps Undeserving Of Recent Rally

While the soaring price of oil and subsequent buildup of reserves have garnered the attention of currency analysts to the MidEast, it is China and its $1.2 Trillion which generates the majority of forex reserves commentary. However, this may soon change.  In a recent report, The Institute of International Finance noted that the collective foreign exchange reserves of the six-member Gulf Cooperation Council now total $1.6 Trillion.  Further, as the price of oil predictably increases over the summer, the reserves will only grow larger, which should ensure that the region remains a mainstay of forex punditry.  The Financial Times reports:

The UAE, Saudi Arabia and Kuwait account for the bulk of the GCC’s $1,550bn of foreign asset holdings, according to the IIF. The overall holdings represented 225 per cent of the GCC’s gross domestic
product.

Read More: Gulf states’ foreign reserves swell

The next FXCM Expo will be held in Dallas on July 14 & 15. On Saturday the 14th, FXCM will present over 20 free workshops, geared towards all trading levels from beginner to advanced. Paid workshops are held on Sunday the 15th.

Read more details at FXCMExpo.com.

It has been mooted on several currency forums, including here, that volatility is the enemy of the carry trade.  For this reason, many analysts predicted that last week’s bond market collapse would send Japanese capital-which had been parked in the US-back to Japan, thus triggering a rapid appreciation in the Japanese Yen. But nothing of the sort materialized. The Yen was virtually unaffected by the week’s turmoil, as Japanese investors continue to invest in countries that offer high-yielding investments, such as New Zealand, which surprisingly raised interest rates to 8%.  A Japanese senior official supported this notion, reports The Financial Times:

“The size of any carry trades that would unwind is relatively small compared to the entire foreign-exchange market.”

Read More: Japan official sees no end to carry trade

Over the last few weeks and accelerating towards the end of last week, the US bond market collapsed.  During that period, the 10-Year US Treasury yield rose 50 basis points to 5.15%, its highest level in nearly a year.  Meanwhile, the USD rose to its highest levels in a couple months.  Coincidence? Of course not. The relationship between the USD and US interest rates has become increasingly predictable, to the extent that increases or decreases in rates are consistently followed by a proportionate change in the value of the USD.  As a result of globalization, capital can be quickly moved to the country that offers the highest risk-adjusted return.  This is especially relevant for the US, which as the world’s least risky country (from a financial standpoint), tends to attract a big chunk of the world’s savings.  Forex traders should take note.

Read More: Dollar continues to strengthen from jump in Treasury yields

The European Central Bank (ECB) today raised the benchmark European lending rate to 4%, its highest level in six years.  The move came amid fierce opposition by European politicians who rightfully fear that higher interest rates will only send the Euro higher against other industrialized currencies and crimp the European economy.  The Euro is hovering around record levels against the USD, Japanese Yen, and Chinese Yuan, even though its economy is probably the weakest of the bunch.  However, the nature of the European Union means the interests of all member countries need to be looked after; while many of the traditional European powerhouse economies are struggling, Eastern Europe, for example, is thriving.  Taking matters into his own hand, France’s new president, Nicolas Sarkozy, is threatening to legislate a forced decline in the Euro, and many analysts think he may succeed.  The Telegraph reports:

“Sarkozy and Prodi are not going to let go of this. There’s a groundswell of feeling that Europe is being taken for a ride by the rest of the world, and they’re not going to put up with it any more.”

Read More: ECB rates rise as gloves come off

Last week, the Canadian Dollar traded at 94 cents against the USD, its highest level in over 30 years. This event is even more unbelievable considering the Loonie’s all time low against the USD occurred less than five years ago, in 2002.  Now, many analysts are cautiously optimistic that the Loonie will be trading at parity with the USD by year-end, and perhaps continue appreciating past that point.  Rising natural resources prices and a strong economy may drive Canada’s Central Bank to raise interest rates, at the same time that its neighbor to the south is contemplating lower rates.  However, not all analysts are quite so optimistic. The Associated Press reports:

But with an expected dampening in the industrial and manufacturing sector on its way, other analysts predict the Canadian dollar will start to weaken because commodity prices will pull back a bit and Canada’s economy may start to struggle because of the strength of the loonie.

Read More: Canadian dollar no longer ‘a weakling’

Low volatility combined with even lower interest rates has made the Japanese Yen into a popular target among forex traders, who borrow in Yen and short the currency in favor of higher-yielding alternatives.  It turns out the Japanese Yen, however, is not the only currency that is being driven downward by the carry trade; the Swiss Franc (CHF) has also become a victim in the last couple years.  Switzerland’s benchmark interest rate, at 2.25%, is the second lowest among industrialized nations, after Japan.  Moreover, the Swiss Franc is highly stable and liquid, which means it is well-suited for the carry trade.  Dow Jones News reports:

With global risk appetite remaining strong and carry trades remaining one of the primary driving forces in global currency markets, the franc is unlikely to get much respite from rate hike expectations.

Read More: Swiss Franc Slide Likely To Continue

Since reaching record-highs against the British Pound and Euro in April, the USD has pulled back slightly, due in part to the perception that the US economy is back in track. Last quarter’s round of GDP and housing data revealed that by some measures, the US economy was expanding at the slowest pace in years.  However, that notion was contradicted by last week’s release of employment, retail, and manufacturing data, all of which exceeded analysts’ expectations.  As a result, some economists have reversed their positions on the near-term outlook for US monetary policy, by switching their predictions from rate cut to rate hike.  The Tapei Times reports:

“Against a backdrop of stubborn inflation and tight labor markets, our analysis going forward will be more focused on the timing of rate hikes, not cuts.”

Read More: Expectations of healthy growth boost US currency