Only last year, Greece, Ireland, Italy, Portugal and Spain were collectively the pride of the EU, boasting strong growth characteristics and buoyant capital markets. In hindsight, this was but a mirage, as the stability of Euro-membership allowed such "peripheral" economies to embark on a colossal building boom and spending spree that was ultimately baseless. Greece, which is perhaps in the worst shape of the lot, witnessed its twin deficits (government debt and trade) rise to dangerous levels; given its membership in the EU, it is unable to resort to currency depreciation to rectify the problem.

The illusion has since been shattered, and it seems investors are trying to overcompensate for their previous naivete. Yields on government bonds for all five countries have begun to creep up, and a handful of speculators are betting on the possibility of default. Most experts insist that such a scenario is unlikely, but at the very least, the credit crisis has exposed the chinks in the armor of the EU, demonstrating that the currency also has its drawbacks. The New York Times reports:

While sharing a currency with some of the mightiest economies in the world helped Europe's poorer nations share in the wealth, a boon during boom times, in hard times the rules of membership are keeping them from doing what countries normally do to ride out economic storms, including enormous spending.

Read More: Once a Boon, Euro Now Burdens Some Nations

The Swiss Franc is in the same boat as the US Dollar and Japanese Yen, benefiting from an increase in risk aversion and an unwinding of carry trade positions. In other words, the currency rising on the back of the sound monetary policy of the National Bank of Switzerland, with its low rate of inflation and proportionately low interest rate. Despite the fact that the Swiss economy is poised to contract in 2009, its economy is in better shape than its rivals, and its current account balance is still in surplus. As a result, the consensus among analysts is that investors will continue to flock to the Franc, as Switzerland is sill perceived as a relatively low-risk place to invest. Especially compared to the Euro, which has risen against the Dollar of late, the Swiss Franc remains undervalued. Bloomberg News reports:

Investors are drawn to the franc in times of international tension and economic upheaval because of the country’s history of neutrality and political stability.

Read More: There's Nothing Swiss Can Do to Stop Franc's Rise

During his confirmation hearings, Treasury Secretary Geithner indicated that the Obama administration consensus is that China is manipulating the Yuan. China predictably refuted the charges, and indicated that it will not be bullied into submission by the US when managing its currency. Thus began a heated back-and-forth between US and Chinese economic officials, with the forex markets caught awkwardly in the middle. Geithner apparently doesn't realize that his position also carries important diplomatic responsibilities, namely helping the US government to pay its bills by ensuring a steady demand for US Treasury securities abroad. Offending the most reliable foreign lender, accordingly, is probably not the best strategy to fulfilling this role. Moreover, Geithner's testimony couldn't have occurred at a worse time, given the planned expansion of US debt and the simultaneous leveling off of China's forex reserves. The implications for the Dollar couldn't be clearer. Forbes reports:

China has been a major purchaser of America's official debt in recent years. If it were to stop…Geithner would likely find his Treasury paper having to offer higher yields to draw investors, putting new pressure on the American budget.

Read More: China Speaks, U.S. Debt Market Listens

Despite backed by negative real interest rates, the Japanese Yen continues to grind upwards, threatening to break through significant psychological and technical barriers. From a monetary standpoint, the Bank of Japan is basically out of options with regard to limiting the currency's upward momentum. Its sole remaining tool is its $1 Trillion in foreign exchange reserves, which it could release directly into currency markets to depress the Yen. It has been four years since Japan last employed such a strategy, and it appears reluctant to dip into the reserves again for fear of offending the G8, which has discouraged such action. The BOJ is also reluctant to build its holdings of US Treasuries (which would be a collateral requirement of holding down the Yen), because bond prices have become inflated. However, loss of face may soon become the least of its concerns, as the economy slides deeper into recession. Unless the notoriously thrifty Japanese consumers can be impelled to action, the Bank may find it has no other choice but to spur the export sector via a cheaper Yen. The Guardian UK reports:

The economic malaise in the United States and Europe is affecting Japan and Tokyo must act to keep the economy afloat, Nakagawa said, a day after the country's central bank forecast that Japan would plunge into its deepest contraction in modern times.

Read More: Japan steps up warning on markets, BOJ gloomy

The deepening of the credit crisis in the EU has triggered a wave of self-reflection, prompting those on the inside to ponder life without the Euro and those on the outside pondering life with the Euro. Their opinions couldn't be any more divergent. Countries like Italy, Spain, and Ireland, for example, have blamed the Euro for their economic woes, arguing that easy monetary policy and cheap credit were responsible for their real estate bubbles. Some commentators, accordingly, have argued that structural differences between these countries and the economic powerhouses of Germany and France are so large that it doesn't make sense for them to share a common currency. Meanwhile, Eastern European countries, most of which are still outside the Euro, are clamoring to join as sudden depreciations in their respective currencies have exposed them to massive economic instability. Business Week reports:

What happened, in effect, was rapid economic isolation. This began as investors moved money from more risky regional stock and currency markets into safer, often euro-denominated, assets, in what economists call a "flight to quality."

Read More: The Euro's Growing Appeal

The Russian Ruble is sliding faster and faster, having most recently reached a pace and level not seen since 1998, when Russia famously defaulted on its debt, and the currency lost more than half of its value in under a week. The Central Bank is keen to avoid a similar catastrophe this time around which is why it has diligently controlled the Ruble's descent, rather than allow the currency to reach an equilibrium in the spot market; such would likely result in a precipitous drop and perhaps a loss of confidence in the nation's banking system. Unfortunately, given the current m.o. of consistent but gradual devaluation, foreign investors are hesitant to own the Ruble, conscious of its inevitable decline. In fact, futures prices indicate that it is due to fall another 11%, with experts suggesting that this could be implemented over a time period as brief as one month, in order to return the economy to "normal" functioning as quickly as possible. Bloomberg News reports:

The falling ruble is causing banks, companies and individuals to hoard foreign currency. "All the attention of the people is focused on the forex market. Companies aren’t buying supplies, they’re investing their rubles in dollars instead because the play is too attractive."

Read More: Ruble Drops to Pre-1998 Crisis Low on 6th Devaluation This Year

While much has been written about the forex implications of the Barack Obama Presidency, most of the commentary has focused on the Dollar, at the expense of reporting on other currencies. The Chinese Yuan, to name one such currency, could soon find its fate tied closely to Obama; it has been widely speculated that he will compensate for the reticence of his predecessor by formally labeling China a currency manipulator and pressuring its to allow the RMB to appreciate at a faster pace. Timothy Geithner, who is set to be confirmed as the next Treasury Secretary, has echoed similar sentiments. It is unclear whether such a sentiment would achieve the necessary legislative support required to levy punitive sanctions against China in order to force it into submission. Given the current global economic climate, however, it seems unlikely that China would comply. Marketwatch reports:

In fact, China itself has every reason to avoid both depreciation and appreciation of its currency. The latter could further weigh on already drooping exports, and the former could lead to capital outflows from the country, at a time it can least afford this.

Read More: Investors await Obama's signals on China's yuan

A steady decline in risk aversion has taken place over the last few months, such that investors once again appear willing to own riskier assets, especially in the developing world. If this continues, increasing demand for emerging market assets would probably be accompanied by currency appreciation. While there are several ways that investors could conceivably profit from this trend, there is an overlooked strategy: currency options. Specifically, some traders have begun to write "out of the money" put options- the equivalent of selling insurance to investors that wish to protect themselves from further declines in emerging market currencies. Those who specialize in currency options, however, have noticed declines in both implied volatility and the risk-reversal rate, which together suggest that such a possibility is now perceived as less likely. Regardless of whether you plan to employ such a strategy, it's worth paying attention to currency options prices, as they represent valuable snapshots of a given currency's perceived health. Bloomberg News reports:

Traders quote implied volatility, a measure of expected price swings, as part of setting options prices. Options are contracts granting the right to buy or sell a specific amount of a security in a given time span.

Read More: Currency Options Best Bet on Risk Aversion Drop, Barclays Says

Even the most diligent forex traders would probably have difficulty distinguishing the Swedish Krona from the Norwegian Krone. Given current market conditions, such a distinction may no longer be necessary. Despite important differences in the structure of their respective economies, both currencies have moved in lockstep and fallen drastically, as a result of investor risk aversion associated with the credit crisis. The Norwegian Krona has been singled out especially due to the decline in the price of its most important export: oil. Despite sluggish growth, however, both Sweden and Norway expect to report large current account surpluses in 2009. In addition, inflation in both countries is practically non-existent. It is no surprise, hence, that both fundamental and technical indicators signal that the Krona/Krone are grossly undervalued. Bloomberg News reports:

Based on purchasing-power parity, which measures the relative level of currencies based on the cost of goods in different countries, the krone and krona are the only ones undervalued versus the dollar among their eight most-traded peers, according to data compiled by Bloomberg.

Read More: Nordic Currencies Beaten in Market Slump Lure Goldman

At the beginning of last week, analysts predicted that the Euro would continue to fall, on the basis of a deteriorating economic situation and the likely consequence of an expected ECB rate cut. Sure enough, the data indicated a decline in both inflation and economic output, paving the way for a 50 basis point cut in the ECB's benchmark lending rate and a fall in the Euro. Unfortunately, the consensus among analysts is that the common currency is poised to fall further. Investor interest in European assets and securities is waning rapidly as a result of a increased credit/economic/currency risk and decreased yield. In addition, the ECB is probably "behind the curve," having waited longer than its counterparts in the US and Britain to ease monetary policy. The Wall Street Journal reports:

"The sentiment is that the ECB is required to play catch-up in cutting interest rates," said Robert Blake, a Boston-based senior currency strategist at State Street Global Markets. "This could lead to further downward pressure on the euro for some time to come."

Read More: Euro Poised to Fall on Rate Cuts

Last week, the British Pound recorded its strongest performance against both the Dollar and Euro in nearly 20 years, on the basis of both technical and fundamental factors. On the surface, the Bank of England interest rate cut that prompted the rally would seem to be be negative for the Pound, since lower yield makes Britain a less attractive place to invest. On a deeper level, the relative modesty of the rate cut signalled to investors that the Bank of England is conscious of currency markets (the record decline in the Pound in 2008) when carrying out monetary policy. In addition, the BOE's proactive response to the credit crisis dwarfs the actions of the European Central Banks, which risks falling further behind the curve. In other words, investors began to question why they were pushing the Euro close to parity, when the economic fundamentals aren't much better in the EU than in the UK. Bloomberg News reports:

"The euro fundamentals are looking increasingly shaky," [said] a currency strategist. "It's clearer than ever the ECB has seriously misjudged the dire situation the region now finds itself in."

Read More: Pound Posts Record Weekly Gain Against Euro as BOE Cuts Rates

Despite a late 2008 rally on the basis of improved risk tolerance, the prospects for emerging market currencies remain grim. The decline in commodity prices have deprived many such countries, namely Russia and Venezuela, of much-need export revenue. Moreover, the credit crisis and consequent abatement in inflation paved the way for massive interest rate cuts, which made investing in emerging market securities much less attractive. Current-account balances have turned from surplus to deficit in a matter of months, and governments have turned to foreign lenders to make up the difference. Unfortunately, confidence in such currencies is still quite low, forcing governments to issue debt denominated in USD, rather than local currency. Even despite this accommodation, investors remain hesitant. Bloomberg News reports:

Lower levels of foreign investment in these countries will make it harder for policy makers to cut current-account deficits, leaving their currencies “potential flashpoints” for losses.

Read More: Emerging Currencies to Drop, Morgan Stanley Says

US government bond issuance in 2008-2009 will shatter all previous records. Fortunately, risk tolerance remains low as a result of the ongoing uncertainty surrounding the credit crisis,and demand for US Treasuries remains proportionally high. However, analysts are beginning to wonder just how much more the market can support, as it appears that a bubble has begun to inflate. A slight recovery in risk appetite, and/or institutional investor concern that the bubble is on the verge of popping could trigger a mass exodus from US Treasuries. Moreover, foreign holders would likely rush to repatriate the proceeds in order to minimize currency conversion risk. The result would be a self-reinforcing downward spiral between the Dollar and bond markets. Reuters reports:

A tanking U.S. dollar on the back of a decline in the U.S. bond market would signify the global economy may not be recovering anytime soon, however, which could leave very few places to hide.

Read More: Dollar investors wary of bond market bubble

Economic and monetary fundamentals throughout the world have become so paltry that one analyst notes tongue-and-cheek that investing in forex has become tantamount to identifying the "least worst" currencies. In virtually every country, all economic indicators are pointing downward, with the lone exceptions of unemployment rates and government spending. In other words, continuing declines in both production and consumptionherald a protracted worldwide recession. On the monetary side, Central Banks have embarked on a race to the bottom, with interest rates on pace to converge at 0% sometime in late 2009. Meanwhile, most governments have announced vast stimulus plans, which could prove highly inflationary if they can't find lenders willing to provide financing. In such an unfavorable climate, where then should savvy forex investors turn? The Financial Times reports:

Asian (ex-Japan) currencies, with relatively healthy banking systems, limited debt problems, positive demographics and undervalued currencies should be the natural harbour for fundamentally-driven investors. Commodity currencies, such as the Brazilian Real, Norwegian Krone, or Canadian dollar, offer characteristics akin to those in Asia and…[could also] participate in the rally.

Read More: A homely parade in the currency 'ugly' contest

The last two weeks have been eventful for the Euro: the common currency celebrated its 10th anniversary, Slovakia became the 16th member currency, and 2008 came to a volatile close. Analysts have taken advantage of this confluence of developments to publish a tide of opinion outlining its future. Supporters argue that the currency has forced member states to become fiscally responsible, as they can no longer print money to fund budget deficits. Moreover, the credit crisis proved the currency's raison d'etre; it has been an island of stability in a sea of volatility, with the currencies of some unlucky countries declining by 20% or more. Exchange rate volatility and interest rate divergence, which can cripple even robust economies in times of crisis, was nowhere to be found in the EU. As a result, Denmark, Iceland, and even the UK, could conceivably adopt the Euro in the not-too-distant future, especially since the latter's British Pound is closing in on parity.

Meanwhile, the Euro's detractors maintain that a one-size-fits-all economic and monetary policy is still not appropriate for a region as economically diverse as the EU. For example, while low interest rates may have been conducive to stable economic growth in Germany and France, they probably fomented real estate bubbles in Spain and Ireland, making the collapse even more painful in those locales than it had to be. Regardless, the consensus is that the Euro is here to stay, and will probably become an increasingly viable alternative to the Dollar. The Wall Street Journal reports:

The euro has climbed sharply again since Mr. Bernanke cut rates virtually to zero last month and signaled his new policy would be "quantitative easing" — i.e., printing as much money as it takes to revive the U.S. economy.

Read More: The Euro Decade and Its Lessons

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While the Australian Dollar and New Zealand Kiwi technically started 2009 in the black, most analysts believe that both currencies will continue their record declines that began in 2008. All economic indicators continue to point downward, due to the adverse conditions created by the worldwide recession. The economies of Australia and New Zealand are extremely dependent on exports of raw materials and dairy products, respectively. Unfortunately, due to a contraction in demand and a decline in speculation, the prices for both types of commodities appears unlikely to erase even a fraction of the losses suffered last year. The death blow into the heart of both currencies will likely be delivered by their respective Central Banks, which are expected to make additional interest rate cuts. This will further erode the rate differential with the US/Japan, that previously signaled the currencies as attractive investments. Bloomberg News reports:

The average forecast is for the currency [AUD] to reach a low of 62 cents in the first quarter before recovering to 66 cents by the end of 2009. New Zealand’s dollar…will bottom at 52 U.S. cents in the second quarter and recover to 55 cents by the end of the year…

Read More: Australian, New Zealand Dollars Complete Worst Year on Record

As investors gradually re-acquaint themselves with risk-taking, the interest rate story is once again dominating forex markets. For the last few weeks, this meant that investors were taking advantage of record-low US interest rates to fund carry trades in riskier currencies. Most recently, however, investors have begun to focus on the interest rate picture on the other side of the Atlantic. The Bank of UK just lowered rates to 1.5% and is "threatening" to match the Fed by dropping rates all the way to zero. The European Central Bank, meanwhile, is probably on the cusp of a similar interest rate cut. As commodity prices have relaxed and the credit crunch has slowed the expansion of the money  supply, the ECB is firmly justified in cutting rates, under the pretext of fulfilling its mandate, which is to guard against inflation. The upshot is that interest rate differentials, which have been fueling the Dollar's recent decline, may become less pronounced over the next year. Bloomberg News reports:

"There is increasingly more room for the ECB to be more aggressive on rate cuts. That will naturally put more pressure on the euro from an interest-rate differential perspective. We're seeing interest-rate differentials really come back into play in terms of a currency driver."

Read More: Euro Falls to Three-Week Low on Speculation ECB Will Cut Rates

In recent years, the idea of parity seemed to pop up repeatedly in forex markets. First, the Canadian Dollar breached the mythical 1:1 barrier against the USD; then, it looked as though the Australian Dollar would follow suit. The most recent battle for parity is being waged across the Atlantic Ocean, between the British Pound and the Euro. Both economic and monetary circumstances favor the Euro, as the housing crisis pummeled the UK economy and the UK Central Bank subsequently embarked on a steep program of monetary easing. The Euro has probably also received a boost from the perception that the EU is one of the most stable economies and investing locales, outside of the US. In any event, investors tend to get carried away with psychological milestones and ignore economic fundamentals, which means the Euro could quickly achieve parity, before pulling back. The Wall Street Journal reports:

On Monday, one euro briefly bought almost 98 pence, a new record. That paves the way for parity “as early as this week,” wrote Ashraf Laidi, chief market strategist at CMC Markets.

Read More: The Battle of Hastings, Revisited in Forex Markets

While the Yen's 30% rise in 2008 is no mystery (a result of the unwinding of carry trades), its performance nonetheless defies economic fundamentals. Exports have fallen and industrial production has collapsed, such that recession now appears inevitable. Japan is not alone in this regard, as a number of economies have suffered unnecessarily as a result of excessive volatility in currency markets. The solution could be the so-called "Tobin tax," which aims to limit forex speculation by levying a nominal tax on short-term currency trades. The proceeds from such a tax would be used to restore some equilibrium in forex markets by providing Central Banks with funds for direct intervention. While the tax itself has never been implemented, countries have previously taken to cooperating on forex matters for the sake of global macroeconomic stability. Seeking Alpha reports:

Exchange rates have to be within a certain range for all economies to prosper. The major economies have to work together to ensure this. If the Group of Five could work together to depreciate the "Super Dollar" in 1985, so the major nations today can and should work together to stem the surge of the super Yen.

Read More: Japanese Yen: An Excessively Strong Currency Spells Recession

The Central Bank of Vietnam finally acceded to reality and devalued its currency, the Vietnam Dong, by 3%. Prior to the change, the Dong (as well as its neighbor, the Chinese Yuan, which has also experienced a decline) was one of the few relative winners of the credit crisis. Perhaps this was because the currency had already depreciated significantly in recent years (35% since 1994), as well as because it remains fixed to the Dollar and hence it is impossible for the markets to short it when it becomes overvalued. Vietnam continues to be plagued by double-digit inflation and a surging current account imbalance, which suggest that the currency will probably have to suffer an additional 'correction' before reaching a sustainable level. In fact, the black market rate remains well below the official rate, reports Bloomberg News:

The devaluation followed five interest-rate cuts by the central bank this quarter to help bolster the economy. Policy makers last lowered the benchmark rate on Dec. 19 by the most ever this year to 8.5 percent, from 10 percent.

Read More: Vietnam Devalues Dong to Fight Slowdown, Help Exports

The Fed is officially in panic mode, having lowered its benchmark federal funds rate close to zero and exhausted all of the tools in its monetary arsenal, with one notable exception: its printing press. In other words, the Fed is trying to jumpstart credit markets by acting as a market participant- investing funds to compensate for the reticence of private investors. Capital markets are naturally enthusiastic about this policy, since some of the new cash will probably be used to make leveraged bets on asset prices and erase some of the losses of the last year. Forex markets are palpably less excited that the Fed has essentially eroded much of the impetus for foreigners to hold their ash in the US, with paltry short-term yields and long-term gains that will likely be offset by inflation. Unless foreign Central Banks follow suit

and eliminate the current interest rate disparity with the US, it could be a bumpy 2009 for the Dollar. Forbes reports:

Citi Analyst Steven Wieting opined: "If you want yield, you'll have to take some risk." With borrowing rates suddenly close to zero and the Fed saying it will keep them at “exceptionally low levels … for some time, you'll get as little of it from government-issued debt as possible."

Read More: After the Fed Panic 

Yesterday, the Forex Blog reported that the Yen could soon peak as a result of renewed interest in the carry trade. On the other side of this equation are emerging market currencies, most of which offer interest rates well above their industrialized counterparts. The spread between South Africa's benchmark interest rate and the rates of Switzerland, Japan, and the US, now exceeds 10%. As a result of near-zero rates in these countries, investors have once again taken to scouring the earth for yield. Apparently, government stimulus plans and monetary incentives have restored confidence in risk-taking. South Africa is especially poised to benefit, as it is one of the world's largest producers of gold, which recently resumed its upward trend. Bloomberg News reports:

“South African interest rates are very high relative to other markets and that yield differential is underpinning the rand at a time when trading is very thin.”

Read More: Rand Rises Versus Dollar on Bets Zero Rate in U.S. Boosts Carry