UK: No rate Cuts for 2 Years

The US Federal Reserve Bank is known for ambiguity and vagueness. The Bank of England, it appears, is not trying to emulate this approach. The Bank put an end to speculation about its near-term monetary policy by announcing that it does not plan to cut interest rates for at least two years. Apparently, inflation has breached the Bank's 2% target, and its internal models are forecasting that it won't be until 2010 that price inflation returns to a more palatable rate. This is bad news for the British economy, which is in the throes of an economic downturn precipitated by the housing crisis and would surely benefit from a loosening of monetary policy. By extension, the British Pound should also suffer a "correction," as a combination of inflation and lack of suitable investment opportunities will send investors rushing for the exits. The Financial Times reports:

Mr King contrasted his position – and its focus on controlling inflation – with that of Ben Bernanke of the US Federal Reserve. “We did not fall prey to the sirens to cut interest rates further as some other central banks have done,’’ he said.

Read More: No interest rate cut for two years, Bank warns

Canadian Dollar Spurred by Oil

Just a few weeks ago, the Central bank of Canada aggressively cut interest rates in order to slow the spread of the US economic downturn to Canada. Accordingly, investors were quite bearish on the Canadian Dollar. With the price of oil surging, however, the Loonie has regained some of its luster, inching back towards parity with the Dollar. If commodity prices remain at current levels, Canada may avoid an economic recession. Economists have scaled back expectations that the BOC will have to continue cutting interest rates. Nonetheless, the median investor expectation is for a sustained decline in the Loonie, perhaps to $1.08 by year end. Bloomberg News reports:

The loonie, as the currency is known because of the image of the bird on the one-dollar coin, has traded near parity with its U.S. counterpart this year after climbing 17 percent in 2007.

Read More: Canada's Dollar Reaches Two-Month High as Oil Surges to Record

Q1: Dollar Down 4%

Although the first quarter of 2008 ended on March 31, it wasn't until last week that the Federal Reserve Bank finally finished tallying all of the data and released its obligatory report on the performance of the Dollar. On a trade-weighted basis, the Dollar declined 4%, a figure which accounts for a whopping 11% decline against the Japanese Yen and an 8% decline against the Euro. According to the Fed's analysis, January was relatively kind to the Dollar, as traders remained uncertain as to how the credit crisis would affect the US economy. An outpouring of negative data in the next 4-6 weeks sent the Dollar spiraling downward, although it recovered at the end of March, as the Fed moved to build liquidity in the financial markets. The Fed also noted that it did not intervene in currency markets during the first quarter, firmly putting to rest rumors to the contrary. Forbes reports:

There had been intermittent discussion in the markets of a coordinated foreign exchange intervention by the G-3 central banks, but the Fed report confirmed officially what markets already realized.

Read More: NY Fed reports trade-weighted dollar down more than 4% in first quarter 

Korean Won is Worst in Asia

In the year-to-date, the Korean Won has recorded the worst performance of any currency in Asia, having recently fallen to a 6-week low. The story is being driven as much by Dollar strength is by Won weakness. US equities have rallied over the last month, as investors may have been overly pessimistic in the previous months regarding near-term US economic prospects.  In addition, the Fed has probably lowered interest rates for the last time, whereas the Central Bank of Korea has held its benchmark lending rate at 5% since the summer. This yield differential, which currently favors Korea, may narrow substantially over the coming months, as the Bank of Korea is forced to reckon with slowing growth and rising inflation. Bloomberg News reports:

Growth, at the slowest in more than three years last quarter, is losing momentum, the Bank of Korea said in a report on May 1. Policy makers next meet on May 8 to decide on the benchmark seven-day repurchase rate.

Read More: Won Declines to Six-Week Low

Fed Lowers Rates

The Federal Reserve Bank recently lowered interest rates for the seventh, and perhaps final, time, bringing its benchmark federal funds rate to 2.0%. Since inflation is still hovering around the 4% mark, the Fed will probably be reluctant to lower rates further. Thus, the markets have been given all of the boost that they are likely to receive, and it is "fate" that will determine whether the economy will find its footing. (GDP growth clocked in at an anemic .6% for the last two quarters). The most recent data (including the just-released jobs data) indicate that the economy may be stabilizing, although consumption and the employment situation are still deteriorating. As a result, the National Bureau of Research has yet to officially declare the current economic downturn a "recession," since the picture remains nuanced. The New York Times reports:

The recession-or-not question is now almost entirely academic, Mr. Bernstein contended, given the steady erosion of American spending power and soaring costs for food and gasoline.

Read More: Low Spending Is Taking Toll on Economy

April Marks Dollar Turnaround

Earlier this week, the Forex Blog speculated that the tide was turning on the Euro, which  had retreated from the $1.60 threshold. Sure enough, the month of April saw the best monthly performance by the Dollar in over two years. The sudden about-face by the Dollar stems from changes in interest rate expectations. Only a couple weeks ago, the consensus among investors was that the Fed would cut rates further at its next meeting; the only point of uncertainty was whether rates would be cut by 25 or 50 basis points.

As of today, however, there is only a 25% chance that the Fed will cut rates at all, if you go by futures prices. Regarding the Euro, investors are no longer so sure that the ECB will hike rates in response to surging inflation. In short, the new consensus is that the US/EU interest rate differential has stabilized. Then there is the economic picture; investors have "chosen" to be pleasantly surprised by the most recent economic data. While the economic downturn still seems inevitable, it may not be as severe as investors had previously feared. Reuters reports:

In contrast to slightly stronger U.S. data, the Ifo German business sentiment index this week showed the biggest monthly fall since September 2001.

Read More: Dollar heads for best month in 2-1/2 years

Chinks in the Euro's Armor

2008 has witnessed a rapid appreciation in the Euro, which recently breached the psychologically important $1.60 barrier. Last week, however, the Dollar dramatically reversed course, leading many traders to speculate that the Euro's best days may be temporarily behind it. There are two ideas underlying this theory. First, the Federal Reserve Bank is probably near the end of its tightening cycle, while the ECB has yet to begin. In addition, recent economic data suggests that the Euro-zone economy, which has appeared recession-proof in spite of the credit crisis, may soon falter. The best-case scenario, according to Dollar bulls, would be a loosening of monetary policy in the EU simultaneous with tightening in the US. If such a scenario were to obtain, it would bridge the interest rate differential between the two economies, which many believe is behind the weakness in the Dollar. The Wall Street Journal reports:

If bad news out of Europe starts to accumulate and the Fed stands pat, the dollar’s slide could taper off.

Read More: An Endgame for the Euro?

BOC Cuts Rates

The Bank of Canada has cut its benchmark lending rate by 50 basis points, to 3.0%.  The move was widely expected by analysts, although some of them had forecast only a .25% cut. Last week, economic data confirmed a mild rate of inflation in Canada, giving the BOC a green light to ease monetary policy without having to worry about the effect on prices.  Despite commodity prices that remain at stratospheric levels, Canada's economy is sagging, due to the subprime crisis unfolding across the border. Some analysts have analogized Canada's situation to the dilemma facing the European Central Bank, which is reluctant to cut interest rates for fear of stoking the fires of inflation. As a result, the Euro has surged 8.5% against the Dollar in the year-to-date, while the Canadian Dollar has fallen. If the BOC opts to cut rates further, the Dollar could retake some of the ground it lost last year. Marketwatch reports:

Against the Canadian dollar, the U.S. dollar is likely to hold support around par, gradually firming back toward C$1.03 ahead of the U.S. Federal Open Market Committee meeting on April 30.

Read More: Canada poised to cut after benign inflation data

Vietnam Dong to Slide Further

In the year-to-date, the Vietnamese Dong has fallen by .7%.  That may not seem like much, but since the Dong/Dollar exchange rate is approximately 16,000 to 1, every .1% is meaningful. Unfortunately for Vietnam, analysts are predicting that the Dong will fall further, due to a confluence of factors. First, the Vietnamese stock market is tanking; the 42% decline recorded thus far in 2008 makes it Asia's worst performer and unattractive for foreign investors. The second factor is inflation, which is nearing 20% and is directly eroding the value of the Dong. Finally, there are technical factors, such as rising imports and market sentiment that the Central Bank will hold down the Dong to support the export sector.  Bloomberg News reports:

"The key concerns are that inflation and excessive domestic growth have been allowed to persist. Those pressures have flipped from dong positive to dong negative.''

Read More: Dong to Drop as Inflation Deters Investors

ECB Holds Rates

The European Central Bank (ECB) has decided to hold its benchmark interest rate at 4%.  Despite signs that the EU economy is slowing, inflation is hovering around 3.5%, and the ECB has announced that its priority will be to maintain price stability. Jean Claude Trichet, President of the ECB, declared during the accompanying news conference that he "deplores" volatility in the forex markets, an indication that he is concerned that the Euro is appreciating too rapidly.  It doesn't help the Euro's cause that the Bank of England lowered its benchmark lending rate to 5% earlier in the week and that the Fed is also in the process of easing monetary policy. Both the US Dollar and British Pound recently touched record lows against the Euro.

Read More: Trichet says deplores excessive forex volatility

Central Bank of Japan Appoints Leader

For several months, the Central Bank of Japan had been leaderless, creating a situation that was politically and economically awkward.  Finally, after much debate, Masaaki Shirakawa, a former academic and veteran central banker, was appointed.  It is unclear what effect Mr. Shirakawa will have on Japan's economy, which is foundering (for reasons unrelated to the global credit crunch).  He is considered highly competent, and analysts have suggested that he could help Japan develop a sensible and focused economic policy, which has been lacking for quite a while. With regard to monetary policy, he is unlikely to either raise or lower interest rates from the current level of .5%.  Thus, if he is to return Japan to economic credibility, he will have to use other methods. Nonetheless, analysts are optimistic. The New York Times reports:

Simply having a hand at the central bank’s tiller will do much to restore global confidence in Japan and its ability to manage its $5 trillion economy, economists and former bank officials said.

Read More: Japan Approves New Bank Chief

Japan (Also) Mulls Intervention

Yesterday, the Forex Blog reported that the risk of intervention in forex markets is growing, in order to prop up an ailing Dollar.  The focus of the post was on the Euro, which is hovering below the record high of $1.60 reached last week. With this post, we wish to extend coverage of the potential intervention to include Japan.  In some respects, Japan is actually a more likely candidate for intervention, since it has a history of actively depressing its currency.  Most recently, in 2004, it accumulated $350 Billion in Dollar-denominated assets in a large scale effort to keep the Yen from rising out of control. 

Japan's consumers are notoriously tightfisted, and consequently, its economy is dependent on the export sector to drive growth. Unfortunately, the more expensive Yen is making this sector less competitive. In addition, Japan's new Prime Minister has yet to lay out an economic plan, and the stock market is foundering. A number of creative solutions are being mulled, including one to buy American mortgage-backed securities, in order to head off the international opposition to intervention. The New York Times reports:

That might win Washington’s approval by helping to ease the credit squeeze in the United States, but given such securities’ role in precipitating the crisis of the last several months, it might well set off cries of dismay here.

Read More: As Dollar Keeps Falling, Talk of a Move by Japan

The Rising Threat of Intervention

Last week, the Euro retreated from the record high of $1.60 that it achieved earlier in the week. Policymakers are still concerned, however, and are perhaps using this lull to come up with a plan of action should the Dollar resume its slide. In fact, the consensus among analysts is that coordinated intervention is likely if the Euro crosses a certain threshold- perhaps $1.65. In order to be successful, the intervention would need to involve the Federal Reserve Bank and the European Central Bank principally, as well as the peripheral participation of the Central Banks of Switzerland, Japan and England.  The situation is complicated by the monetary policy of the ECB, the tightness of which is causing the interest rate differential with the US to widen dramatically. Already, volatility levels in forex markets are slowly climbing, suggesting that investors are bracing themselves for a big move.  The Guardian UK reports:

ECB Executive Board member Lorenzo Bini Smaghi said in a speech on Tuesday markets sometimes overshot, with possible negative implications for the world economy. Since his speech, the dollar has strengthened by almost 2 cents against the euro.

Read More: Euro intervention edging nearer, but still distant

Brazil to Alter Forex Rules

In a thinly disguised effort to stem the appreciation of its currency, Brazil has announced sweeping changes to its rules governing forex.  Rather than revert to outright intervention in the forex markets, however, Brazil will permit businesses to hold more foreign currency as part of their reserves.  In this way, the Central Bank won't have to purchase Dollar-denominated assets directly.  Instead, it is hoping that the natural attraction of US and other Western capital markets will be enough to drive private Brazilian companies to increase their holdings abroad.  It is intended that this will act against the upward pressure on the Real, which rose 20% against the Dollar in 2007, and 5% already in 2008, and now threatens to drag down the economy.  Dow Jones reports:

The strong real has made some Brazilian manufactured exports such as textiles and footwear less competitive. Meanwhile, it also has introduced a boom in imports resulting in a narrowing of the country's trade surplus.

Read More: Brazil Council To Meet Wed To Change Forex Rules

BOC to Cut Rates Further

Ironically, the faltering US economy has induced the Dollar to appreciate against many of the world's currencies. The reasoning is that countries whose economies are tied closely to the US will falter even more than the US during a recession. One of those countries is apparently Canada. As a result, the Bank of Canada has already moved to cut rates by 50 basis points in order to mitigate against a full-blown Canadian recession. All of the economic indicators are already pointing downwards and GDP growth is projected to be a paltry 1.8% in 2008.  In addition, exports to Canada's largest trade partner, the US, have sagged noticeably, such that its current account recently slipped into deficit for the first time in nearly a decade. The Bank of Canada is busy plotting strategy, with additional rate cuts in the offing.  It looks like the monumental run of the Loonie has finally come to an end.  Bloomberg News reports:

Canada's dollar will probably remain within the range it has held since the start of the year because investors are still avoiding risk amid the unsettled U.S. economic outlook. It has traded within about 4 percent of parity with its U.S. counterpart, after surging last year as high as 17 percent.

Read More: Canadian Dollar Falls on Speculation More Rate Cuts Are Coming

Bank Collapses, Dollar Plummets

Over the weekend, Bear Stearns, a prestigious American investment bank, hurriedly scrambled to find a buyer in order to avoid having to file for bankruptcy. While a buyer (JP Morgan) was ultimately secured, investors remained jittery, as the collapse of this magnitude is virtually unprecedented.  When forex markets re-opened on Monday, the Dollar crashed against all of the world's major currencies, namely the Euro and the Yen. Furthermore, analysts are now beginning to view forex intervention as increasingly likely. It's still unclear whether the Bank of Japan or the European Central Bank (with or without support from the Fed) would spearhead any such intervention.  At the breakneck speed at which events are unfolding, however, no one will be surprised if a plan is quickly cobbled together. The Wall Street Journal reports:

"Were such intervention to be seen, (the euro) could briefly trade down to $1.55, yet unless the (ECB) is prepared to back up such intervention with a rate cut, intervention will be futile," said [one analyst].

Read More: Dollar's Slide Keeps Pace

Currency Traders Dump Bernanke

On January 31, 2006, Ben Bernanke officially replaced Alan Greenspan as Chairman of America's Federal Reserve Bank. At that time, the EUR/USD and USD/JPY exchange rates hovered around 1.20 and 118, respectively. For the first year of his tenure, Bernanke lived up to investor expectations and burnished his credentials as an inflation fighter by continuing a string of interest rate hikes begun by Greenspan. Fast forward to today, where the US economy is in tatters, inflation is raging, home and equity prices are slumping, and the Dollar has declined to $1.55 against the Euro and 100 against the Japanese Yen. Meanwhile, forex volatility levels are climbing rapidly, suggesting that the Dollar's troubles still havn't reached their climax.

Needless to say, currency traders- and a whole host of other investors and analysts- are furious with Bernanke. Many insist that he misled them, by downplaying the seriousness of housing jitters and insisiting stubbornly that inflation isn't a problem.  Even now, he is lowering interest rates in order to spur the economy, but at the expense of price stability.  As any experienced currency trader can attest, low interest rates and high inflation are a recipe for a weak currency. Reuters reports:

Bernanke "has sacrificed the dollar in an attempt to save jobs and U.S. business," said one analyst. "He had to do something, but at the same time he is only putting off the crisis. We will face tight credit for a decade and we will have stagflation."

Read More: Bernanke rapidly loses fans in the forex world

BOC Lowers Rates

Last week, the Bank of Canada lowered its benchmark interest rate by 50 basis points, to 3.50%.  Though the move was widely anticipated by analysts, whose only uncertainty was whether the bank would cut 50 bps or 25 bps, investors nonetheless punished the Canadian Dollar. The reason cited by the Central Bank in its press release accompanying the rate cut was a sagging economy, due in part to a more expensive Loonie and the concomitant decline in exports. In addition, the Bank indicated that it will likely have to cut rates further over the next few months in order to avoid recession.  In short, it doesn't look like the Canadian Dollar will upstage its 17% rise in 2007. Bloomberg News reports:

The central bank "has some very dovish words for the Canadian economy.  Retaining the full easing bias and saying the risks to growth are intensifying have caught investors' attention.''

Read More: Canada Dollar Falls as Bank Reduces Rate, Signals It's Not Done

Fed vs ECB

Yesterday, the European Central Bank (ECB) maintained its benchmark lending rate at 4%.  Meanwhile, America's Federal Reserve Bank has cut rates by 2.25% over the last six months.  For years, the ECB existed entirely in the shadow of the Fed and conducted monetary policy accordingly, but in this latest downturn, it seems to have broken free. The reason for the split can be found in the Central Banks' different mandates: the Fed aims to promote growth, while the ECB is charged primarily with creating price stability. Thus, the ECB can easily avoid succumbing to analysts' expectations that it will ultimately lower rates.  In addition, while EU politicians are pressuring the ECB to hold down the common currency, the ECB's mandate is actually supported by the expensive Euro because it lowers the cost of imports. The New York Times reports:

Mr. Trichet has long held that central banks do their best work when their threats to raise interest rates deter inflationary actions in the first place, avoiding the need for excessive swings in the benchmark rate.  [He] called this concept “credible alertness.”

Read More: In Europe, Central Banking Is Different

Fed in Lose-Lose Situation

Remember the expression "Goldilocks economy," used to to characterize the Fed's perennial aim of simultaneously pursuing economic growth and price stability?  How about "stagflation," a term coined in the 1970s to describe a unique period in US economic history where low growth coincided with inflation.  Now, these two scenarios are being juxtaposed as the Goldilocks economy gives way to stagflation. The Fed is trying to delicately toe the line, as equity and home prices sink while prices rise; one index suggests prices have risen over 7% year-over-year.  The index more often cited, the CPI, reads 4.3%.  Both of these figures exceed current interest rate levels. 

What, then, is the Fed's proper course of action, especially as far as Dollar bulls are concerned?  If it holds rates or contindfues to lower them, the economy could avert recession but prices would likely continue to climb, eroding the value of the Dollar.  On the other hand, if rates are hiked to mitigate against inflation, a recession would almost become inevitable, and the Dollar would feel the drag of capital being pulled overseas. The New York Times reports:

“February may go down in history as the month that the previously indefatigable U.S. consumer finally threw in the towel, beaten by a combination of deteriorating labor market conditions, surging prices for food and energy and collapsing house prices,”

Read More: As Inflation Rises, Home Values Slump, Data Show

Commentary: Yuan et al Must Appreciate

Although the Chinese Yuan is ostensibly allowed to fluctuate in value, the reality is that the size of its fluctuations and the pace of its appreciation are tightly controlled by China's Central Bank.  Since its currency is still effectively fixed to the Dollar, China is severely curtailed in its ability to conduct monetary policy and must closely mirror US policy.  Same goes for the rest of Asia, excluding Japan. While US monetary policy was relatively tight, as it has been for the last five years, this necessity didn't cause too many problems; most of these economies would have kept interest rates high irrespective of the US.

Since the Fed began loosening monetary policy over the last six months, however, many of the emerging economies in Asia, especially China, have been forced into a bind.  On the one hand, lowering interest rates is exacerbating the problem of inflation.  On the other hand, they want to keep their currencies stable so as not to limit economic growth.  In short, Central Banks must determine which is more important: fighting inflation or promoting growth. According to some economists, these economies are so strong, having grown by nearly 10% collectively last year, that they can afford to slow down, if it will result in greater price stability.  But the only way to stabilize prices is to drastically raise interest rates, which will put even greater pressure on their currencies to appreciate.

In addition, the Central Banks of Asia have amassed a staggering $4 Trillion in foreign exchange reserves.  In the past, this has been a neutral, sometimes profitable activity.  Since the Fed began cutting rates, the interest rate differential has been turned upside-down such that Central Banks are now losing money on each unit of local currency they sell in exchange for Dollars.  According to one analyst, over $160 Billion has been lost since July 2006, and those losses will mount with each additional intervention.

Read More: Fed's Lower Rates Pressure China to Strengthen Yuan

Iran has Forex Reserves?

Every month seems to witness the induction of a new country into the pantheon of those with burgeoning forex reserves.  The new member for the month of February is...Iran?  Most of the attention Iran receives is political rather than economic, but with oil prices recently topping $100 a barrel for the second time, you can bet that Iran will start appearing on the radar screens of more and more analysts.  Iran's reserves currently total $76 Billion, which is unimpressive in itself, but represents a 30% year-over-year increase.  Of more significance, perhaps, is that Iran is leading the charge against the Dollar by actively diversifying its reserves into Euros. It remains to be seen whether any "non-rogue" countries will follow suit.  The Economic Times reports:

Iran, the world's fourth largest oil exporter and the second ranking in OPEC, has benefited from record crude prices which have helped it to weather domestic economic problems.

Read More: Iran's forex reserves top $76 bn

Bernanke Hints Rate Cuts

In testifying before the Senate Budget Committee, Ben Bernanke, Chairman of America's Federal Reserve Bank, hinted strongly that further rate cuts would be necessary to stabilize the US economy.  Last week, the Forex Blog covered an editorial which suggested that Bernanke knew something about the state of the economy that the American public did not, which his testimony seemed to confirm.  Bernanke testified that the Fed is also committed to fighting inflation, but the emphasis was clearly on spurring economic growth. As a result, futures markets are pricing in a rate cut of 50 basis points, projected for the next month.  The forex markets were unambiguous about the implications of this development for the Dollar.  Thomson Financial reports:

'By highlighting the downside risks to growth, Bernanke confirmed prevailing aggressive rate cut speculation, which currently keeps the dollar under broad pressure,' said Antje Praefcke, currency strategist at Commerzbank.

Read More: Dollar remains under pressure following Bernanke's testimony

Israel Considers Intervention

The Israeli Shekel has surged over 15% against the Dollar in the last six months, and by over 20% in the last two years. Analysts have suggested that the appreciation is due to the strength of Israeli's economy vis-a-vis the US economy, which seems headed for recession.  In addition, Israeli citizens have repatriated billions of dollars in capital that had been held overseas and invested it in Israel's financial markets, which in itself, has exerted much of the pressure on the Shekel.  There is now a surplus in the balance of payments, which means more capital is coming in to Israel than is being taken out.  As a result, Israeli exporters are getting nervous about the perceived consequences of a relatively expensive currency and are pressuring Israeli political leaders to take action.  The Central Bank, understandably, is reluctant to do so. Haaretz.org reports:

"Intervening in [the currency] market is risky and inefficient," [said] Bank of Israel Governor Stanley Fischer...earlier this week.

Read More: Dollar falls as Fischer says won't intervene in currency market

ECB Holds Interest Rates

At its meeting last week, the European Central Bank (ECB) held its Euro-zone benchmark lending rate at 4.00%.  While the decision itself came as no surprise, analysts were nonetheless waiting with baited breath to hear what remarks would accompany it.  Jean Claude Trichet, the Bank's President, eased up on hawkish comments he made the previous month, when he signaled that his primary concern was inflation rather than the risk of economic recession. This month, however, he changed his rhetoric markedly, indicating that the ECB was less willing to preempt rising price levels and would instead shift its focus to the possibility of a 'sharp slowing' of EU growth. Forbes reports:

Our view [is] that rate hikes are definitely off the agenda at this stage and by bringing a greater degree of uncertainty on the growth assessment, the ECB may be getting ready for a shift towards a more dovish policy language.

Read More: Euro sags after Trichet tones down hawkish stance

China is Earning Negative Carry

China's foreign exchange reserves currently approximate $1.5 Trillion, the majority of which is denominated in USD.  Moreover, the Central Bank of China earns interest on every Dollar it adds to its reserves but must also pay interest on every RMB note that it must issue to offset the Dollars. Since the Fed began easing monetary policy, the amount of carry (the difference between what the Central Bank receives on Dollars and pays on RMB) earned by the Central Bank has completely inverted, such that it now loses 250 basis points on average for each Dollar exchanged for RMB. 

Based on the rate at which China is currently accumulating reserves, this amounts to between $5 Billion and $10 Billion per month, depending on which method of accounting is utilized. Furthermore, this trend has been exacerbated because China is accumulating reserves at a faster rate than its economy is growing. Some analysts have speculated that this could turn into a major political issue, with important implications for the RMB/Dollar exchange rate. The Financial Times reports:

The renminbi has started to appreciate more rapidly in recent months, rising at an annualised rate of about 20 per cent, compared with 6-7 per cent over the whole of 2007.  In the longer-term, say economists, China will have no choice but to allow its currency to appreciate faster, even in the face of entrenched domestic resistance.

Read More: Beijing starts to pay for forex ‘sterilisation'

Why the Fed Cut Rates

It seems self-evident that the Fed is easing monetary policy because it is trying to stimulate the economy and shore up confidence in capital markets by making credit less expensive.  Dig a little deeper, however, and a more nuanced picture begins to emerge.  Conspiracy theorists believe that the Fed knows something that investors don't, perhaps that the subprime mortgage situation is more serious than the public is being led to believe. Accordingly, the theory goes, it is trying to prevent a complete collapse of the financial system.  Another theory holds that the Fed is cutting rates because it has nothing to lose by doing so. Inflation is still low, from a historical standpoint, and the Fed may be trying to inject liquidity into the financial markets before it is too late.  Yet another theory holds that the Fed is deliberately targeting a weak Dollar and high commodity prices, as the former benefits the US directly by narrowing the trade imbalance, and the latter benefits the US indirectly by helping emerging market economies, which are relatively more dependent on commodities.  The Chicago Tribune reports:

An increase in exports was one of the positive features of Wednesday's disappointing fourth-quarter report on U.S. gross domestic product. The cheaper dollar is a major factor in export growth, both in terms of current sales and expansion of overseas market share by U.S. manufacturers.

Read More: Fed rate cut conspiracy or power play?

India Projects Forex Reserve Growth

Those who make a living tracking and betting on the foreign exchange reserves of Central Banks officially have a new player to keep tabs on: India.  Nearly 17 years ago, India's reserves dipped below $1 Billion, and government ministers began sounding the alarm bells. In comparison, fiscal 2007 witnessed a rise of $47 Billion in India's reserves, bringing the total to $280 Billion.  The government is projecting an even greater increase in 2008, estimated at $100 Billion.  Now, the challenge is what to do with all of the reserves; investors will be tracking developments in this regard because of the implications for the currencies of which the reserves are denominated in.  The Dollar and Euro are currently jockeying for position; while the Dollar is way ahead, the Euro is quickly closing in.

Read More: India expects to add $100 bn to forex reserve in FY'08

Fed Lowers Rates...Again

Today, the Federal Reserve Bank lowered interest rates for the second time in as many weeks, bringing its benchmark federal funds rate down to 3.00%.  The Fed has now lowered rates by 2.25% since August. The move came as a relief to investors, who now see that the Fed is serious about preventing the economy from slipping into a full-scale recession. However, it remains to be seen whether the rate cuts will provide the necessary boost to the economy or instead prove too little too late. As far as the Dollar is concerned, the rate cuts carry two (conflicting) implications.  On the one hand, the economy and stock market could rally, which would likely be matched by a Dollar rally.  On the other hand, the interest rate differential between the US and EU is now a 1% and risk-averse investors hungry for yield will be hard-pressed to justify shifting capital to the US. The New York Times reports:

Many economists are far from convinced that even a combination of tax rebates and cheaper money would prevent a recession. And in a sign that bond investors are fretting that the moves could lead to higher inflation, yields on 10-year and 30-year Treasury securities edged up slightly on Wednesday.

Read More: Fed Cuts Key Rate as Stimulus Plan Advances

ECB to Avoid Rate Cuts

When America's dot-com bubble collapsed in 2001, the Federal Reserve Bank moved quickly to quell the panic by slashing interest rates.  The European Central Bank (ECB), on the other hand, was adamant that it would not have to follow suit since the European and American economies were no longer so intertwined.  Several months later, it became increasingly clear that the ECB was wrong, and it was ultimately forced to lower rates.  Now, some analysts fear that history is repeating itself, as America's housing crisis threatens to run a similar course as the collapse of the stock market bubble. The Fed has lowered interest rates twice in the last few months, while the ECB has yet to act, insisting that its primary concern is inflation. For now, the interest rate differential is supporting the Euro, but if the ECB falls behind the curve, a stagnating EU economy could bring down the common currency.  The New York Times reports:

But when it comes to the economy, Europe remains optimistic it can decouple itself and withstand collateral damage from a possible recession in the United States.

Read More: Why the European Bank Is Sitting Back

BOC Cuts Rates

Last week, the Bank of Canada cut interest rates by 25 basis points, bringing its benchmark lending rate down to 4%.  Fortunately for the Canadian Dollar, the rate cut paled in comparison to the 75 basis point move effected by America's Federal Reserve Bank. While the Bank of Canada offered a hackneyed rationale of "keeping aggregate supply and demand in balance"  for the change in monetary policy, there is still some surrounding haze since Canadian inflation is rising and economic growth is strong. The currency had slipped below parity against its American counterpart, but is now slowly crawling its way back. If commodity prices remain high, the currency will likely push back across that psychologically important barrier of 1:1 with the USD.

Read More: Canadian dollar firms as BoC cuts rates

Fed Dramatically Lowers Interest Rates

Last week, the New York Times published an article with the byline "Is the Federal Reserve’s chairman, Ben Bernanke too nice for the job?" Apparently, talk had been building on Wall Street that Bernanke was not tough enough to deal with the growing problems faced by the world's largest economy.  Bernanke responded publicly in a speech in which he promised that the Fed would act quickly and decisively to confront such problems.  Then on Tuesday, the critics were silenced peremptorily by a Fed rate cut of 75 basis points, the largest single cut in two decades. Moreover, Bernanke intimated that additional rate cuts could come as soon as next week. 

It's unclear how this activity will affect the Dollar.  On the one hand, it implies beyond a reasonable doubt that the US economy is indeed headed for recession.  Bond yields are declining and the stock market has lost 15% of its value since October.  On the other hand, the Fed has demonstrated that it is willing and able to take the necessary steps to avoid a hard landing at any cost. At the same time, investors around the world fear that a US recession will have an adverse impact on the global economy.  And where do investors park their money during periods of global economic uncertainty? Answer: USA. Sure enough, the Dollar has already begun to rally after taking a big hit immediately following the rate cuts.

Read More: Fed Rate Cut Halts Market Free Fall

Chinese Yuan Accelerates Upwards

When Henry Paulson was appointed Secretary of the US Treasury last year, he made China and its purportedly undervalued currency a cornerstone of his economic plan. Lo and behold, several months ago, the Yuan suddenly accelerated in its upward path against the Dollar, rising at an annualized rate of 14%. Currency futures are now pricing in an 8% rise in 2008, while several economists are forecasting a 10% increase.  Ironically, there are still American policymakers who think the Yuan is appreciating too slowly, as well as Chinese policymakers who reckon it is increasing too rapidly.  Accordingly, the current pace probably represents a fair compromise.  Besides, inflation is threatening the US, so a slow appreciation would enable the economy to adjust to higher prices in the long term.  While China also faces rising inflation, it doesn't want to send investors the message that the movement of its currency is uni-dimensional, which would encourage further inflows of speculative capital.  The Economist reports:

But Chinese policymakers have stressed the need for gradual adjustment. To show that the currency is not just a one-way bet, the PBOC may try to nudge the yuan a bit lower in coming days.

Read More: Revaluation by stealth

Economist: Fed Should Prop Up Dollar

In a recent editorial published in the Wall Street Journal, the Chief Economist for Bear Stearns (an American investment bank) advocated intervention by America's Federal Reserve Bank on behalf of the Dollar.  He reasons that the best way both to fight and inflation and alleviate the possibility of recession is to strengthen the USD.  Current measures, which include lowering the discount rate and manipulating the money supply, are actually worsening inflation.  As a result, institutional investors are moving their capital en masse outside the US in order to prevent the declining dollar from corroding their investment returns. While paying lip service to the prevailing wisdom that Central Banks are essentially impotent when it comes to managing currencies, he insists that strong rhetoric by the Fed could conceivably convince investors that it stood behind the "Strong Dollar Policy" it promotes.  The Wall Street Journal reports:

By saying they want a stronger dollar, the Fed...could make it happen. Government policy makers have almost absolute control over perceptions of the future scarcity of dollars. This controls the demand for dollars almost as much as it does the supply, setting its value as much or more than rates do.

Read More: Markets and the Dollar

China's Forex Reserves Roar Past $1.5 Trillion

On January 24 last year, the Forex Blog reported with great fanfare that China's forex reserves had breached the epic milestone of $1 Trillion. [In hindsight, it turns out that the psychologically important barrier was broken several months earlier, but that is beside the point].  Less than one year later, China's forex reserves reached another important threshold, soaring past $1.5 Trillion. It appears that new reserves are being accumulated at  an exponential rate, having increased $460 Billion last year and over $30 Billion in the month  of December alone. By no coincidence, China's 2007 trade surplus of $262 Billion shattered the previous record and is expanding at a comparably supersonic pace.

Most analysts reckon that the country is locked in a vicious cycle: when its trade surplus grows, its forex reserves grow proportionately. Moreover, the lopsided trade imbalance th\at China maintains with most of the world ensures that the demand for Chinese Yuan exceeds the supply. In the short run, a more expensive currency equates to higher prices paid for its exports which only increases the trade surplus and forex reserves further, and exerts still more pressure on the currency to appreciate.  Meanwhile, as the Yuan rises, the value of China's forex reserves, which are denominated predominantly in USD, falls.  What a conundrum indeed! Xinhua News reports:

The value of Chinese RMB against the US dollars has appreciated by over six percent in 2007. The central parity rate of the RMB was 7.2672 to the US dollar on Friday.

Read More: Forex reserve tops $1.53 trillion

Central Banks in the News

As we wrote last week, the direction of the Dollar may be influenced more by external economic events rather than by internal activity.  Accordingly, it would behoove forex traders to direct their attention away from the Fed and towards the Bank of England and the European Central Bank, both of which face important monetary policy decisions later in the month. With regard to the Bank of England, futures markets have priced in a 2/3 chance that rates will be cut by 25 basis points. In the case of the ECB, the markets are expecting rates to be maintained at current levels. However, analysts will be scrutinizing the Banks' respective press releases and monitoring other developments in this area due to the implications for the US-EU-Britain interest rate differential.  Reuters reports:

Some analysts think that hawkish comments from Trichet will be brushed aside with weaker economic data leading to the prospect of falling euro zone rates later in the year.

Read More: Pound down, others flat before ECB, BoE decisions

Fed Will Cut Rates in January

Last week, the Institute for Supply Management released the results of its monthly manufacturing survey, which fell to a four-year low.  Taken with testimony from bond expert Bill Gross, the picture is now quite bleak. In fact, economists are projecting that the US economy will slip into recession as soon as the first quarter of 2008; Gross believes that the economy is already in recession.  As a result, futures markets have already priced in a 75% chance of a 25 basis point rate cut and a 25% chance of a 50 basis point move by the Fed at its next meeting, scheduled for the end of January.  As expected, the Dollar is taking a beating in forex markets, as traders price in the effect of the rate cuts, which would create interest rate parity with the EU.  DailyFX reports:

The minutes from the last FOMC meeting confirmed that growth is the Fed’s primary concern at the moment. The deterioration in incoming economic data has forced them to lower their growth estimates for 2007 and 2008.

Read More: US Dollar Falls as Traders Consider 50bp Rate Cut for January

Venezuela's Currency Loses a Few Zeros

In Venezuela, the inflation rate for 2007 is estimated at 20%, a slight increase over the 17% growth in prices that was observed in 2006.  The nation, led by Hugo Chavez, plans to deal with inflation by dropping a few zeros from the currency's exchange rate.  Currently, the official exchange rate is 2,150 Venezuelan Bolivars for every US Dollar.  Under the revaluation, the new official exchange rate will become 2.15 Bolivars/USD.  Critics charge that the change will not have any impact on inflation, especially since the market exchange rate implies a Bolivar that is three times less valuable than government rates.  Chavez retorts that the revaluation is only one part of a broader, more sophisticated strategy.  Down Jones reports:

The Central bank president had earlier in the year said the effect on inflation would be neutral, and most economists agree, but [Finance Minister] Mr Cabezas said "it's definitely going to have a positive effect" on the government's fight against price increases.

Read More: Chavez drops zeros to fight inflation

India's Forex Reserves Near $300 Billion

India is quickly becoming a major force on the foreign exchange reserve scene.  While India doesn't fix its currency to the USD like China does, it still removes most foreign currency from circulation in order to mitigate against inflation.  As a result, its reserves have ballooned to nearly $300 Billion, having increased by $100 Billion this year alone.  India will now be faced with the same decisions that many other forex reserve hogs have been forced to reckon with, namely how to allocate its reserves. While India hasn't weighed in prominently on the issue as China has, analysts will be watching closely.  The Economic Times reports:

Rate cut by the Fed in the US along with the positive perception prevailing about the emerging economies such as India has led to sharp rise in inflows, it said.

Read More: Forex Reserves to touch $300 bn by March 2008

Dollar Declines in Forex Reserves

What analysts have been warning of for years has finally come to pass: the USD officially occupies a smaller portion of global foreign exchange reserves.  According to a recent IMF reports, the fraction of reserves denominated in Dollars has fallen from 66.5% to 63.8% over  the last year, with much of the difference offset by a proportional rise in the preponderance of the Euro.  Analysts first began sounding alarm bells as early as 2003, when the Dollar fell nearly 15% against the Euro.  However, it wasn't until 2006, when China began to accumulate reserves at an ever-increasing rate as its trade surplus exploded while at the same time the USD was tanking, that commentators began paying attention. 2007 brought several anecdotal reports that foreign Central Banks were both passively and actively diversifying their reserves.  Now, it looks as though these were not isolated incidents, but instead part of a broader trend. AFP reports:

In recent months, several emerging-market countries, whose foreign currency reserves have ballooned as a result of such factors as high commodity prices and strong exports, have signaled their intention to further diversify their foreign exchange reserves to offset the US currency's depreciation.

Read More: IMF says dollar losing ground in global forex reserves

Interest Rate Story Hurts Pound

The British Pound has been reeling since the Bank of England cut rates at the beginning of this month, from 5.75% to 5.50%.  Last week, the minutes for the meeting were released.  They revealed that that members of the Bank were growing increasingly nervous about the state of the British economy and are worrying particularly about how fallout from the credit crunch will impact growth.  British interest rates are still among the highest in the industrialized world, behind only Australia and New Zealand.  Thus, it seems investors are punishing the Pound indirectly for the rate cuts, because of fears concerning the near-term prognosis for the British economy.  At the same time, the minutes indicated that members of the Bank were adamant about not lowering rates further, so some of the concerns may be overblown.

Read More:  Pound weakens after BoE minutes show concerns for growth

Fed to Cut Rates Next Month?

In recent speeches, two high-ranking officials from America’s Federal Reserve Bank gave conflicting indications regarding the likelihood of rate cuts next month. Both officials were deliberately ambiguous in their speeches, though one went so far as to rule out a rate cut while the other hinted at its inevitability. Nonetheless, analysts used the speeches to buttress their conclusion that a rate cut is probable. In fact, the futures market has priced in a 94% chance that rates will be cut by 25 basis points at the next meeting, on December 11. Likewise, it seems a rate cut has already been priced into the USD, which was virtually unaffected by this story. MSNBC reports:

On the currency markets, the heightened expectations of a US rate cut cut did little to hurt the dollar, as investors took the view that the currency's recent weakness had gone far enough.

Read More: Fed stance sends equities soaring

Indian Rupee is Stabilized

India’s forex reserves are growing at nearly $20 Billion every month and are quickly approaching $300 Billion.  Of course, accompanying this windfall are the inevitable questions about what to do with the money.  The Royal Bank of India (RBI) had determined that at most, the Indian economy can absorb $50 Billion a year.  Accordingly, the bulk of the capital inflows are “sterilized” through the issuance of forex stabilization bonds, which are aimed both at controlling inflation and limiting the appreciation of the Indian Rupee.  Unfortunately, due to already-high inflation in India, the RBI must pay a higher rate of interest on the stabilization bonds than it is earning on the underlying assets, which means the scheme is a losing proposition.  The Economic Times reports:

The RBI is also hesitating to allow further appreciation in exchange rate. While it can allow appreciation of the exchange rate to avoid injecting liquidity (by way of buying dollars and selling rupees), it is concerned about the fact that it is already over-valued.

Read More: The 250-bn dollar question of capital inflows

Brazil Continues to Intervene

For nearly two months, the Central Bank of Brazil was content to sit on the sidelines and watch its currency, the Real, appreciate rapidly against the Dollar.  Beginning on October 8, however, the Central Bank has intervened in forex markets every day as part of a targeted effort to depress the Real.  Its efforts have been relatively straightforward; rather than issue currency stabilization bonds, the Central Bank has opted to purchase massive quantities of Dollar-denominated assets in the open market, bringing its foreign exchange reserves to $168 Billion.  Moreover, its efforts have been largely successful, as the Real has fallen slightly against the Dollar during this period of intervention.  However, logic (and past experience) dictate that as soon as it stops intervening, the Real will resume its  previous (upward) course against the Dollar. Bloomberg News reports:

Foreign flows into Brazilian financial markets and booming commodity exports have made the real the best performer against the dollar this year among the 16 most-actively traded currencies tracked by Bloomberg, gaining 20 percent.

Read More: Brazilian Currency Falls After Central Bank Buys U.S. Dollars

Fed to Hold Rates?

In a recent speech, a prominent Federal Reserve Board governor strongly hinted that the Fed would maintain US interest rates at current levels at the Fed's next meeting.  The Fed is caught in the delicate position of trying to balance economic growth with the specter of inflation.  While technically the Fed is always trying to meditate between these two outcomes, its current position is especially tenuous since the US economy is trending downward while inflation trends upward.  Despite the emphatic claims to the contrary, futures markets are still pricing in a rate cut, setting the stage for a showdown with the Fed.  As usual, the Dollar's fate hangs in the balance.  The Financial Times reports:

Mr Kroszner said that in the near term "the economy will probably go through a rough patch" with falls in house prices, home construction and subdued consumer spending. He did not rule out a future cut in rates.

Read More: Fed and markets set to clash

Central Banks Prop up Dollar

Yesterday, we posted about the Central Bank of Australia, which intervened on behalf of its currency over the summer. In fact, several Central Banks have either intervened or are in the process of intervening, all with the goal of holding their currencies down (against the US Dollar) rather than lifting them up, as Australia had effected to do.  Columbia has already imposed strict rules governing the inflow of foreign capital, intended to discourage speculation, which is driving up the South American nation's currency.  Indian regulators have since followed suit with similar rules.  South Korea's Central Bank, meanwhile, is using slightly different tactics, undertaking a review of forex forward contracts, which it believes (probably erroneously) are interfering with its ability to hold down the Korean Won.  Bloomberg reports:

"Central banks are trying noninterest rate methods to stabilize growth and capital flows.  It's something extraordinary. They haven't used these venues for a long time. It's sort of the last resort the central banks would like to tap."

Read More: Currency Controls Return as Central Banks Fight Gains

Australia Intervened in Forex Markets

According to recently-released documents, the Central Bank of Australia intervened on behalf of its currency in August, marking the first such intervention in over six years.  Surprisingly, its purpose in intervening was to lift up its currency, rather than hold it down, which is the reason most central banks intervene.  Apparently, the global credit crunch that flared up over the summer, generated tremendous volatility in forex markets.  As a result, many carry traders- for whom volatility is anathema- quickly unwound long positions in the high-yielding currencies Australia and New Zealand, causing them to plummet.  However, both currencies have since resumed their appreciation, which means any future intervention will likely be aimed at holding the Australian Dollar down. Bloomberg News reports:

The Australian dollar underwent "a particularly sharp depreciation in mid-August as the increase in global risk aversion arising from the credit-market crunch triggered an unwinding of carry trades."

Read More: Australian Central Bank Bought Currency to Ease Market Turmoil

ECB Still Mulling Rate Hike

At its last meeting, the European Central Bank (ECB) voted to maintain rates at current levels.  Nonetheless, inflation risks persist, and the ECB has not ruled out the possibility of hiking rates at its next meeting. At the same time, the Euro-zone economy is stalling, and the Bank has the onerous task of balancing these risks in trying to facilitate a "Goldilocks" economy. As a result, the ECB is in "information-gathering mode." Additionally, most of this information is publicly available economic data, and forex traders would be wise to do their own research, since the Euro-USD exchange rate outlook is tied closely to the monetary policy outlook. The Guardian Unlimited reports:

The ECB has said that slower growth in the 13-nation region would have an impact on its policy-relevant medium-term inflation outlook, and Gonzalez-Paramo said currency movements were one factor affecting growth.

Read More: ECB still in data-gathering mode

Fed Comments Punish Dollar

A recent speech by Ben Bernanke, chairman of the US Federal Reserve Bank, sent the Dollar spiraling downward to fresh lows against all of the world's major currencies.  This is perhaps surprising, given that Bernanke used the speech to warn that higher-than-expected inflation may drive the Fed to hike rates, which is exactly what Dollar bulls wanted to hear.  The downside of the speech, reflected in the markets' reaction, was that the primary cause of the inflation is rising oil prices, would could plunge the US economy into stagflation: slow growth and high inflation, an unenviable position if there ever was one.  Forbes reports:

Rhonda Staskow at Thomson's IFR Markets said: 'There is no Goldilocks scenario from Bernanke, who sees risks from inflation and an economic slowdown - the worst of both worlds.'

Read More: Dollar sinks after Bernanke speech

ECB to Hold Rates

The European Central Bank (ECB) will likely maintain its benchmark interest rate at 4.00% at its meeting his week.  The Bank of England is also expected to hold its lending rate in place, at 5.75%.  While these two moves should be seen by Dollar bulls as acts of clemency, they are more akin to a stay of execution than to a commutation of its death sentence.  The reasoning is that it is inevitable that the US-EU interest rate difference will be bridged over the next few months, as the Fed continues to lower rates while the ECB is in the process of hiking them.  The only question is when.  Accordingly, analysts will be paying close attention to the language employed by the heads of the various Central Banks at their next meetings to get a sense of timing.

Read More: Dollar hovers above lows

China talks up Diversification

A high-ranking official in China's government recently gave a speech urging the Central Bank to (continue to) diversify its vast holdings of foreign exchange, currently estimated at $1.4 Trillion and rising.  The speech was atypical in its level of directness, as Chinese officials tend to speak with a certain degree of circumspection if they think there is any possibility that their comments will reach the public. Specifically, he advocated making a play on the current volatility in forex markets, by selling “weak currencies” in favor of “strong currencies.”  In fact, the most recent data shows that China is already doing just that: its holdings of US government bonds have declined even as its reserves have risen.  The Financial Times reports:

Although he later tried to play down his comments, saying he had not been speaking in an official capacity, the damage was done.

Read More: Dollar sinks to new lows

The Other Side of the Debate

Yesterday, I posted about how market volatility could spell the end of the carry trade, bringing down the Australian Dollar in the process. Today, I will explore the opposite side of the debate, by looking at the factor(s) which support a continued appreciation of the AUD.  A rise in global commodity prices have provided a windfall to Australia, which is rich in natural resources. Unfortunately, the boom in exports and the surge in domestic demand has trickled down in the form of inflation.  As a result, the Central Bank of Australia recently embarked on a campaign of tightening monetary policy.  While this may curb domestic demand, it may attract more foreign capital in the form of carry trades. The gap between US and Australian interest rates is now 2.25%, and looks set to widen further. The Australian Business reports:

The [Australian] dollar's trade-weighted value rose by 20 per cent between late 2002 and early 2004 but was much slower to respond in the 1970s boom, when the exchange rate was set by government.

Read More: Action needed as current boom echoes overheating of 1970s

HK Maintains USD Peg

This week, the Central Bank of Hong Kong intervened in forex markets for the first time in nearly two years, by purchasing over $1 Billion in US government securities.  The intervention was precipitated by fluctuation on the HK Dollar, which had been tending towards the upper end of its tightly controlled trading band.  Strength in the HK economy combined with a strong performance in HK capital markets have sucked large amounts of foreign capital into the Chinese-controlled city-state, which exerted upward pressure on its currency.  Hong Kong's Central Bank also matched the recent rate cut by the Fed with a rate cut of their own.  Many analysts had put forth the idea that Hong Kong would scrap its peg when the Chinese Yuan slid past it, but this recent move suggests the Dollar peg is here to stay.  The Financial Times reports:

Joseph Yam, HKMA chief executive, said on Thursday: “We again reaffirm that the [Hong Kong] government has been clear in its financial policy and is committed to maintaining the peg.”

Read More: Hong Kong to stick with US dollar

Loonie Set to Surge Further

The Canadian Dollar, or Loonie, recently cleared a 47-year high against the US Dollar.  Its next major milestone is crossing a level last seen in the late 19^th century! There are a few reasons for the Loonie’s continued strength, namely interest rate parity and economic strength.  As a result of the Fed cutting rates for the second time in as many months, the Canadian benchmark interest rate is now equal to the American federal funds rate, both at 4.5%.  In addition, record-breaking oil and commodity prices will ensure that Canada’s economy will expand further, perhaps as the same pace as its currency.  Reuters reports:

If the U.S. Central bank signals another rate cut in December, or if it goes against expectations and chops rates by 50 basis points, it could pull the rug out from under an already unsteady U.S. dollar and clear the way for the Canadian currency to shoot higher.

Read More: Loonie eyes 130-year high if Fed makes big rate cut

Australia to Hike Rates

Australia’s benchmark interest rate, at 6.50%, is already the highest in the industrialized world, after New Zealand. Ignoring the pleas of the Treasurer, the Central Bank of has all but decided to hike rates even further into the stratosphere at its next meeting.  The country is in a bit of a pickle, since a booming economy and the consequent inflation seems to demand a rate hike.  At the same time, this rate hike will ensure that Australia continues to be on the receiving end of Japanese carry trades, and this is precisely what irks Peter Costello, Australia’s Treasurer. In other words, the world’s massive economic imbalances will only be exacerbated by an Australian rate hike, but this may be a moot point as far as the Central Bank is concerned.  The Sydney Morning Herald reports:

Instability on global financial markets between now and the next Reserve Bank board meeting on Melbourne Cup day is seen by economists as the only force that could stay the bank's hand from raising rates to the highest level in a decade.

Read More: Look out for the tsunami, says Costello

Fed may Cut Rates Again

The Dollar is still reeling from the 50 basis point rate cut imposed by the Fed last month. Nonetheless, some analysts are predicting that the Fed will cut rates again on October 31, this time by a quarter of a percentage point, to 4.5%. The looming fall in real estate prices (termed the sub-prime crisis) has officially spread to the rest of the economy, and the Fed is trying to preempt a complete collapse in investor and consumer confidence.  Experts remain divided as to whether the Fed will cut rates now or next month. Either way, you can expect the Dollar to drop to fresh lows against the Euro.  Thomson Financial reports:

“The combination of weak US data, rising expectations of aggressive Fed easing and a stable, albeit fragile, Wall Street is a perfect recipe for euro-US dollar and Australian dollar-US dollar strength,” said one analyst.

Read More: US dollar hovers near all-time low vs euro on chances of Fed rate cut

Asian Central Banks Plot Intervention

Asian currencies, with the exception of the Chinese Yuan and Japanese Yen, have notched stellar performances this year.  The currencies of Thailand, Malaysia, Singapore, South Korea, to name but a few, have experienced double-digit increases (in percentage terms) against the Dollar. Worried about the impact of a rising currency on export growth, Asian central banks are in the process of intervening in forex markets.  Singapore, which uses currency manipulation as a form of monetary policy, believed to have already made purchases of US government bonds in order to depress the Singapore Dollar. South Korea, as well, has a history of forex intervention, albeit unsuccessful intervention, and may issue currency stabilization bonds before year-end.  The Gulf Daily News reports:

The Bank of Korea has repeatedly stated that it would closely monitor currency markets, expressing concern about the level of the won and money supply growth.

Read More: Asian banks calm currency surge