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

Turkish Lira Set for Decline

2007 was a banner year for the Turkish Lira, which appreciated 21% against the US Dollar. However, in the year-to-date, the currency has returned nearly 10% of this gain, making it the third worst performing currency in the world. Turkey generally, and the Lira specifically, are considered by investors as proxies for emerging markets. The global trend towards risk aversion, as well as skyrocketing inflation, are hurting many such currencies. In Turkey, inflation is so problematic (9.4% at last count) that the Central Bank has raised its benchmark interest rate to 15.25%. Ironically, the more the Lira depreciates, the harder it becomes for the Central Bank to control inflation, causing the Lira to slide further as part of a self-perpetuating free-fall. In addition, the country is beset by political uncertainty, as the courts determine whether the nation's current government can stay in office. Bloomberg News reports:

"The recent political developments are likely to complicate policy-making and the investment climate. The deteriorating political backdrop will in turn undermine the prospects for restoring fiscal discipline and reviving the reform agenda."

Read More: Lira Goes From First to Worst as Politics Whack Bulls

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

Fundamentals Harm Emerging Market Currencies

Since the inception of the credit crunch, one of the themes in forex markets has been the surprising strength of the Dollar. Despite growing economic uncertainty, the US is still viewed as a relatively safe place to invest. On the other hand, emerging markets, especially those with current account deficits, have witnessed capital flight and subsequent currency depreciation.  The currencies of South Africa and Iceland, for example, have both experienced declines 20% since the start of this year.  Risk premiums had fallen to historic lows prior to the credit crunch, and neither country experienced great difficulty financing its respecive deficits.  However, investors are growing increasingly nervous and are shifting capital to countries with stable current account balances. The Financial Times reports:

Goldman Sachs says: "We have long argued that in times of global turmoil suppliers of capital are poised to outperform countries in need of capital.  However, it is only since January 2008 that we have seen the current account theme really gain momentum in the FX market."

Read More: Currencies at mercy of deficits

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

Ruble as Regional Reserve Currency

Two weeks ago, then-First Deputy Prime Minister of Russia, Dmitry Medvedev, commented publicly on a more significant role for the Russian Ruble in the global economy, and especially in the regional economy.  Fast forward to yesterday, when Medvedev was elected the next Prime Minister of Russia, which means his ideas on forex are more likely to become policy.  Medvedev has argued in favor of turning the Ruble into a regional reserve currency.  This would first necessitate liberalizing its forex policy by permitting the Ruble to float freely; it is currently fixed to a basket of Euros and Dollars.  Given the uncertainty surrounding the Dollar and the global economy at large, as well as the recent boom in Russia's economy, Medvedev clearly smells an opportunity. Neighboring (former Soviet bloc) countries could be persuaded to denominate their reserves partially in Rubles as well as to consider using Rubles in energy transactions. Reuters reports:

Russia, which receives most of its energy revenues in dollars, buys euros, pounds sterling, yen and Swiss francs to diversify its $478 billion gold and forex reserves, the world's third-largest.

Read More: Free Float Seen as Key For Reserve Currency

GCC Ponders Revaluation

The three rules of monetary policy- goes the old adage- are inflation, inflation, inflation.  Well, maybe not.  But that is certainly the story in the Middle East; Saudi Arabia's official inflation rate is the highest in 12 years, and Qatar and the UAE have witnessed double-digit percentage increases, in annualized terms. Since their currencies are pegged to the USD, however, their Central Banks are unable to raise rates accordingly, leaving them with a tough decision: allow the currency to appreciate or watch prices spiral out of control.  It is the same story being told in every developing country that pegs their currency to the Dollar, and the members of the Gulf Cooperation Council (GCC) are certainly not exempt. As the ranking member, Saudi Arabia will all but determine if and how the official forex policy changes.  An announcement could come any day. The Gulf Times reports:

Mohammed al-Jasser, Saudi Arabia's deputy central bank governor, had said last month that the Gulf Arab states should maintain their currency pegs to the US dollar regardless of rampant inflation in the region or the impact of US rate cuts.

Read More: Saudi to mull forex policy as more US rate cuts loom

Rupee Will Face Test in 2008

While the Chinese Yuan quickly ascended the ranks of the world's most important currencies, the Indian Rupee has not yet made it.  But that might change in 2008, as the Royal Bank of India ("RBI") will be forced to decide between a more valuable rupee and price stability.  Until now, the RBI has successfully pursued the "impossible trinity of a fixed exchange rate, independent monetary policy, and open capital account" through judicious use forex intervention and the issuance of sterilization bonds. Now, as prices are creeping up, the RBI has found itself constrained in its ability to hike rates because of the resulting pressure on its currency. Furthermore, the rupee has already begun to appreciate, costing jobs in certain export-dependent (and politically sensitive) industries. The Economic Times reports:

Monetary policymakers have been torn between letting the rupee appreciate and intervening in the currency markets to inject more rupee liquidity which could be potentially inflationary in nature.

Read More: Gazing through the crystal ball

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

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

Dollar Benefits from Risk Aversion

As talk and evidence of a US economic recession builds, the Dollar has witnessed a slight upswing.  How to explain these seemingly contradictory trends? The rationale is surprisingly simple.  While a US recession would predictably hit the US harder than other countries, it would still hamper growth abroad, especially in emerging markets that have come to depend on exports to the US to drive growth.  Accordingly, investing in such emerging markets becomes relatively more risky than investing in the US, which is still considered to have the world's most stable investing climate from a long-term perspective.  Thus, as risk aversion rises, so does the Dollar. Thomson Financial reports:

The combination of poor data weighed on stock markets in the US and Asia, while major bourses in Europe have all opened lower today. This meant the dollar gained support as investors shy away from riskier emerging market assets.

Read More: Dollar gains on the back of rising risk aversion

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

Kiwi Rises and Falls with Risk Aversion

Most of the world's major currencies are affected by a variety of technical and fundamental factors, such that only taking into account one factor is tantamount to using P/E multiples as the sole basis for purchasing shares of stock. The New Zealand Dollar, which barely qualifies as a major currency seems to be one of the few exceptions to this common sense rule.  The preponderance of carry traders involved in trading the Yen ensures that the NZD inversely tracks the Japanese Yen.  In addition, the demand for Kiwi is directly proportional to appetite for risk, such that when risk aversion declines, the Kiwi increases, and vice versa.  The reasoning is quite simple: the Kiwi boasts the highest interest rates in the industrialized world. Because the investment climate in New Zealand is less stable than in other industrialized countries, New Zealand often witnesses capital flight during periods of global economic uncertainty.  The New Zealand Herald reports:

Gains in equities markets emboldened investors to take chances, prompting use of the low-yielding yen to buy assets in higher-yielding currencies like the kiwi in carry trades.

Read More: Equities send dollar up

South African Rand Resumes Trend

The South African Rand is not the subject of much analysis in the forex community, which typically confines itself to the majors and the BRIC currencies - Brazil, Russia, India, and China. But recently, the Rand found itself on the radar screen  of at least one analyst, who pondered the implications of a growing trend towards risk aversion. It appears that the Rand has resumed a clearly identifiable downward path against the Dollar, a course which had been temporarily interrupted in the early years of the decade.  Now, inflation is picking up  again and investors globally are becoming more hostile towards risk, two factors which bode ill for the Rand.  On the other hand, South Africa is rich in natural resources; judging from the performance of the Canadian Loonie and the Australian Dollar, commodity economies are still in vogue. The Times reports:

The curve ball for precious metals would be a sustained stronger dollar, unlikely while the US economy is in its current predicament and the Fed is cutting rates.

Read More: A warning to beware of banking on the rand

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

Central Banks Inject Liquidity

After months of delay and perhaps overly wishful thinking regarding the global credit crunch, the world's Central Banks are finally ready to take action. America's Federal Reserve Bank will join forces with the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank as part of a concerted effort to introduce greater liquidity into global capital markets.  Under the plan, the Banks will auction off tens of billions of Dollars worth of bonds denominated in their respective currencies, and lend the proceeds to commercial banks.  The goal of the plan is to to limit growing risk aversion, which has caused banks to significantly rein in lending.  Further, while the move is designed primarily to boost confidence in equity markets, certain sectors of forex may also receive a bump.  High-yielding currencies such as the New Zealand Kiwi and Australian Dollar, which have been shunned in recent months, seem to be the most likely beneficiaries.  Forbes reports:

"If the market is convinced that central banks are finally doing enough to ease the liquidity situation we are likely to see the funding currencies (the yen and the Swiss franc) fall back, and higher-risk currencies like the Aussie and Kiwi currencies, rally."

Read More: Dollar rises as Fed, other central banks move to shore up liquidity

Bahrain Counters Forex Speculation

The Petrodollar phenomenon, analyzed recently by the Forex Blog, is now beginning to play out in real time. Last week, several high-ranking officials from the government and Central Bank of Bahrain, a small Mid East island-nation, publicly criticized the region’s collective policy of pegging their respective currencies to the USD. As a result of this and similar comments by officials from nearby countries, a flood of speculative capital has poured into the country as well as the region at large, betting that a change in the forex regime will take place as soon as next week. Now, countries such as the Bahrain are on the defensive, trying to hold down their currencies until a decision can be made. The Economic Times reports:

“Their speculation will not yield the gains they expect.” Bahrain's central bank threatened to take action against anyone betting on dinar appreciation and accused foreign banks of spreading revaluation rumours.

Read More: UAE warns markets against betting on dirham revaluation

Gulf States to End Dollar Peg

Earlier this week, we reported that the members of OPEC are mulling the possibility of pricing oil contracts in a basket of currencies, rather than solely in Dollars.  In a related move, the members of the Gulf Co-operation Council (GCC) are also rethinking their exchange rate policies. Currently, the members of the GCC, consisting of United Arab Emirates (UAE), Saudi Arabia, Kuwait, Qatar, Oman and Bahrain, all currently peg their respective currencies to the Dollar, in some form or another.  However, this policy is being scrutinized as a result of the falling Dollar, which has dragged down GCC currencies proportionately and triggered double-digit inflation.

In fact, Kuwait has already de-linked its currency from the USD and instead pegged it to a basket of currencies, so as to give it more flexibility in conducting monetary policy.  This represents the most likely course for the rest of the GCC, since it would allow them to maintain exchange rate stability while increasing their flexibility in conducting monetary policy.  This policy change, combined with the potential switch in oil pricing among OPEC nations, bodes ill for the Dollar. At the very least, it would result in decreased demand for USD and for Dollar-denominated assets. At worst, it would result in active diversification, of rotating foreign exchange reserves into assets denominated in other currencies, to support the new peg.

Read More: Countdown to lift-off

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

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

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

Emerging Currencies at Risk

Most of the world's emerging economies link their currencies to either the Dollar, the Euro or a basket of currencies, through an outright peg or a so-called "dirty float."  These countries have attracted waves of foreign money, with the intent of buying cheap exports, foreign direct investment, and capital/forex market speculation.  As a result, while the upside of these pegs has been seemingly boundless economic growth, the downside has been inflation, since many of these countries have been forced to print money in exchange for foreign currency.  Countries in the Middle East, Asia, and Eastern Europe, especially, have effected tremendous increases in their respective money supplies with double-digit inflation rates to match.  Many savvy investors, namely hedge funds, have begun to target countries with fixed exchange rates that are suffering high rates of inflation, with the reasoning that it is inevitable such currencies will soon be forced into appreciation. The Telegraph reports:

Further east, Vietnam is throwing in the towel as inflation hits 9pc. It said it will no longer hold down the dong by massive purchases of US bonds. Singapore, Taiwan, and Korea have begun to change tack, slowing dollar accumulation before inflation gets out of control.

Read More: Hedge funds target currency pegs

Brazil Intervenes on Behalf of Real

Continuing our coverage of BRIC countries (see previous post), the Brazilian Real has climbed 20% in value this year alone, on top of gains recorded in previous years. Fearing that an expensive currency will adversely affect its economy, Brazil's Central Bank announced its plans to intervene in forex markets on behalf of the Real. The Central Bank will buy Dollars at the spot rate, which should bring down the Real slightly.  However, the Central Bank also intervened about two months ago, with limited effect on the Real.  And it doesn't hold that this time around will be any different.  Ultimately, there are economic forces beyond the control of the Central Bank which are propelling the Real upward.  Reuters reports:

"But I don't think the bank is going to be able to prevent the real from strengthening further," said one analyst. "The dollar inflows into the country are too strong."

Read More: Brazil stocks, currency slip as c.bank intervenes

India's Forex Reserves Top $250 Billion

Among the so-called BRIC developing countries (Brazil, Russia, India, China), India is probably the second hottest economy at the moment, after China of course. And following in the footsteps of other developing countries, it is quickly building a massive stock of foreign exchange reserves in order to hold down inflation. Previously, I resisted covering India, because its reserves were small compared to those of China and Japan and hence its potential impact on the Dollar was limited. However, having set another record, India's forex reserves now top $250 Billion, which rank the country among the highest in the world in this regard. In fact, India is accumulating reserves at the blistering rate of $3 Billion/week!  The breakdown of the reserves (in terms of foreign currency) is unclear, but it seems reasonable to believe that it is dominated by Dollar assets.

Read More: India’s forex reserves rise to record $251 billion

Korean Won Benefits from Falling Dollar

It seems the collapse of the USD is quickly spreading; the Korean Won has become the latest currency to cash in on the sagging Dollar.  As with regard to other currencies that have risen against the Dollar, forex analysts are not attributing the Won's rise to strength in the Korean economy, but rather weakness in the US economy.  It is also worth noting that previously, when the Won rose sharply against the Dollar, the Korean government moved quickly to intervene in forex markets in a vane attempt to protect the export-dependent Korean economy. However, as the Won inevitably continued to rise, the government incurred massive losses, essentially for naught.  As a result, analysts expect the Korean government to remain on the sidelines this time around.  The Korea Times reports: 

"Other than verbal intervention, it will be difficult for the government to actually meddle in the market to help stop the won's appreciation."

Read More: Dollar's Demise Means Mightier Won

Brazilian Real rises on rate differential

The Brazilian Real is one of a string of currencies which is rising against the USD on the heels of speculation that the Federal Reserve Bank will cut US interest rates at its next meeting. If the meeting conforms with market expectations, the Fed will cut the benchmark federal funds rate by 50 basis points, to 4.75%. Such a move would further widen the gap between American and Brazilian interest rates, which are currently among the highest in the world.  The Brazilian Real has already climbed 10.5% against the USD during 2007, a run which should continue if the Brazilian economy further outperforms the US. Bloomberg News reports:

“Markets pressing the Fed for a rate cut will remain the story in global currency markets for a few more days,” said a local trader of Brazil's foreign debt. “A rate cut would allow investors in Brazil to focus on the fundamentals, which point toward a stronger currency.”

Read More: Brazil's Real Advances on Bets U.S. Will Cut Rates Next Week  

Thailand moves to Curb Baht

Nearly one year ago, Thailand’s military overthrew the government in a bloodless coup, and commentators immediately began painting doomsday scenarios around the country’s economy. Since then, the Thai economy has surged, and the Baht has appreciated by over 20% and isn’t showing any signs of slowing. In response to concerns that the rising currency would begin to hinder exports and economic growth, Thailand has introduced a spate of measures designed to hold the currency in check. Namely, Thai businesses and citizens will be afforded more flexibility in transferring money outside of the country and keeping Thai currency in offshore accounts. MarketWatch reports:

“In the absence of a clear softening in the currency's upward momentum, we expect Thai authorities to continue to apply a variety of measures -- including further reductions in interest rates…”

Read More: Thailand relaxes currency rules to curb baht

Indian Rupee Surges Unexpectedly

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

Read More: Rising rupee: The causes and consequences

Gulf Reserves Swell to $1.6 Trillion

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

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

Read More: Gulf states' foreign reserves swell

Asian Nations Form Forex Bloc

The leaders of 13 Asian nations recently agreed to pool part of their combined $2.7 Trillion in forex reserves to create a safety net of sorts, which would protect any and all of the member countries in the event of a currency crisis. The move stems from the 1997 Southeast Asian economic crisis, in which several Asian economies summarily devalued their currencies and were forced to enter into burdensome agreements with the International Monetary Fund.  The bloc also announced that it would continue preliminary discussions over the possibility of a common Asian currency.  However, this is probably still at least a decade from coming to fruition.  Xinhua reports:

“A relatively modest proposal for a currency index comprising a weighted basket of regional currencies has been bogged down in wrangling.”  Officials from the ADB now agree the proposal of a single currency is "many decades from being viable."

Read More:

China

joins Asian bloc to create a forex safety net

Brazil Aims to Curb Appreciation in Real

According to Bloomberg markets, Brazil’s currency, the Real, is the best performer this year among 16 major currencies that Bloomberg tracks.  It should come as a wonder to no one, since the country boasts a surging economy and one of the developing world’s highest benchmark interest rates, at 12.5%.  Brazil’s case is further helped by an air of stability, a perception which has brought billions of dollars of foreign capital into Brazil and is contributing to the country’s $50 Billion-a-year trade surplus.  Last week, Brazil’s Central Bank, took its boldest step yet in stemming the rise of Real, by engaging in a large series of reverse currency swaps, in which the Bank essentially bought USD in the futures market.  Analysts interpreted the move as a sign that Brazil is about cut interest rates.  Bloomberg News reports:

“Now, if this is not a sign that they are holding the real and will have to cut 50 basis points at the next monetary policy meeting, I don't know what is,” said one economist.

Read More: Brazil's Real Falls on Reverse Currency Swap Contracts Sale

Thai Baht surges upward

The Thai Baht has been on a tear recently, up 10% since the start of this year and up close to 20% since last summer. Up until a few weeks ago, the currency had largely been flying under the radar of forex traders. Since then, however, the Baht has appreciated at a breakneck pace, surging to a 9-year high against the USD. JP Morgan, an investment bank, has raised its rating on Thailand, calling it one of the most promising emerging markets on its radar screen. Many analysts feared the worst several months ago, when a military junta seized power in Thailand, an event which was quickly followed by draconian capital controls and political stability. Thailand’s economy seems to have largely shrugged off these concerns, propelling the Baht upward. Nation Multimedia reports:

JP Morgan compared Thailand to Korea in 2004. In October 2004, the Korean won started a sharp appreciation. [That year] Korea outperform emerging markets by 20 per cent in 2005, and Asia Pacific excluding Japan by 30 per cent.

Read More: JP Morgan upgrades Thai market

Singapore will appreciate currency

In continuing with this week’s unofficial theme of Asia on the forex blog, I have chosen to cast a spotlight on Singapore’s currency, the Dollar, which typically receives scant coverage. Singapore pegs its Dollar to a basket of currencies, allowing it to fluctuate tightly within a carefully managed range. In fact, Singapore has been known to adjust the relative value of its currency-rather than interest rate levels- as a means of conducting monetary policy. Towards this end, it recently announced that it would induce its currency to appreciate, in order to combat domestic inflation. Bloomberg News reports:

Singapore's policy contrasts with Thailand and South Korea, who are seeking to stem currency gains to protect exporters. Stronger currencies may cut demand for goods sent overseas as they increase costs to buyers based abroad.

Read More: Singapore will manage currency, bank says

Indonesia’s forex reserves near $50 Billion

China and Japan are no longer alone in their unofficial quest to pile up foreign exchange reserves. Indonesia just announced that its reserves have surpassed the $45 Billion mark, and to the surprise of no one, these reserves are largely held in USD-denominated assets. The announcement is significant for a few reasons. First, it means that Asian nations not lumped in with the Asian Tiger economies – Taiwan, Hong Kong, South Korea, and Singapore – have begun to reap some of the fringe benefits of economic growth, notably surging forex reserves. Second, it is symbolic of the fact that the USD remains the world’s de facto reserve currency. At the same time, it should make USD bulls quiver, because such countries could conceivably pile out of the USD just as quickly as they have piled in.

Read More: Indonesia says forex reserves hit 45 bln USD

Indonesia fill not intervene in FX markets

Several weeks ago, the Central Bank of Thailand suddenly implemented capital controls designed to curb the inflow of foreign money that was causing the Thai Baht to appreciate. Speculation immediately began to mount that other Asian countries would follow suit, since many of the region’s other currencies also experienced significant appreciation in the latter half of 2006. Indonesia has become the first country to step forward and allay investor concerns by announcing that it intends neither to impose similar capital controls nor to intervene on behalf of its currency, the rupiah. Apparently, the country’s economic policy team believes that continued foreign investment will be critical to maintaining high GDP growth. The Wall Street Journal reports:

The rupiah has appreciated about 7% against the dollar this year, less than half the increase in the value of the baht. And Indonesia's propensity to suffer from bouts of inflationary pressure will act as a natural brake on rapid currency appreciation.

Read More: Indonesia Won't Intervene on Rupiah

Bank of Korea pledges not to touch Won

As the year 2006 winds down, traders and investors are evaluating the performance of their portfolios, especially in the context of competing investments. One currency which stands out in forex markets is the South Korean Won, which has slowly and steadily inched its way upwards against nearly all of the world’s major currencies. In fact, the Won recently eclipsed a 9-year high against the Japanese Yen and has appreciated over 7% against the USD in the year-to-date. While the Korean Won has performed well over the last five years, this year the currency has attracted far less attention than in years past because Korea’s Central Bank abstained both from commenting on the currency’s rise and from threatening to intervene in forex markets to stem its appreciation. Perhaps, it realized such intervention is futile, since Korea’s economy is expected to grow 5% this year, perhaps positioning the currency for another strong performance in 2007.

Read More: Seoul faces dilemma over won's climb

Gulf Reserves Near $500 Billion

Most of the reporting on foreign exchange reserves addresses the swelling stocks of Asian countries, namely China, Japan, and South Korea. But, as I have been reporting for several months now, the oil-rich countries of the Middle East are beginning to amass equally impressive stockpiles of reserves. In fact, it is estimated that by 2007, the Gulf Coast Countries will own a combined $500 Billion, with Saudia Arabia leading the pack with nearly $225 Billion. The irony, is that, while protectionists gripe about how soaring commodity prices are inflating the trade deficit, the oil exporters are simultaneously financing our deficit.

"These increases reflect a sharp improvement in current account positions in some countries, and higher foreign investments and other capital inflows in other countries," IMF said.

Read More: UAE's forex reserves to reach $29b

Interest Rates drive Kiwi

The New Zealand Dollar (Kiwi) is still rallying against the world’s major currencies, due primarily to the country’s interest rate climate. Yesterday, I reported that that the carry trade is driving the Yen downwards, as investors short the Japanese currency in favor of higher yielding alternatives. On the other side of the carry trade stands the Kiwi, which is being driven higher by investors in search of yield. In addition, since New Zealand inflation is currently tracking near the top end of the Central Bank’s comfort zone, another rate hike may be in the cards, which would push New Zealand’s base rate to 7.5%. Bloomberg News reports:

There is a 44 percent likelihood of a quarter-point rise in New Zealand's official cash rate on Dec. 7, when the central bank next reviews borrowing costs, according to an indicator calculated by Credit Suisse, based on trading in overnight interest-rate swaps.

Read More: New Zealand Dollar Rises to Seven-Month High on Rates Outlook

Korean Won remains ‘stable’ in wake of nuke test

Last week, North Korea shook the world by admitting that it had defied international warnings and tested a nuclear weapon. As political strategists created diplomatic schemes and contingency scenarios, currency traders assessed the potential implications to forex markets. Many traders expected investors would begin to shift capital out of South Korea for fear that the North Korean political crisis would harm the economy of its neighbor to the south. However, no such capital flight materialized, and the Korean won was largely spared from depreciation. The JooAng Dail reports:

“There were some concerns…in the currency market in particular, but market sentiment stabilized faster than expected thanks to a large foreign exchange reserve and ability to manage risks,” the central bank said yesterday.

Read More: Central bank: financial, currency markets ‘stable'

Commentary: Emerging markets drive forex reserves

Last week, The Economist published a survey of the world economy, confirming what many economists have been arguing for years- that emerging markets will provide most of the world’s economic growth going forward. Led by the BRIC nations (Brazil, Russia, India, and China), emerging markets are projected to grow by 6.8% this year. These nations already consume half of the world’s energy, produce half of all exports, and contain 2/3 of the world’s population. Now, you might be wondering: what are the implications of this phenomenon for forex markets.

A few weeks ago, I argued that emerging market currencies are currently undervalued and represent attractive alternatives to the world’s major currencies. This week, I would like to explore a different effect of the rise of emerging markets: surging forex reserves. The world’s developing countries currently hold $2.7 trillion in foreign exchange reserves, the majority of which is held in USD-denominated assets. The ultimate cause of this surge is clearly strong economic fundamentals. The proximate causes, however, are more complicated.

First, the members of OPEC and other nations rich in natural resources have found themselves inundated with cash due to soaring commodity prices. However, the capital markets in these countries provide few opportunities to invest these proceeds, so countries have turned around and reinvested their windfall into American assets, notably equities and government securities. Second, since developing countries run a combined $500 Billion current account surplus, they have found themselves awash in foreign currency. In order to prevent their currencies from appreciating, they prevent this currency from circulating by holding it in reserve.

Now that we understand why the global stock of forex reserves is expanding, let’s explore why it matters. One of the only reasons that the USD has not plummeted in value as its current account deficit has ballooned is that foreigners largely remain willing to finance the deficit. If countries suddenly decide that they either want to inject their foreign currency into their economies (which would deplete their reserves) or if they decided to diversify their reserves by holding a larger fraction of them in non-USD-denominated assets, the USD would certainly suffer.

Emerging Market currencies hurt by risk aversion

Forex markets punished emerging market currencies this week, due to heightened economic and political risk. Many traders had piled into carry trade positions, selling low-yielding, stable currencies in favor of higher-yielding, but more volatile currencies. After a string of negative political and economic developments, many traders unwound their positions and moved back into the more stable currencies. After all was said and done, the currencies of Turkey and South Africa had declined more than 3%, while those of Brazil and Mexico declined by almost 2%. However, analysts now feel the sudden drop was nothing more than a long overdue correction, and remain bullish on emerging markets. Daily News and Analysis Online reports:

Post that shake-out, high risk currencies enjoyed a strong rebound. Low interest rates encouraged speculators to re-enter carry trades and build up large speculative positions, going short on the Yen and Swiss Franc.

Read More: Emerging currencies slip on risk aversion

NZD strength attributed to hedge funds

Of the world’s 16 major currencies, the New Zealand Dollar (NZD) has been the best performer over the last couple months, having appreciated 10% since July. The strength of the Kiwi has baffled central bankers, who have been unable to connect the currency’s rise to any economic or technical indicators. Their only explanation is that hedge funds have piled into the Kiwi, in search of an attractive, relatively stable return. Hedge funds would use the carry trade technique to short low-yielding currencies and use the proceeds to purchase New Zealand short-term debt, which is currently yielding 7.25%. However, the Central Bank urges caution, insisting that the Kiwi could suffer a collapse at any moment. Bloomberg News reports:

“The assumption certainly of the Reserve Bank and which I share is that the medium-term trend in the New Zealand dollar is down.”

Read More: Cullen Says Hedge Funds May Be Behind New Zealand Dollar Surge

Thai Baht shakes off political crisis

Last week, the Thai military usurped control of Thailand’s government while the Prime Minister was in New York attending a United Nations conference. Thailand’s currency, the Baht, immediately lost over 1% of its trade-weighted value, as analysts feared the military coup would harm Thailand’s economy. In the following week, the Baht retraced almost all of its losses, as the markets reacted positively to promises by the leader of the coup, that democracy would be returned to Thailand as soon as the Constitution could be rewritten. This episode was the most significant interruption to the Thai Baht in over a year, during which time the currency appreciated over 10% against the USD. The Globe and Mail reports:

Many analysts agree that King Bhumibol Adulyadej’s support of the coup and any timeline for fresh elections to restore democratic government will be key in determining when, or if, the Baht will recover.

Read More: Thai Baht hits currency markets

How high will the Kiwi go?

Over the Last three months, the New Zealand Dollar (affectionately known as the Kiwi) has been on a tear, having appreciated 10% against the USD. At first, traders just assumed the upward price movement was a correction of sorts- to offset the Kiwi’s slide over the previous months. Now, however, forex experts believe they are witnessing a bona fide uptrend, and it is anyone’s guess when the Kiwi will return to earth. Analysts are attributing the currency’s strength to a renewed focus on yield, which had previously been placed on the back-burner in place of fundamentals-based trading. Since New Zealand currently offers the highest interest rates in the developed world, traders hungry for yield began flocking to the Kiwi when the carry trade became trendy again. The New Zealand Herald reports:

[One analyst] said the yield story had been underestimated by local markets, which had focused on pessimism from economists and the “tsunami of uridashi redemptions” which would bring the kiwi down as overseas investors withdrew their money.

Read More: Experts pick kiwi to keep on flying

Israeli Shekel may be undervalued

Many investors watched the recent Israel-Lebanon conflict with bated breath, in order to gauge how the crisis would affect Israel’s economy. While the conflict will certainly diminish Israel’s prospects for growth this year, economists are predicting that its economy will still expand by a healthy 5%. Venture capital and private equity continue to flood Israel, and Israel’s interest rates remain at an attractive level. Meanwhile, its current account surplus exceeds 3.5% of GDP. In short, economists estimate the Israeli Shekel is undervalued by 13.5% against the USD and up to 30% against a broader basket of currencies. The Business Online reports:

These two trends are likely to continue thanks to strong growth in productivity which is making Israeli goods and services more competitive in the world markets, further boosting the case for a stronger shekel.

Read More: Shekel is proving to be bullet-proof

Global economy might be hurt by US

For many decades, it was an accepted truth that the fate of the global economy depended largely on the state of the US economy. Over the last few years, however, this link has gradually eroded and many economists now believe the global economy can expand even when the US is in recession. As it becomes more apparent that the US economy is peaking, this belief will soon be put to the test. US housing data, which is closely followed by economists because of the important role it plays in the US economy, indicates that the real estate market is beginning to recede. If emerging markets-which are most dependent on the US as an export market- are able to cushion their economies from the looming US recession, their currencies will be the first to gain. AFX News reports:

Major currencies were stuck in narrow ranges against each other amid concerns about the prospect of a slowdown in the US spilling over to affect growth elsewhere in the world dampening sentiment all around.

Read More: Major currencies rangebound amid worries about slowing growth outlook

Commentary: Carry trade comes to an end

One of the most popular trading techniques used by forex traders is known as the carry trade. The goal of the carry trade is to find two countries with vastly different interest rates, and profit by buying the currency of one and selling the currency of the other. This trade is popular precisely because it is safe and somewhat predictable. By borrowing in denominations of the lower-yielding currency and lending in denominations of the higher-yielding currency, a savvy investor can capture a spread equal to the interest rate differential, as long as the values of the currencies themselves do not change. Towards this end, most of the talk in forex markets over the last year has focused around interest rate differentials.

However, the prominence of the carry trade is coming to an end for the time being, since Japan and the EU have begun to raise interest rates and erode the profits of carry traders. If forex traders are to survive this period of narrowing interest rate differentials, they must become more creative. In short, it means they must stop focusing on interest rates, and begin focusing on currency fundamentals, such as economic indicators and the actual supply & demand relationship for particular currencies.

The currencies of many emerging markets represent strong candidates on both fronts. Brazil, Mexico, Eastern Europe, India, SE Asia, have all witnessed rapid appreciation in the values of their currencies on the heels of a global economic boom. Many of these nations have implemented important structural changes to their economies and have begun to see prolonged periods of political stability. This has resulted in an improved investment climate, and foreign companies have been quick to capitalize through portfolio and direct investment. This, in turn, has driven increases in productivity and exports, spurring economic growth, which only makes foreigners even more eager to invest. Since the respective money supplies of each of these countries are quite small, all it takes is a slight uptick in foreign capital inflows to drive significant appreciation in the value of their currencies.

Thai Bhat continues to soar

The last couple of weeks have witnessed a few milestones in emerging market currencies, which have largely outperformed the major currencies. The Thai Baht is the latest storybook currency, having appreciated over 10% in the last year, on the heels of a booming economy. The Thai Baht still remains well below its 1997 value, when the Southeast Asian economic crisis forced many nations to devalue their currencies. As a result, Thailand’s Central Bank is not sounding the alarm bells quite yet. Besides, inflation rates are edging up, and an expensive currency could help keep Thai prices in check. The Bangkok post reports:

“If the baht is allowed to become too weak it could affect inflation and if it is too strong, Thailand could suffer a greater trade imbalance, as Thai products will become more expensive and less competitive in the international market.”

Read More: Central bank unworried by strong baht

Brazil attempts to depreciate currency

Brazil’s currency, the Real, is currently hovering around a five-year high against the USD, after an historic run-up in value. In recent months, the Central Bank of Brazil has begun to grow nervous that a more expensive Real could stifle Brazil’s economy by crimping exports. Accordingly, the bank has purchased massive quantities of USD in a bid to hold down the value of the Real. While the Real has certainly stabilized, such intervention is misguided and probably doomed to fail in the long run. Other Latin American countries have followed suit, since western investors began pouring in investment money. Reuters reports:

Brazil's central bank has been aggressively buying U.S. dollars on the spot foreign exchange market in recent months to build up reserves and, indirectly, prevent the country's currency, the real, from strengthening too much.

Read More: Brazil's foreign reserves rise to $70 billion

Emerging market currencies face sell-off

Emerging markets have fared well this year, due to a combination of increased investor appetite for risk and strong fundamentals. Many emerging countries have also witnessed a rapid appreciation in their currencies, as foreigners pored money into direct and portfolio investments. As rates have risen in the developed world, however, many investors have begun to reevaluate the economics of such investments. In fact, the risk-return profile is changing to the extent that it may prove more efficient to invest money in lower-yielding, but safer American and European debt securities. The Financial Times reports:

“The market is only pricing in a 36 per cent chance of a rate rise in September…, so there is room for dollar upside, which would squeeze emerging markets.”

Read More: Emerging market currencies lower on profit taking

Korea continues to intervene in currency markets

For longer than I care to remember, the U.S. and other developed nations have accused China of blatant currency manipulation and clamored for China to revalue the yuan. This has deflected attention away from Korea, which continues to intervene in forex markets. Korea’s currency, the Won, has appreciated 8% against the USD in the first four months of this year. In an effort designed to curb the Won’s rise, the Central Bank of Korea has announced it will issue more currency stabilization bonds. These bonds enable the Bank to purchase massive quantities of USD in a transaction that should theoretically depress the Won. TCS Daily reports:

It turns out that the won closely shadows the yen and has developed a similar linkage to the yuan. Therefore, little ground will be lost in terms of the pricing of export goods with Korea's primary competitors.

Read more: Money Meddlers

India considers currency liberalization

Over the past decade, many aspects of India’s economy have been loosened and reformed as the country sought to match the growth of China. One facet that has yet to be liberalized, however, is the exchange rate system. While the Indian Rupee is technically free-floating, repeated intervention by India’s Central Bank has prevented it from appreciating. Further, the Rupee remains only partially convertible, for it is very difficult for Indians to invest domestic capital in foreign assets. As a result, India has built up foreign exchange reserves of nearly $150 Billion. This may soon change, as India’s parliament is finally mulling the possibility of full convertibility. The Economist reports:

A more open capital account would bring great benefits—notably, faster growth through easier access to capital. A convertible rupee is also essential if Mumbai is to fulfill Mr. Singh's ambitions for it as a regional financial center.

Read More: Fear of Freedom

SE Asian currencies outperform in ‘06

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

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

Read More: Perky pesos, rallying rupiah

Brazilian Real Climbs to 5-year high

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

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

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

Iceland Krona may fall further

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

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

Read More: Dollar gains weigh on emerging market FX

Iceland currency crisis highlights risks of carry trades

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

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

Read More: Krona crisis drama prelude to carry trade tragedy