Tides may turn in the forex market into 2010

December 24, 2009

JaneFoley.JPG-Jane Foley is research director at Forex.com. The opinions expressed are her own.-

The final weeks of 2009 have brought a sense that tides may be turning in the foreign exchange market reflecting broader developments in the global economy. The predominant changes relate to the dollar.

December’s 5 percent recovery in the USD index is linked to an improved outlook for the U.S. economy.

There are risks to this optimism, but short dated U.S. yields have pushed higher since late November allowing the dollar to shrug off the downtrend that characterised it during 2009 and potentially embark upon a cyclical recovery; at least against some currencies.

Better U.S. economic data in early December couldn’t have come soon enough for the Japanese authorities. In late November USD/JPY had fallen to a 14-year low.

Having proclaimed the economy to be in deflation the Japanese government openly pressured the Bank of Japan to take further supportive policy measures.

The Bank announced an emergency credit facility and subsequently stated it will not tolerate a negative inflation rate. This, combined with a rise in short dated U.S. yields, has allowed the JPY to take back the mantle of favoured funding currency from the dollar. The downtrend in USD/JPY that has been in place since mid 2007 may be turning.

In view of weak domestic growth prospects, there is a lot of political will in Japan and the Eurozone in favour of a stronger dollar.

During 2009 EUR/USD was driven almost exclusively by the pros and cons (mostly cons) of the USD; Eurozone fundamentals were decidedly in the back seat. Over the last couple of weeks, there has been an increase in the negative press surrounding the fiscal difficulties of some EMU members which has pressured the EUR.

No doubt there is more bad news on budgets waiting in the eurozone’s wings which could come from Greece, Ireland, Spain or Portugal.

Austria, the Baltics and Iceland may also have a few nasty surprises up their sleeves. While there appears to be no real risk of the European Economic and Monetary Union breaking down, there could be sufficient bad news to highlight the inadequacies of EMU’s budget criteria and bring a rocky ride for the euro.

December’s 2.9 percent drop in cable is more moderate than the 4.8 percent decline in EUR/USD. The EUR’s underperformance reflects its sovereign deficit problems. That said the outlook for the UK remains mired by its own weighty problems.

While decent labour data have brought the first really good UK news since the start of the recession, the issues surrounding the budget deficit, slow growth and forthcoming general election are likely to weigh on sterling at least into the spring; with the EUR under pressure, cable is likely to reflect most of this weakness.

It is feasible that the USD could maintain a better tone vs the EUR, the JPY and GBP while still underperforming higher yielding currencies.

AUD/USD has moved off its recent highs on fears that having tightened policy three times the RBA may leave rates steady for an extended period.

Given Australia’s proximately to the fast growing Asian region, in all likelihood the RBA will be hiking again before the Fed is even off the starting blocks. AUD/USD may see parity in 2010.

While the dollar’s downtrend may persist against some currencies, dollar appreciation vs the yen and the euro would likely be sufficient to keep the USD index trending higher.

This would relieve immediate pressure on China to revalue its effective USD peg. That said once China is confident that external demand has strengthened a revaluation of the CNY will become more likely, meaning a move is possible in H2 2010.


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