past may have been the most wrenching in the history of US equities.From Monday to Friday the Dow lost 18.1%, the
S&P 18.2% and the Nasdaq 15.3%. European and Asian bourses had their worst
week on record and exchanges in Russia,
Indonesia and the Ukraine
halted trading. But once again, as stocks crashed and burned the dollar rode
high. The US
currency may have lost 3.8% against the Japanese Yen and traded even against
the Swiss Franc but it gained against every other major currency:2.0% against the Euro; 9.4% versus the New
Zealand Dollar; 3.8% against the Pound Sterling; 16.2% against the Australian Dollar
and 8.7% versus the Canadian Dollar.
coordinated 50 basis point rate cuts by the central banks of the United States,
the European Monetary Union, England, Canada and Sweden, combined with the
earlier 100 point cutby the Reserve
Bank of Australiaand the smaller
reduction by the Peopleâ€™s Bank of China killed
any remaining rational for the carry trade. Though the Bank of Japan did not reduce
rates, its base stayed at 0.5%, the rate differential between high yielding
currencies and the yen that had drawn so much risk capital to the yen crosses
is headed into oblivion. The banks that cut will cut again and for traders these
crosses are on a one way elevator down.
The degree to which the New Zealand and Australian
Dollars and to a lesser extent the Canadian Dollar, the Euro and the Swiss
Franc were fortified by their yen crosses is illustrated by the extraordinary capitulation
we have seen.The nzd/yen and aud/yen
have lost 38.5% and 39.6% since their respective peaks, the cad/yen 31.5%. The
US Dollar has gained 27% against the kiwi, 33% versus the aussie and 28%
against the loonie. The euro and its cross have seen similar movement with the
euro/yen off 20% from its high and the euro down 16% against the dollar. Even the
relatively low yielding Swiss Franc and its cross have declined with the
swiss/yen off 15% and the franc down 18% against the US Dollar.
beginning of the stock crushing phase of the credit crisis the currency markets
have clearly viewed Wednesdayâ€™s rate cuts as a foregone conclusion. Why else
sell the yen crosses so hard?Perhaps
the equity markets, which had been clamoring for these cuts for several weeks,
might have taken early comfort in currency tradersâ€™ opinion that rate cuts were
true that some of the positive movement to the US Dollar is part of a mass
flight from central bank rate inevitability in the yen crosses. But dollar
strength is not just the byproduct of the collapse of the carry trade.It is also a vote for the supremacy of the
greenback and the US
economy. The currency markets are telling the economic and financial world
where the recovery will take first and strongest root.This conclusion, perhaps unbelievable in the
face of the current economic catastrophe, is supported by the current level of
the US Dollar against its major competitors. The euro has returned to the level
it held against the dollar before the eruption of the sub prime problem last
August. The Pound Sterling and all the yen crosses are far below the levels of
last August, as are the Aussie, the Kiwi and the Canadian Dollar.Only the Japanese Yen and the Swiss Franc are
stronger versus the US Dollar.
preference for the US
currency over that of every other country in times of crisis is historically
understandable.The US has the
largest unified economy in the world, the largest internal market, and the
worldâ€™s reserve currency. No foreign economy or currency could well survive a US collapse.
Whatever measures are successful (or not) in
stemming this economic crisis, currency markets are betting that the first
beneficiary will be the US Dollar and its economy.Investors can rationally expect that the American
government will not let its banking system dissolve and that it has the power
to accomplish that task.The prime
lesson Mr. Bernanke took from his study of the Depression, and the chief Fed
policy error at that time was that it permitted and indeed encouraged a
contraction of the money supply.At the
risk of future inflation the Fed has poured money into US financial
system in unprecedented amounts.
the currency market assumption that worldwide rates would have to come down surfaced
when the financial crisis turned into a severe credit crunch and was
illustrated by the huge selling of the high yielding yen crosses, so it appears
that the ascent of the dollar is the currency markets judgment on the outcome
of the economic crisis.
sub prime and credit crises have far outstripped their source in the United States. As
was the fount of the crisis so, at least in the opinion of dollar traders, will
it be the source of the recovery.
Joseph Trevisani Chief Market Analyst FX Solutions
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