Forex Market Analysis 29-09-2010

Long Term Perspective:
                The last big drop of the dollar grew concerns about the US economic and budgetary situation. The dollar could be in a downward spiral in the long term caused by the repeated Quantitative Easing. Investors expect the Fed to increase its balance sheet by at least half a trillion dollars by November [1] (see survey). The next Fed minutes are going to provide a clearer perspective. By increasing its balance sheet the Fed is boosting the US Bond market. In fact, many market watchers do believe for many good reasons that the Fed will always prefer inflation to deflation. The current policy is proving by multiplying the Quantitative Easing that they will use all available resources to avoid a deflation that could put America back to recession. Meanwhile, The secondary effect of such a longer than expected stimulus is a long term downward pressure on the US dollar and a systematic risk of hyperinflation.
                Another important issue rises as the global community could question the US dollar as the world's primary reserve currency as well as to be the international pricing currency for commodities. The political pressure between the United States and China regarding the currency market could fuel eventual conflicts during the G20 as U.S. lawmakers believe that China should revalue the Yuan by as much as 40 percent[2].
                After a big mediatized decline from October 2009 to June 2010, the Euro has passed the stress test of the European government debt crisis in the euro zone (Portugal, Ireland, Italy, Greece and Spain). Chances are that proposals concerning a change in the status of the reserve currency and commodity pricing currency surge as China and others have been calling for a new world reserve currency[3]. Even if this is not official, other countries such as Mexico have been diversifying their balance sheet with other currencies to limit exposure to the US Dollar to a certain extent[4].
                That being said it is very unlikely that the shift away from the dollar is to happen in the short term. Meanwhile it is important to consider that G20 in collaboration with the IMF might be working towards a gradual change in this domain possibly by implementing a basket of currencies (i.e Euro, Dollar ,Yen , Yuan...) ,commodities or an index as accepted reserve and mean for commodity pricing. In such a scenario, world political hierarchy and economic changes could accelerate with the trend of a growing share of emerging countries in the global economic landscape. This could lead to a big downward pressure on the US Dollar.
                Even if the long term perspective on the US Dollar can be shown as bearish, the Euro area has its own difficulties and continues to deal with the recent government debt crisis. Because of the current levels of the US Dollar, technical analysis and midterm perspective show a strong probability of a large drop of the US Dollar especially relative to the Swiss Franc (CHF) and to the Yen (JPY). In the longer term, The Australian dollar (AUD) and other "future safe heaven currencies" such as the Singaporean dollar (SGD) could gain power as well.

Medium Term perspective:
The recent decline in the Dollar has raised some concerns regarding other countries' ability to export.  There is recent speculation that the BOJ could ease next week[5] .We can talk about a competitive depreciation de facto weather it is in purpose or not. The process can easily be seen with the evolution of gold prices. The following charts show the overall downtrend of major currencies relative to gold.

Weekly bar chart - semi-log scale. Gold in Euros, U.S. Dollars, Aus. Dollars, and Yen. All charts with 20 week (100-day) Moving Averages.
If this process continues we can imagine the currencies going back and forth relative to one-another while the basket of the major currencies continues to depreciate relative to Gold. This could consequently boost commodity prices in the midterm and remove deflation fears associated with a double dip recession by many economists leading to a inverse risk of hyperinflation.

Short Term Perspective:

                Technical analysis suggest a possible upward move for the US Dollar in the short and medium term. This could be triggered by new mediatization of Europe's sovereign debt crisis. We could be seeing growing concerns within the next week about possible Greek debt restructuring[6] and Ireland following Greece's steps[7].

© Joé Thierry Arys Ruiz 29/09/2010.

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Adapt Chapter 9 bankruptcy code for Greece. Financial Times, Sept 28 2010.
[7] Markets fear Ireland is another Greece. Financial Times, Sept 27 2010.