Capital markets have been quite active over the last few weeks, but currency markets have been quite range-bound, with the US dollar losing some of the strength it gained after the crisis hit.

I expect this to be the bottom for the USD's weakness. In fact, I consider this month quite crucial for the USD.

The British pound was again difficult to analyze, due to heavy cross-rate activity particularly against the Japanese yen. However, I would hazard considering the current highs as the top for the GBP and hence a good opportunity to sell.

I would also change my analysis on the USD/JPY and expect it to move to 115. Earlier I have been recommending selling USD/JPY for a target of around 80 yen.

Likewise, for USD/CHF I expect this to be the bottom and hence an upward movement should start.

Having said all of that, a lot will depend on the upcoming Jobless claim numbers and non-farm and unemployment data. If the data is too negative, the USD could go into freefall.

The G20 is one event to watch, but its still far away. Moreover, US policy continues to support a strong USD and hence I do not see how agreement could be reached for another reserve currency.

Though the USD has recently strengthened against other currencies and is likely still to strengthen more, I will continue to treat this shift as temporary. In my experience, it takes the US around one and a half to two years to turn things around. While measures are being taken, it takes time for them to fructify and for results to be evident. Keep in mind, elections are also round the corner in the US.

The inflation scenario in the US might help the USD, if the interest rates go up. For now, I do not anticipate the euro going lower than 1.4550/1.4420 agains the USD (this week). Then I expect the euro to bounce to approximately 1.4910, followed by another decline until it settles around 1.41.

While, the GBP is the most vulnerable currency and a lot of cross selling of the pound is going on. I wouldn’t be surprised if the pound reaches 1.75 in the near future. When it comes to the PLN, I would like to revise my złoty target to 2.35 against the USD, but more about that in my next report.

Here are some factors that are making the markets nervous.

1. Russia and Georgia
2. Iran
3. Hurricane Gustav
4. Banks collapsing in the US. Another bank, Integrity went down last week.

Considering these factors, I also want to look at one more market trend to better understand the possibilities for Euro.

Since 2000, global investors have been borrowing low-cost currencies such as the YEN and CHF on a long term basis and selling them against high yielding currencies like STG, AUD, NZD, EUR and others in order to benefit from the yield differential. Due to this activity, high yielding currencies, as mentioned above, strengthened considerably against YEN and CHF until the year 2007.

Now, due to the current financial crisis in USA, weakening global economies like the UK’s, commodity price meltdown and expected lower interest rates in high yielding currencies are all contributing to unwinding of these “carry trades” since the beginning of the year.

As a consequence, we are already seeing the high yielding currencies especially STG dropping heavily against YEN and which may continue for a while. Due to the expected short term strength in the USD, weak UK economy and unwinding of carry trades, STG may drop from the current level of 1.8250 to 1.7450 during the next few weeks. If the economic situation in UK deteriorates further, interest rates may go down, which could push the STG much below 1.74 or more specifically towards 1.60 against the USD.

--

Comments can be directed to my email at m.sharma@interglobalfb.com.pl