Forex Markets: A Look Into The US Dollar, Part IV

Welcome to Part IV of a four part series discussing the current state of the foreign exchange markets and the future problems and issues that will surround it. For this fourth and final installment in the series, I will be wrapping up with a look into what the future holds for the Dollar and Euro. I am going to touch on how a U.S. and global recession will affect the currencies in the next 6-12 months, the role of continued low oil prices or a rebound in those prices, and what is in store for interest rates in both the U.S. and the European Union.

U.S./Global Recession

The word “recession” has been hurled around the biggest financial capitals in the world from New York to London to Tokyo, and no one really wants to be the one to drop the bomb. While all the experts and economists around the world want to debate who is or is not in a recession right now, it is pointless and frankly useless information. I think the incessant chaos and obvious current state of the global economy is clear cut enough that we all are facing major hurdles in moving forward with our economies. The fact of the matter is, all the major economies are hurting badly and answers are becoming more infrequent and costly as time continues.

Amongst a multitude of important topics to discuss in relation to a worldwide recession, the currency markets are a great source of risk and sometimes guaranteed investing opportunities no matter how unpredictable the world’s stock markets are trading. It’s quite clear that over the past six months, the Euro was the place to be if you wanted to lose a lot of money. Sure it was trading at all-time highs versus the Dollar back in May, but why not with the U.S. slashing interest rates, seemingly unaware that their beloved currency was crashing and burning in front of their eyes? Now, the Euro has given all of those wonderful gains back and then some, to the tune of 2 year lows. It seemed that an even one-to-one exchange rate was the next stop for the EUR/USD, until the past 10 days when bad went to worse.

As bellwether, blue-chip companies continue to fold across the U.S., the only solution “we” can come up with is to give them all the money they need to stay alive and skip out on the much publicized Chapter 11. I firmly believe that the average U.S. consumer simply cannot handle reality in times of massive financial distress and force the government to hold their hand through this horror movie that is the year 2008. With government money flooding the economy and interest rates on their way to 0% and beyond in the U.S., inflation is on the brink of exploding and no one is going to want to be anywhere close to a U.S. Dollar.

Oil Relief

Rising crude oil prices over the last two years and the general rush to commodities has been a major roadblock for the U.S. Dollar. As I discussed in article one of this series, there has generally been a negative relationship between crude oil prices and the value of the U.S. Dollar. It is no coincidence that as oil prices peaked in May, the Dollar was at all-time lows versus the Euro, and conversely as oil prices have shed over 60% in value since then, the Dollar has rallied against most major currencies. Something that has been a very debatable topic is how crude oil prices have fluctuated so wildly in the past 12 months and the role of speculators in the commodities market.

With oil prices falling this year primarily on falling consumption and increasing reserves, how countries like the U.S. and China react to the recent economic turmoil will determine the fate of crude oil prices going through 2009. As I see it, the recessions affecting all the major economies will remain dire without substantial relief in sight in the near future.

Provided speculators do not drive the prices up and the recent terrorist attacks in India fail to spread panic in the Middle East, I suspect crude prices will remain modest and will not have a major effect on the U.S. Dollar. Nonetheless, if there happens to be a large run-up in oil prices back towards the $100 mark, the Dollar will be back on the defensive.

Interest Rate Debate

Interest rates have been a huge talking point over the last year as credit markets across the globe have tightened up as bad credit has hit consumers hard. Up until the last few months, the U.S. was the major player in the rate-cutting party as rates have fallen from over 5% to a mere 1% with cuts in the near future already priced into the markets. As was mentioned in the last article, the European Central Bank has begun to cut their main interest rate down to 3.25% with future rates very likely lower as their focus shifts from inflationary worries to maintaining liquidity and kick-starting the EU’s economies.

The problem going into the future will be forecasting who continues to cut rates in response to the worsening credit crisis and who becomes more concerned with inflationary pressures. For the United States, inflation has been nothing more than a mere afterthought due to the continual issues with the world’s largest financial and automotive companies.

The Federal Reserve continues to overlook inflation as they cut rates and commit hundreds of billions of taxpayers’ dollars whenever the market demands. Soon it is going to be evident, if it is not already, that inflation is as important of an issue as the credit markets. With no end in sight in terms of rate cuts in the U.S. and the ECB becoming more concerned with deflation, the direction of worldwide interest rates will continue to be a major talking point well through 2009 and until the credit crisis begins to show some signs of letting up.

Looking forward to the end of the year and the start of the new year only a month away, speculation will be fueling the currency markets as much as the fundamentals within these markets. A keen eye must be kept on dialogue among the world’s central banks to see where their concerns are the strongest: the economy or inflation. I expect continued volatility in forex trading as the bulk of third quarter earnings are complete and all eyes will be turned to holiday retail sales and predictions for 2009 start coming in. Not to mention the Obama regime is adding another variable to the equation as we inch closer to a new president.

Disclosure: None

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