Financial Markets Giving Key Clues On Currencies

by Bryan Rich

The financial markets have been highly inter-related since the current crisis unleashed fear and uncertainty starting in late 2007. And investors around the world went running for the doors … out of risky assets and into safety.

So when we want to find clues about the direction of currencies in this market environment, we just need to take a look at what’s happening in stocks and commodities.

Both of these markets have rolled over. And the relief rally of the past four months appears to have run its course.
As a result, currencies like the euro, the Australian dollar, the British pound and emerging market currencies have started their fall as well.

My chart below shows the tight relationship that currencies have had with stocks and commodities over the past 12 months …

The reason these market relationships remain tight is because all of the risks that drove these “crisis correlations” still loom:

The housing market is still a major problem with no relief in sight.

The same financial system that was staring into the abyss of total collapse because it was buried under billions of dollars in toxic assets is still the not-so-proud owner of those toxic assets.
Now …
6.8 million Americans are out of work,

Another 18 million are underemployed,

And those who have jobs are working fewer hours.
These conditions make a recovery in consumption an unlikely achievement, which makes recovery forecasts very vulnerable to disappointment.

And officials, though promoting estimates for a recovery in 2010, are hedging themselves with public warnings saying …
Beware of “Downside Risks”

The Organization for Economic Co-operation and Development (OECD) stated: Substantial downside risks remain, especially if global risk appetite were to falter.

The World Bank declared that: The world economy remains unusually uncertain.
The International Monetary Fund (IMF) said: The forces pulling the economy up are still weak.
And the G-8 reported that it was: Premature to reverse world economic stimulus.

The bottom line: The global economy is mired by risks that could easily divert recovery and send things into further depths of contraction. That means risk aversion is, and will be, the overwhelming theme in markets, which makes the risk-taking interest of recent months merely opportunism.

With this said, the below table shows what you can expect from the currency markets for the foreseeable future …

The World Bank declared that: The world economy remains unusually uncertain.
The International Monetary Fund (IMF) said: The forces pulling the economy up are still weak.
And the G-8 reported that it was: Premature to reverse world economic stimulus.

The bottom line: The global economy is mired by risks that could easily divert recovery and send things into further depths of contraction. That means risk aversion is, and will be, the overwhelming theme in markets, which makes the risk-taking interest of recent months merely opportunism.

With this said, the below table shows what you can expect from the currency markets for the foreseeable future …

U.S. dollar
Loses
Wins
Swiss franc
Wins
Loses
Japanese yen
Loses against higher yielders
Wins first, then loses
Euro
Wins
Loses
British pound
Wins
Loses
Canadian dollar
Wins
Loses
Australian dollar
Wins
Loses
Emerging Market Currencies
Wins
Loses

That’s not all … on a relative growth basis, the U.S. economy is now expected to lead in a global economic recovery, albeit a weak and fragile recovery scenario.

According to the IMF, in 2009 the U.S. will have among the smallest economic contractions of developed market economies at 2.6 percent. Meanwhile Japan is expected to contract 6 percent, the UK by 4.2 percent and the Euro area by 4.8 percent.

And in 2010, advanced and emerging economies are expected to experience some growth, with one exception … the Eurozone.

The euro has gained 15 percent against the dollar since March. But the relative underperformance of the Eurozone economy makes the euro a likely candidate for another steep fall.
So my suggestion for you today is: Beware of downside risks.

Regards,
Bryan

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