Fx and Interest Rate Monthly - January 2009
- While capital markets fell in unison, FX highlighted relative risks...
In global capital markets dominated by de-leveraging, correlations tend towards unity as investors seek cash by liquidating their assets. However, FX markets are driven by where that money goes next. Are the sellers overseas investors withdrawing their cash or domestic owners paying down foreign currency borrowings? The FX markets have consistently been the first to reveal the fault lines of globalisation as the US sub-prime collapse has reached out to pull the global economy into recession. - …most obviously in more vulnerable emerging markets...
For emerging market countries, the correlation between a measure of short-term financing requirements and the performance of the currency is strong and it doubled after the bankruptcy of Lehmans triggered further de-leveraging in financial markets. - ...but also driving exchange rates and capital market performance all around the globe.
But the importance of FX extends beyond emerging markets, as the flow of international capital seems to have reversed the previous relationship whereby a falling currency and increasing competitiveness boosted the domestic equity market. Globalisation and the flow of international capital means that FX should play an increased role in determining and rewarding relative performance between local capital markets. - Yield premiums are being eroded for currencies...
We see scope for some further short-term dollar and yen weakness as the current rally in risk markets encourages some profit-taking on the recent winners. However, we expect that this will prove short-lived, not least because continuing rate cuts around the world will quickly erode any yield premium over US and Japanese interest rates. - ...as interest rates across the world are cut to emergency levels.
We forecast that interest rates will be cut to emergency levels – as close to zero as is appropriate for the functioning of the local banking system. While we forecast that economic growth will resume in the second half of 2009, it will be 2010 before growth is likely to be sufficiently robust to require monetary tightening.
Please click here for the full report (pdf,181KB)
