Archives: 2007 June

Since 2001 the US Dollar has been in an extended downtrend against major currencies.

The two issues that fueled in large part the decline of the dollar, the massive trade deficit, and the massive fiscal deficits, are still with us. However, the fall of the dollar may have just about reached its maximum for this cycle.

The primary reason I say that is due to the financial storm that is brewing in the sub prime US real estate financing market. Foreclosures have already reached record highs with much more havoc to follow.

The exotic sub prime mortgage market is going bad in a major way as borrowers are unable to pay the much higher monthly payments on their housing loans as resets take place.

Many of these marginal at best borrowers were sucked into financing homes with ARM, adjustable rate mortgages, which offered low initial interest rate loans with low payments for the first couple of years. Many borrowers closed on these loans not fully understanding that in the near future their monthly payments would be reset to much higher levels.

The day of reckoning has already arrived for a few of these unfortunate borrowers and will arrive for many more as 2007 passes by.

The disaster in the sub prime lending market has already impacted some major lenders. HSBC has reported large losses and 23 lending instructions have filed for bankruptcy so far in 2007.

The implications for the US Dollar are this. As troubles mount in the sub prime lending market there will be a tremendous liquidity squeeze. While the US government will attempt to supply as much funding as necessary to head off a collapse of the US housing market the effort probably will not work.

The Australian Dollar is a currency that I really should have mentioned in my “energy rich currencies” post.

Australia is one of the major world producers of Uranium. On the back of concerns about peak oil and the increasing energy needs of a growing world economy nuclear power is making a comeback in a major way.

Australia and the Australian Dollar will benefit from the long term growth trend of the nuclear power industry. Of course, the more nuclear power reactors in use around the world the greater the need for Uranium.

Australian will also benefit as a supplier of metals and agricultural products to a world hungry for commodity resources.

The Australian Dollar is certainly in the fortunate position of being an energy rich currency.

For traders with the patience and financial ability to take long term currency positions in markets that are often fast moving and short term confusing taking long positions in “energy currencies” will likely work out quite well.

By an “energy currency” I mean a currency issued by a nation that has surplus oil reserves and is able to export relatively large amounts of petroleum products to world markets.

An example of an energy currency is the Canadian Dollar.

Traditionally, in spite of the US being an energy deficit nation, the US Dollar has benefited in world currency markets from increasing oil prices as oil transactions around the world are generally priced in US Dollars. Higher oil prices increase the demand for Dollars to pay for oil transactions.

While the world oil market is still primarily priced in US Dollars there is a gradual movement out of Dollars as an oil pricing currency. This is gradually decreasing the demand for Dollars.

Some oil delivery contracts are already being priced in Euros, rather than Dollars. This practice will likely intensify as the US Dollar continues to erode in a peak oil world.

Energy deficient currencies are currencies issued by nations that have an energy deficit. That is, the nations consume more petroleum products than they produce and must import the shortfall.

An example of an energy deficit nation is the United States.

While a strong bull trend in energy currencies may be now underway any currency tends to whip around within the trend. This may create fear and confusion in the forex trader unless you have a written plan for your trade and your positions are well managed.

In the study of forex movements over time you often see a high correlation between currency movements and interest rate differentials.

As an example, if British Pounds are paying 6% on deposits and US dollars are paying 5%, with all other things being equal, investment funds would flow into the currency paying higher interest rates and that currency would strengthen relative to the other currency.

In the example given above we would therefore expect that the British Pound Sterling would gain in value against the US Dollar.

Of course, this is a rather simplistic view as for one thing the “other things” are never equal. At times it is even difficult to know exactly what the “other things” may be.

There are times when markets seem to ignore fundamentials completely and trade in a highly technical manner.

However, in making a judgement about the possibility of a market maintaining a long term trend one can not ignore interest rate differentials . A review of forex price movement charts will often show that a currency paying a relative high rate of interest will in fact trend higher against currencies paying lower interest rates.  

That is one important reason why forex traders pay so much attention when central bankers of a major currency nation have their interest rate policy meetings. Occasionally the central bankers will surprise the forex market with an unexpected change in the level of interest rates and spark a fast change of price levels.