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Australian Dollar Might Be the Biggest Victim of the Current Financial Crisis

Friday, 17 October 2008 14:03:08 GMT  |  Antonio Sousa, Chief Strategist

The biggest housing and credit bubble in history, which had its roots in the United States, is now threatening the entire global financial system. However, with the world economy slowing down, export dependent countries like Australia could face the biggest risk of falling into a much sharper recession.

Performance of 10 Major Currencies Against the Australian Dollar (One Month Period)

The Australian dollar has been the worst performer among the world’s most heavily traded currencies. However, the key question for the currency trader is whether we will continue to see further losses in the aussie. In fact, a sharp increase in market volatility makes it very difficult to make any type of short term predictions but given the current market environment of uncertainty and de-leveraging in world’s  financial markets, high yielding currencies are likely to remain particularly vulnerable against lower yielding currencies. Moreover, with the world economy slowing down is reasonable to think that the demand for commodities will also begin to dry up and export dependent countries like Australia and Canada could face a significant risk of falling into a much sharper recession. I have been short AUD/JPY since last week and I expect more Japanese strength going forward.

source: Tradestation

 

High Yielding Currencies Look Vulnerable to a Sharp Correction

Generally, currencies with higher interest rates are more attractive to foreign investors but given the current market environment of de-leveraging in the world’s financial markets, high yielding currencies are more likely to depreciate because central banks in these countries will be forced to cut rates to promote growth. The interest rate heatmap posted below plots an interesting relationship between the current level of central bank rates against interest rate expectations. Rate expectations are very important but difficult to obtain and hard to measure. We suggest to measure interest rate expectations by taking the difference between LIBOR rates with different maturity. The negative slope of the regression clearly shows that countries with high interest rates are expected to cut rates in 2008/2009 which could make their high yielding currencies vulnerable to a sharp correction.

 

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Written by Antonio Sousa, Chief Strategist for DailyFX.com
To contact the author of this report, e-mail asousa@fxcm.com

 

 

 

 

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