Forex Trading Strategies Blog

The Japanese central bank, Bank of Japan, in a statement early February, said that it plans to pursue its zero percent interest rate policy, which would imply a weaker Yen, especially after the US having raised its interest rates. However, in a recent statement, the Bank stated that it may be open to ending the easy monetary regime and may raise interest rates.

Japan seems to be in a catch 22 situation. Its economy is not in the best of shapes. So if it raises interest rates, any chance of rapid revival would be doomed. If it doesn’t raise interest rates, its currency will slip.

In economics it has been said that the currency of a country is like a stock. It reflects the health of the economy. Thus, if Japan’s economy is not in the best of shapes, a softer Yen is only revealing the truth. And, a softer Yen may actually help Japan with its exports as they would get cheaper.

More on the Yen, from the International Herald Tribune.

While China had been facing tremendous pressure form G7 to revalue its currency and put it on a float, their stance softened after  China undertook token adjustments and introduced a narrow trading band.

The French issued a new statement that the Yuan’s value is the sovereignty of China and it may be better to approach the subject in an informal way rather than exert formal pressure.

While, certain lawmakers in the US have threatened to introduce legislation that will erect trade barriers against China, the Bush administration is completely against the idea.

It’s the complex nature of the global economy that is making nations shy of taking a firm stance on the issue. Disturbing the equation by revaluing the Yuan could slow down the Chinese economic rate of growth as its exports would become dearer. That could prove to be disastrous for global economic growth, so why take chances.

The Indonesian Rupiah moved up to 9235 against the dollar on the news of S&P upgrading its rating outlook. The Rupiah this year gained 6.15% against the dollar, with the country’s central bank raising interest rates. Indonesia ’s interest rates are now the highest of the 14 major Asia-Pacific countries.

The central bank has raised the reference interest rate six times sine July to keep inflation under check. It now stands at 12.75%. The currency markets for the Rupiah witnessed hectic activity as speculators took long position in the currency.

By raising interest rates continuously, the Indonesian central bank has ensured that it sends out the right signals to the international community in maintaining a stable value for its currency, taming inflation and creating an enabling macroeconomic environment.

To read more about the Rupiah, click here.

Traditional economics has laid down a thumb rule for determining the value of a nation’s currency viz a viz its current account status. If a country has a growing current account surplus, its currency should appreciate. On the other hand a rising current account deficit implies that the value of the domestic currency should fall.

However, in the case of the US Dollar, the theory seems to be faltering. The US has the largest current account deficit in the world and is also the most indebted nation. But, the dollar does not seem to reflect this as it has stayed buoyant for quite some time now.

Billionaire financiers George Soros, Bill Gates, and Warren Buffet have all taken long term positions against the dollar and feel that the currency is overvalued. However, there is no simple answer to this situation. Globalization has made the equations very complex and lot of economists believe that the situation of a strong dollar and a current account deficit is sustainable.

China holds one of the largest forex reserves in the world. China has managed to accumulate such huge reserves from a record growth in their exports. Till recently, the Chinese currency was pegged at a fixed value to the USD. On July 21 last year China, ended this decade old peg and allowed the Yuan to float in a highly-guarded narrow trading band, while allowing it to appreciate marginally. The Yuan’s current value is 20% to 40% below its true market value.

Its undervalued currency gives China a huge trade advantage vis a vis other countries and is one of the key reasons for its high GDP growth. China has been facing multilateral pressure to allow its currency to float. China’s Central Bank Governor commented in Davos on the side lines of the World Economic Summit that China will follow a prudent economic policy and introduce gradual decontrol of the Yuan.

The German economy’s expected zero growth in Q4 of 2005 did not affect the Euro to a great extent as the European Central Bank is likely to raise interest rates in March. The overall growth of the 12 member Euro Zone was down to 0.3% after it experienced a 0.6% growth in Q3 of 2005.

At present, the European refi rate is at 2.25% and the market has factored an increase of 25 basis points, which has enabled the Euro to hold grounds at the 1.19 euros to the dollar. While the overall economic sentiment for the Euro zone is positive, the rate hike is to guard against any possible increase in inflation.

To read more about the Euro and the Euro zone, click here

The global economy has become extremely interconnected and a currency crisis in one part of the world can have a ripple effect for other economies as well. This is especially the case for the US as it is the largest importer of goods and is also the largest foreign investor.

Let’s take the example of the South East Asian currency crisis of 1997 to understand this issue. Thailand had pegged it currency to the Dollar at 25 Bahts. This was backed by a sovereign guarantee. The Thai government’s objective in pegging the currency was to eliminate the foreign exchange risk for investors, so that they could bring in money, invest make profits and repatriate without risk.

While this worked well for a while after sometime it was realized that due to massive inflows of foreign funds, the Thai economy had become highly overleveraged. Large amounts of money had gone into real estate speculation and local banks had accumulated huge bad debts. At the same time the Thai government followed an independent monetary policy and did not manage its inflation rate unlike Hong Kong, which follows a currency-board and has fixed its currency’s exchange rate to the USD and also follows a rigid monetary policy in line with the US monetary policy.

Quite apparently, high inflation means that the value of the local currency is depreciating faster than the USD and the exchange rate holds no meaning. Foreign investors, lenders and speculators sensed this and started pulling out their investments. George Soros, being one of the biggest speculators blew the whistle and the rest is history. With so much of demand for the Dollar vis a vis the Baht, the government was likely to run out of its Dollar reserves. It was left with no option but to allow the Baht to depreciate. Its value fell from 25 to the Dollar to 50 to the Dollar.

For foreign investors, the value of their holdings depreciated rapidly. For the local Thais, imports became expensive and the prices of imported products doubled. For importers of Thai products, the prices halved. Thus drastic fluctuations in currency values can change equations considerably.

The Reserve Bank of Australia, the country’s central bank issued a statement that if required it will raise interest rates to tackle inflation in the face of rising consumer demand or other inflationary pressures ensuing from higher oil prices. Australia’s benchmark interest rate has been held steady at 5.5% since March last year.

At the same time the Bank has revised inflationary forecast down from and earlier estimate of 3% to 2.75%. Experts are of the opinion that the Bank’s statement was issued with the intent of talking down inflationary pressures and that it is unlikely to increase the interest rates. The Australian Dollar stayed range bound on this news.

The Philippine Peso strengthened to a 3 ½ year high of 51.48 against the dollar, with the nation’s exports growing at a scorching rate. The currency also took cue from S&P having raised the country debt rating to stable after the government’s commitment to reduce the budget deficit.

Exports jumped 16.8% in December to $3.83 billion. Export is a major contributor to the $85 billion economy, accounting for nearly two-fifths of the total GDP. The government has pinned a lot of hopes on exports to spur GDP growth to 6.3% this year for the 5.1% last year.

To read more on this issue, click here.

That China’s currency is highly overvalued is a commonly known fact. What is unknown is when China is likely to correct this aberration. Until July last year the Yuan’s value was pegged to the dollar and determined by the government. As a first step towards liberalizing the currency, the government allowed the currency to float in a narrow band and revaluated it by a paltry 2.1%

The expectation that China would either revalue its currency in the near future or allow it to float, led to a large amount of hot money pouring in to make a killing from this appreciation. However, Bank of China’s Governor issued a very clear statement that the country is not considering a revaluation anytime in the near future. This has cooled of the inflow of hot money for now.

One will have to wait and watch whether the Governor made this statement to curb hot money flows or if this is the direction that China wants to take.