FX&MM Magazine – Currency Wrap
20 October 2009
In a similar trading pattern to that of 2008 current USD currency misalignments from fair value calculations are being stretched towards breaking point. Currency devaluations should, in theory, have no long term economic benefits as the associated increases in inflation tends to offset any short term economic advantage. So it is no surprise that commodity prices have moved sharply higher this year. The increase in commodity prices also threatens inflationary expectations. Policy making becomes increasingly difficult as inflationary pressures can lead to early expectations of rate hikes. These rate hike expectations tend to push exchange rates even further away from fair value levels.
Increasing commodity prices can also correlate with accumulating currency reserves in developing countries. As these reserves are recycled, when central banks predominantly sell US dollars and purchase the EUR, generalised USD weakness tends to extend well below levels that the fundamental valuation models suggest is appropriate.
We saw in 2008 that these trends were unsustainable. The further that these currencies stretch away from fair value in the weeks ahead the more dramatic the corrective phase will likely be. We expect another period of increased currency volatility to follow the current weaker trend in the dollar.
Ken Dickson, Investment Director – Foreign Exchange and Money Markets, Standard Life Investments
This article was first published in November’s edition of FX&MM Magazine.
