For investors moving funds offshore into various asset classes, there is often the additional factor of selecting the appropriate currency. In terms of the 2 major currencies, the question is being asked, which issuing region has the larger fiscal woes. This is focusing foreign exchange participants on the euro/dollar trade.
The G10 countries, their current exchange rates to the US dollar and Standard Bank G10 fixed income and forex research departments forecast is as follows:
The global currency market is described as the largest and most liquid in the world. Because it’s a decentralised “over the counter” market, i.e. there is not one central clearing house for all trades, exact volumes are not exact, but according to the Bank for International Settlements, the average daily turnover in global foreign exchange markets exceeds $ 4 trillion.
The foreign exchange market is often described as a perfect market because of the following factors:
• Massive liquidity in major currencies
• Geographic dispersion
• 24 hour operation through the working week
• The generally low margins on trading compared to other markets
The modern foreign exchange market started developing in the 1970’s when countries gradually started moving from the fixed exchange rate regime to the floating exchange rates, following the collapse of the Bretton Woods system in August 1971, after US President removed the gold backing from the US dollar. Up until then countries were obliged to adopt a monetary policy that maintained the exchange rate of its currency within a fixed value – plus or minus one percent.
Currencies are quoted one relative to another. The first currency quoted is the base currency that is quoted relative to the second currency called the counter currency. Example the EUR/USD rate is currently 1.37, which is the exchange rate of 1 euro expressed in US dollars. i.e. 1 euro = 1.37 dollars.
The many participants in the market include the major banks, central banks, currency speculators, companies, governments, and other financial institutions.
There are myriad factors that influence exchange rates. Unlike a share price, which has some semblance to the future cash flows of a company, and therefore a degree of being estimated, currencies trade as relative prices and are therefore far more difficult to predict.
Factors that affect the exchange rate are numerous and include:
• Actual money flows
• Expectations of changes in monetary flows, due to factors such as:
• The relative purchasing power parity
• Relative interest rates
• Relative inflation rates
• Balance of payments and
• Budget deficits and
• Large cross border merger and acquisition deals
The Euro
The Euro, launched in January 1999 at first depreciated relative to the US dollar, stabilised in 2001/2002 at around 0.95 dollars and then has generally appreciated over the years.
It reached a high in mid July 2008 against the US dollar at around $1,60, then declined for the remainder of the year, appreciating in 2009, but falling once again in recent months on concerns about the debt problems within member countries.
A Standard Bank foreign exchange report this week is looking for the euro/dollar to fall to 1.30 over the next month or two. The immediate concern is the debt in some Euro countries.
Generally euro zone budget news remains poor. There is a possibility that the Q1 GDP falls back into negative territory. The consensus for the release of the 4th quarter 2009 GDP is 0,3%.
The graph below reflects the massive short positions in the euro – i.e. foreign exchange traders are expecting a further decline in the euro relative to the dollar.
Some of the bigger problem countries within the euro zone are Greece, Portugal, and Spain. The European Central Bank cannot afford a default on member country bonds, but at the same time they are limited as to what backstop they can provide.
There is a special meeting of European leaders this Thursday, addressing the region’s economy and the particularly problem countries. In the meantime the world financial markets are watching what action will come from this and how the EU and ECB deal with what could spin out to be a larger problem if Greece does default on its debt.
Kind regards
Ian de Lange
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966