Global-View.com Month Ahead Currency Outlook for September 7, 2008

Bubbles, bubbles, bubbles? This is the bubble era, dot-coms, real estate, commodities, etc., and now the euro. It is a characteristic of a bubble that asset valuations get wildly overvalued. Bubbles then collapse after the last greater fool has gotten long. Bubbles, bubbles, bubbles? This is the bubble era, dot-coms, real estate, commodities, etc., and now the euro. It is a characteristic of a bubble that asset valuations get wildly overvalued. Bubbles then collapse after the last greater fool has gotten long.

The last several days have seen risk aversion resurface in key markets. Investors are rushing into government bonds and dumpimg equities. They are selling carry tade positions and buying back the low interest rate currencies (i.e. JPY) that are financing them. Favored carry trade investment vehicles AUD, NZD and EUR are hurting from these liquidations. These have been long-standing plays, so there is a lot to be unwound.

Worry about a new bout of economic weakness has triggered intensified interest in another round of Fed ease. This has not impacted the USD yet because the interest has been elsewhere.

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At its meeting on Thursday, the ECB kept its official target rate for its refi rate steady, but it took a technical step which effectively raised the cost of refi financing for financial institutions using certain types of collateral for financing loans by the central bank. Dealers are seeing this as an inappropriate policy tightening by the ECB. The past week saw the release of more weak economic data from the Euro-zone. The data reinforce the view that a slowing global economy, an overly tight monetary policy and an overvalued EUR have been taking their toll on the Euro-zone. Dealers see the single-minded inflation-targeting policy of the ECB a major negative for the currency.

We remain positive the USD against the leading European currencies (EUR, CHF and GBP). The JPY has been playing the role as an anti-EUR currency and can?t be counted on any more to trade closely with the European currencies vs. the USD.

Demand for the commodity currencies (AUD, CAD and NZD) is driven by market perceptions about demand for commodities. Such demand is thought to be generated by the global economic growth. As the global economy slows, this bloc of currencies can only weaken against the USD.

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As for the market dynamics, dealers are no longer on the fence for EUR/USD, and still lean in the direction of a higher USD in a longer term time perspective. Our best guess is that the current correction phase is temporary.

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