Thursday, October 2, 2008

Market Mayhem

The dollar is on course for one of its best weeks in history, despite a tirade of weak economic data out of the US and a worsening of the credit crisis, with no official approval yet on the US government’s rescue package for the banking system. How can the dollar make such hay in this environment?

The answer is simple. FEAR! Logic abandoned financial markets several weeks ago and now traders and investors alike are living on their wits. The credit crisis has spread across the globe and with liquidity having dried up, markets are much thinner than normal and it does not take much to move them in one direction or the other. It has been all one way traffic this week however with the dollar and the yen taking all other major currencies to the cleaners. The euro at one stage today was down 9 cents from where it was trading against the dollar last Friday. Sterling was down 11 cents against the dollar in the same time. The euro fared even worse against the yen which has been the week’s strongest currency. Risk aversion is at an extreme level and funds are flowing into the low-yielding yen and dollar at a breath-taking pace. The commodity currencies have also been hit hard with the Aussie dollar coming off the worst. The carry trade has been completely liquidated with the yen now trading at multi-year highs against all of the high yielding currencies. We should be close to the bottom in terms of many of these currencies, but logic does not apply in the present market and economic indicators and technical charts have virtually zero influence. The greenback has today hit a 12 month high against the euro, the Aussie dollar and the Canadian dollar.

The euro has been plagued by bailout stories of European banks and this has badly damaged the once teflon currency. The short-term outlook may be unkind to the single currency but when the dust settles, the euro’s healthy current account balance should prevail over the worsening debt situation in the US. The ECB is resisting calls to cut interest rates but with some European Governments taking it upon themselves to resolve the banking crisis, the ECB’s credibility and indeed the euro itself is being undermined.

This is not a market for small traders and intra-day trading and most traders are advised to avoid it until we see some semblance of order once again. If you must trade, employ very low leverage to minimise your exposure and trade pairs that do not include the dollar or the yen. A backlash against the dollar will happen, but only once market players have calmed down and there is some evidence of light at the end of that dark tunnel.

The regular column will return next week.

Bob B - Oct 2