Now that the Federal Reserve has lowered the Fed Funds rate to 2%, currency pairs will be adjusting to a new set of expectations. In forex, money always seeks to gain an edge by resting in currencies that pay a differential in rates. It is a constant search for yield.
With the U.S. dollar at 2%, there are still strong bearish dollar forces in the form of higher yielding currencies. But a countervailing force is that of expectations. The highly questionable expectation that the credit crisis has peaked and commodities have topped offers a respite for the dollar. This may be psychological with dollar weakness resuming its downward path when discouraging U.S. economic news makes a rally no longer justified. Yet if traders can’t figure out where the U.S. economy is going, they simply can look elsewhere and there is a geometry of opportunity being shaped in the EUR/JPY, AUD/USD and NZD/USD. Let’s take a look.
The EUR/JPY has experienced a 1,000 pip move and traders who have missed the move up can very well catch the move down. The price action also follows a fundamental vector, which is a slowing down of the European economy. When economic data shows a slowdown, currencies use that data as leading indicators. If a slowdown is anticipated in the eurozone, then the euro’s weakness will make it difficult for the EUR/JPY pair to have the momentum to remain at previous highs in the 166+ range. A EUR/JPY correction is in the cards and it could be 1,000 pips.
The AUD/USD also offers an interesting opportunity. The 15-year Australian economic expansion may be ready to plateau. The AUD/USD had benefited from the commodity boom, particularly in gold, as Australia is the third largest gold producing country. A correction in gold or in the broader commodity markets would be a recipe for a potentially massive downward move in the Aussie.
The New Zealand dollar, also known as the kiwi, is perhaps the most interesting of all. It sits at the top of the interest rate pyramid, offering 8.25%, yet the fundamentals are beginning to soften.
For example, the New Zealand home building approvals are slowing down. New Zealand, like the United States, Britain and many other countries, has housing sectors that are highly correlated to currency direction. A slowdown in New Zealand offers their central bank the opportunity to cut rates without fearing inflation. If a rate cut comes, the NZD/USD could experience a significant sell off.
As we approach the second half of 2008, currency pairs like the EUR/JPY, AUD/USD and NZD/USD seem ready to assume new patterns reflecting expected changes in the world economy. The forex trader needs to prepare for inevitable shifts in world fundamentals.
Abe Cofnas is president of learn4x.com LLC. E-mail him at firstname.lastname@example.org.