We are at year-end schizophrenia in the currency markets. After a strong dollar rally, the market woke-up to the new Fed of quantitative easing. The rate target was set at 0-25 bps and the Fed flooded the market liquidity. In many countries, interest rates are higher so we saw a dollar sell-off as the risk aversion delevering story wound down. The strong move was especially the case for the Euro which moved from 1.26 on December 1st to a high of 1.47 yesterday. Today the dollar dropped below 1.40 reversing much of the gain from the previous day. This is partially liquidity driven but also a reaction to varying moods about global economics.
The market has realized that there is no safe haven in Europe even if rates are higher. More bad economic news in France and Italy was announced today and the Geramn IFO survey continued to move lower. The relatively tight ECB policy of holding rates at 2.5% will not last.
Yield differentials are not enough to continue capital flows as the race to zero continues around the world. Japan cut rates another 20 bps to a 10 bp target. The Swiss have rates at 50 bps and Canada is hovering at 150 bps. Rate differentials will not figure in these crosses.
The dollar sell-off was by many technical measures overdone and with coupled business cycles there is more reason to think that G10 currencies will stay within a range for the near-term.
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