2007: A Forex Review

As 2007 draws to a close, the Forex Blog would like to formally deliver its second annual ‘state of the markets’ address. While the picture in most capital markets was blurry and nuanced, the story for forex markets was relatively straightforward. Simply speaking, the story was all about the US Dollar, which followed up its worst year in recent memory in 2006 with an equally abysmal performance in 2007. In fact, over the last two years, the Dollar has fallen over 20% against the Euro, and even further against most of the world’s other important currencies.

During the early part of the year, evidence mounted that the current US economic cycle had peaked, and analysts began to speculate that the US Federal Reserve Bank would cut interest rates. Nonetheless, the Dollar traded sideways for the next nine months, until the housing bubble burst and the ensuing credit crisis quickly metastasized to the rest of the economy.  The Fed responded by cutting interest rates by 50 basis points, and the Dollar began to unravel, losing 10% of its value in a matter of weeks.  After that point, the bad news began to pour in.
The oil-exporting countries delivered a one-two punch to the Dollar, first by announcing that the possibility of accepting payment for oil in other currencies, than hinting towards a collective dissolution of their respective Dollar pegs. The Canadian Dollar reached parity with its counterpart to the south shortly thereafter.  Countries in the developing world, including Brazil, Russia, and India, also witnessed surges in their respective currencies. The Chinese Yuan continued its slow climb, rising over 6% for the year, though this figure is probably closer to 2-3% in real terms. Even the Japanese Yen, previously held in place by the carry trade, notched an impressive performance as the credit crunch touched off a cascade of risk aversion.  Then, of course, there was the interest rate story: by the end of the year, US interest rates were only 25 basis points above EU rates, and Dollar bears were licking their lips.
The news was not all bad, however.  Foreign investors proved that they were willing to continue to finance the US twin deficits, though perhaps to a lesser extent than before.  There were even several high-profile investments in US financial institutions, led by Sovereign Investment Funds, which collectively claim hundreds of billions of dollars at their disposal.  In addition, the world’s Central Banks announced plans to pump over $500 Billion into global capital markets, which should especially benefit the Dollar since the US bore the brunt of the credit crunch.  Finally, economic data now indicate that US exports have been helped by the declining dollar. 
All things considered, it could have been worse.  Tune in later this week, as we unveil our forecast for 2008.