Dollar Declines in Forex Reserves

What analysts have been warning of for years has finally come to pass: the USD officially occupies a smaller portion of global foreign exchange reserves. According to a recent IMF reports, the fraction of reserves denominated in Dollars has fallen from 66.5% to 63.8% over the last year, with much of the difference offset by a proportional rise in the preponderance of the Euro. Analysts first began sounding alarm bells as early as 2003, when the Dollar fell nearly 15% against the Euro. However, it wasn't until 2006, when China began to accumulate reserves at an ever-increasing rate as its trade surplus exploded while at the same time the USD was tanking, that commentators began paying attention. 2007 brought several anecdotal reports that foreign Central Banks were both passively and actively diversifying their reserves. Now, it looks as though these were not isolated incidents, but instead part of a broader trend. AFP reports:

In recent months, several emerging-market countries, whose foreign currency reserves have ballooned as a result of such factors as high commodity prices and strong exports, have signaled their intention to further diversify their foreign exchange reserves to offset the US currency's depreciation.

Read More: IMF says dollar losing ground in global forex reserves

Fed to Cut Rates Next Month?

In recent speeches, two high-ranking officials from America’s Federal Reserve Bank gave conflicting indications regarding the likelihood of rate cuts next month. Both officials were deliberately ambiguous in their speeches, though one went so far as to rule out a rate cut while the other hinted at its inevitability. Nonetheless, analysts used the speeches to buttress their conclusion that a rate cut is probable. In fact, the futures market has priced in a 94% chance that rates will be cut by 25 basis points at the next meeting, on December 11. Likewise, it seems a rate cut has already been priced into the USD, which was virtually unaffected by this story. MSNBC reports:

On the currency markets, the heightened expectations of a US rate cut cut did little to hurt the dollar, as investors took the view that the currency's recent weakness had gone far enough.

Read More: Fed stance sends equities soaring

Malaysia experiences economic slowdown

Malaysia announced that it expects its economy to grow at only 5-6% this year, down from 7%. Economists attribute the slowdown to a decline in exports. As an emerging economy, Malaysia is heavily depend on exports (especially technology related exports) to fuel economic growth. However, a global decline in IT and technology spending has hit Malaysian exporters especially hard. Even with the artificially favorable exchange rate, maintained at value which experts estimate to be 20% below fair value, exports are declining.

Malaysia will be forced to rely on the other factors of GDP if its economy is to grow. The first factor is government spending, which on outlays such as education, agriculture, and health care, looks to remain constant this year. Consumption, on the other hand should drive Malaysia's economy. Consumption and growth effect each other in a circular manner. As the economy grows, consumers are left with more disposable income which they typically use to purchase more goods and services. This increases aggregate demand which increases GDP growth, which then increases consumption, until the process diffuses. Finally, investment in Malaysia continues to strengthen. as speculators pour money into Malaysian capital markets. Such speculators anticipate a revaluation in the exchange rate, which Malaysia insists will not happen. Reuters reports:

Bank Negara indicated speculation and short-term capital flows would not spark a change in currency policy. "The basis for any change would therefore be made on long-term structural considerations and not short-term movements in capital flows or transient shifts in exchange rate expectations," it said, adding that it could continue to absorb foreign inflows through money market operations.

Read More: Malaysia GDP growth seen slowing to 5-6 pct in '05

New currency ETF debuts on AMEX

An exchange-traded-fund (ETF) is similar to an index fund in that both types of securities are designed to track the performance of the index to which they are assigned. The crucial difference, however, lies in the fact that there is no centralized market for mutual funds, whereas ETFs trade on exchanges, and hence, charge lower fees to investors. At first, investment companies were reluctant to create currency ETFs, because they weren’t sure if demand was large enough to justify such products. Since currency trading surged in popularity, a spate of new currency ETFs have been introduced, the newest of which is designed to track the performance of a composite of ten of the world’s most important currencies. Previously, this type of product was only available to wealthy investors. Now, anyone with a brokerage account can index in such a way, and would be smart to do just that, in order to hedge against the decline in any single currency. The Daily News reports:

The fund is managed by DB Commodity Services LLC. “DBV will offer investors easy access to the returns of the currency markets by following a highly developed index previously available only to very sophisticated investors.”

Read More: New Means of Access to Currency Markets

ECB nervous over Euro appreciation

Jean Claude Trichet, president of the European Central Bank, is know for his terse, deliberately vague commentary. This week, he veered slightly away from that modus operandi by speaking out against Euro “volatility” in forex markets. In other words, he has not been delighted by the Euro’s rapid appreciation against the USD. While Trichet indicated that such an appreciation is bad for EU growth, he did not encourage EU governments to attempt to stabilize the currency. Thus, it is not clear how the markets will react to such comments, although if it appears likely that the ECB will alter its monetary policy as a result of the Euro volatility, the markets will certainly take notice. The International Herald Tribune reports:

ECB President Jean Claude Trichet said that while globalization had led to lower import costs for manufactured goods, it had boosted demand and increased oil prices.

Read More: ECB president says volatility in currency markets not good for long-term growth

Interest Rate Story Hurts Pound

The British Pound has been reeling since the Bank of England cut rates at the beginning of this month, from 5.75% to 5.50%. Last week, the minutes for the meeting were released. They revealed that that members of the Bank were growing increasingly nervous about the state of the British economy and are worrying particularly about how fallout from the credit crunch will impact growth. British interest rates are still among the highest in the industrialized world, behind only Australia and New Zealand. Thus, it seems investors are punishing the Pound indirectly for the rate cuts, because of fears concerning the near-term prognosis for the British economy. At the same time, the minutes indicated that members of the Bank were adamant about not lowering rates further, so some of the concerns may be overblown.

Read More: Pound weakens after BoE minutes show concerns for growth