Foreign Exchange: Dollar Expectations

Those trading forex during this past year certainly have gained some combat stripes as the global equity and commodity markets rocked through a major shift in valuations. The impact on currencies was a significant increase in volatility. Among the majors, realized volatility grew exponentially by

the beginning of December. These increases in volatility have posed greater challenges for the forex trader whose trading strategies, honed in calmer conditions, may no longer work as well. These conditions impose the necessity to examine strategies and tactics that go beyond a simple review to changing one's view about the forex market. There are several areas worth exploring.

First is the view of what moves currencies. In normal conditions currencies decline and increase in value as interest rates increase or decline. In this world of fundamental forces, if a central bank decreased interest rates, the currency would weaken. But these have not been normal times. In early December, the Reserve Bank of Australia cut rates by 1%, yet the Aussie rallied and the market showed a flight to the U.S. dollar as U.S. interest rates declined further. This has been a pattern except for the USD/JPY pair, where the yen has benefited from the unwinding of the carry trade.