US Dollar & Main Currencies

The majority of all foreign exchange trades involves the US dollar against another currency. This has historical reasons as well being due to the fact that the US economy is the largest in the world and the global leader and benchmark. Many commodity markets are denominated in US dollars leading to additional need for US dollar trading.

Traditionally, the German mark and the Japanese yen have been the basis of a lot of trading as well, with sterling and the Swiss franc trailing a little behind the three main currencies. Each of these markets has very distinct features relevant both in the past and now. The German mark has for all practical purposes been replaced by the Euro.

The dollar has suffered violent swings as the credibility of US economic policy has been questioned on many occasions. In the Eighties, in particular, the dollar moved from being the market darling to being dumped aggressively following the Plaza accord.

The German mark was a tower of strength over the past twenty to thirty years, due in particular to the widespread respect the German central bank - the Bundesbank - enjoyed. But the traditional role of the Bundesbank as the world’s most dedicated inflation fighter was undermined after unification with the former East Germany and it has now been replaced as the most influential central bank in Europe by the European central bank.

The yen has been highly volatile in recent years, initially strengthening throughout the early nineties, then relieved by US support to the dollar. But in the past year or two, the longstanding Japanese problem of an appreciating exchange rate squeezing its exporting companies has returned as the yen turned dramatically after falling to 147 against the dollar. In October 1998, the most dramatic currency move in many years was seen as the dollar fell some 15% in just a few days against the Japanese currency. Japanese interest rates seem to be stuck at rock-bottom levels.

The Swiss franc serves, as does the dollar from time to time, as a "safe haven". This is due to the isolation of the Swiss economy, its independent and neutral political stance and the secrecy of Switzerland’s banking system. The attractions of this combination have led to a relentless inflow of funds into Swiss francs in times of trouble and a resulting very low level of interest rates.

The pound, always a big part of foreign exchange markets and the first currency to be traded actively against the US dollar via the transatlantic cables (hence the description "cable"), has traditionally weakened against most other currencies. This tendency has been reversed in recent years and the pound will remain an interesting currency as it takes its place as one of the few key European currencies.

European Currencies

European currencies have gained in importance in the last twenty years and have suffered some major crises due to the continued attempt to peg exchange rates to each other.

In the late eighties, playing the interest rate spreads between high and low interest rates between currencies - that were fixed - provided easy profits for speculators. Or at least, so it seemed until the major devaluations in 1992-93 forced a long-needed realignment between economies that were severely out of sync.

The key to Continental European currencies has been the German mark-French franc Axis that was seen as the backbone of the common currency. The Benelux countries have benefited from long-term stability as well, whereas most Mediterranean and Scandinavian currencies have fluctuated wildly against this European core.

The introduction of a common currency in 2001 spelled big changes to foreign exchange trading in Europe. As early as 1998, the participating currencies were fixed against each other and this has forced many European banks to reconsider many of their trading activities. Overall, however, we do not consider the introduction of the Euro to be particularly detrimental to foreign exchange markets. A weaker Euro has taken the place of the mark and non-participating European currencies will become more volatile and more vulnerable to speculative attacks.

This will spell a new dawn for sterling trading that will become the main national currency market (together with the Swiss franc) in Europe.

Emerging Markets

So-called exotic currencies have long offered enormous profit potential as well as very substantial risks. The most noticeable approach has been to single out weak, but fixed currencies for brutal speculative attacks, leading to large devaluations and extensive economic problems for the countries involved.

The reason that many emerging currencies are pegged to the US dollar or other currencies is normally to force local monetary authorities to act with more discipline and to reassure holders of the currency against the risk of depreciation. Unfortunately, it has proven nearly impossible for most emerging countries to maintain the necessary discipline to justify stable currency levels and the result is nearly always a dramatic devaluation. In leveraged trading, such devaluations offer big profit potential, but in the intermediate periods where the currency is stable, high interest rates will benefit investors with the nerve to hold onto the currency.

This makes the emerging markets very tricky to trade and while nobody should trade any foreign exchange market without a solid grasp of the technical aspects, this is even more true in emerging markets. Seen from a commercial company’s point of view, however, failure to protect against the risks in such markets can be fatal.

Predominantly, interest focuses on South East Asia and South America, but there is no reason that both the African Continent and Eastern Europe should not provide interesting markets in the future.