USD Stuck in a Wait and See Trading Range

The first quarter of 2009 has come and gone, and despite the daily barrage of good and bad news, the USD continues to trade in a somewhat narrow range with no real identifiable catalyst to break through to either the upside and downside levels in a meaningful way. The second quarter theme is clearly focused on economic and financial stabilization later in the year with optimistic growth prospects and corporate profitability priced into every asset class. The markets have also become very accustomed to the global central bank's monetary policy mantra of zero-percent local interest rates, aggressive quantitative easing actions and contradictory economic reports on a daily basis. Because of the high level of uncertainty surrounding any sustained recovery, the USD continues to benefit from "bad news" days, but quickly looses ground on days that points to better conditions later in the year. Economic data remains mixed at best.

The recent G-20 meetings in London last month delivered a boost to International Monetary Fund (IMF) funding and sentiment in emerging markets should improve marginally as a result. Financial stability tends to be only the first step to economic recovery. Disappointing Q1 earnings and Q2 data will most likely keep risk appetite at bay and contain USD losses.

In the Eurozone, the European Central Bank's (ECB) recent failure to cut by 50 bps risks delaying any recovery as monetary policy remains far too tight in both absolute and relative terms. An expected 25 bps cut in May and the ECB pledge to decide whether unconventional measures will be adopted continues to be the consensus. As the Eurozone growth figures remain disappointing, dovish ECB monetary policies are structurally damaging to the EUR, and could push EUR/USD back down to the 1.25 - 1.30 trading range.

In the UK, the Bank of England (BOE) is monitoring the performance of its quantitative easing through its asset purchase facility. The MPC is expected to keep the current base rate at 0.5 percent. GBP has gained ground recently due to improved risk appetite and the BOE's aggressive monetary stimulus appearing at least to be making some progress. The recent failures by the ECB to move ahead with unconventional measures will most likely have a negative effect on Eurozone growth and the recent EUR/GBP's decline is a sign that markets still value a more aggressive approach. The ECB is also facing an even greater threat of deflation compared to the U.K. but the BOE's willingness to take preemptive action should begin to pay dividend as growth trends diverge. The U.K. has also begun to see some signs of improvement in the housing market and leading indicators, but actual growth numbers should begin to outperform the Eurozone in the coming quarters.

The value of JPY remains a function of both risk appetite coupled with the ever-present grim prospects for global growth. The Bank of Japan (BOJ) continues to focus on the gradual evolution in the array of assets that the central bank buys while injecting massive amounts of liquidity. A recent BOJ meeting via its Tankan survey for Q1 reiterated a collapse in local business conditions.

The aggressive actions by the Bank of Canada (BOC) may quell investor fears regarding potential credit and quantitative easing, but other comments on the economic and labor backdrop have renewed worries of a weaker CAD despite its latest risk rally. BOC Governor Carney recently said credit and quantitative easing may not be necessary as current fiscal and monetary actions should slowly filter through the economy. GDP declined in January on a month-over-month basis for the fourth month in row, with the key Ivey PMI report also coming in below expectations. Both Prime Minister Harper and Finance Minister Flaherty have recently made comments about expected job losses continuing in the months ahead, and the fact that economic conditions will be spotty at best. Commodities - specifically crude oil -/ will continue to drive USDCAD rates as the market trades around $50/barrel.

The large swings in AUD continue to be dominated by risk appetite (carry trading), but structurally the currency is likely to appreciate based on the view the Royal Bank of Australia (RBA) will maintain orthodox monetary policies and apply a wait-and-see approach. The great unknown for the AUD continues to be the health of the local banking system, which has been affected by the uncertainty that its non-performing loans as a portion of total loans will deteriorate in an orderly manner. NZD levels remain linked to the view that a deteriorating NZ economy, but will benefit in a reflationary environment going forward.

As we continue to make our way through this unprecedented environment, the USD remains the world's reserve currency for the foreseeable future, primarily because of investor confidence in U.S. policymaking, the liquidity of safe haven U.S. Treasuries markets, the pricing of global trade in dollars and the untested quality of EUR, which is thought to be the main alternative reserve currency. Foreign exchange participants should continue to discount the debate on the greenback's reserve status and keep focused instead on investor sentiment as the key driver of the USD going forward. Any renewed weakness in global equities - as was the case in late March - will continue to put upward pressure on the safe haven USD.