At the beginning of the last year we were arguing that the U.S. dollar could lose its position as the most popular reserve currency in favor of the Euro. But in the second quarter of 2008 the dollar suddenly started to rebound and began one of its biggest rallies in years, going from 1.6 to 1.2 dollars per euro in only three months.
Indeed, back in 2006 and 2007, several countries were considered to be in much better economic condition than the United States. For example, in that period the Euro Area economic growth surpassed that of U.S. and as a result, international investors were more willing to hedge dollar exposure with investments into the Euro Zone. Moreover, even though some economic slowdown was becoming visible in the United States, the majority of economists believed that the slump would be short and there would be no chance of spilling over to other countries. However, few months later the situation changed drastically, and the underestimated slowdown in the U.S. economy was soon transformed into a major global recession. More importantly, as everyone was being hit by recession fears, the U.S. dollar was once again seen as a safe haven currency, supported international demand for U.S. government securities.
Even so, at Trading Economics we think that current safe heaven position of the U.S. dollar could be temporary. For some time, the U.S. economy has been running a current account deficit and the bill for biggest fiscal stimulus plan in the U.S history could bring the U.S. financial debt to the world very close to unsustainable levels. In fact, with the Japanese and Chinese economies also fighting with the global economic slowdown, one should not be is the yields on U.S. treasuries rises to unprecedented levels, making the fiscal stimulus more pricey than previously estimated.
At the end of January, the Japanese yen reached a series of multi-year highs, hitting a 13½-year high against the dollar, a seven-year peak against the euro and a record high against sterling.
One of the reasons of the recent strength in the Japanese yen is that the currency has been perceived by many investors as a safe-heaven when all major economies are in recession. Indeed, Japan's banks exposure to subprime losses, are not alike the ones in Europe or United States. Moreover, oversees investors, prompted by the intensification of the financial crisis, have started closing carry trade positions and paying off low-yielding, yen denominated loans used for financing of purchase of riskier assets outside Japan. In addition, as the world's third largest economy is shrinking and the interest rates all over the world are falling, getting closer to low Japanese levels, it is likely that domestic investors will bring yen home, driving the currency even higher.
At Trading Economics we think that there is also an increasingly high probability of intervention by the Minister of Finance to sell its currency since a strong yen is damaging already weak exports. Looking further ahead, the Japanese currency is likely to decline once the global economy starts recovering in 2010.