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For financial markets, August was one of the most tumultuous months since the 2008 financial crisis. Depressed by signs of a slowing global economy and slammed by deterioration in European debt markets, traders fled into the relative safety of the Japanese yen, Swiss franc, and US dollar. As September begins, calm appears to be returning, but the potential for violent exchange rate movement remains.
Global Outlook
Two themes are likely to exert significant influence over the currency markets in the month ahead:
Monetary Safety Net Unravels
Financial markets are kicking off September after being kicked in the teeth throughout August.
Economic pessimism began to set in when a series of negative employment, manufacturing and purchasing reports landed on trading desks in the early part of the month. Sentiment was given a further knock when Standard & Poor’s downgraded the United States in early August. Although the move was widely expected, and did little to dissuade investors from purchasing US dollar debt, it certainly served to damage faith in the real economy.
Buffeted by these crosswinds, investors spent much of the remainder of the month awaiting a magic show performed by Ben Bernanke and his Federal Reserve.
However, if developments over the last few years have established anything, it is that central banks are unable to resurrect economies on their own. The Federal Reserve may have the monetary rabbit, but it doesn't have the fiscal hat.
As a result, we expect central bankers to do their best to anchor policy expectations further into the future, while avoiding repeats of the massive asset-buying programmes seen over the past few years. The risks are too large, and the rewards too unclear.
Financial markets will be forced to ride on their own, without the support of government-provided training wheels. Asset prices are vulnerable, and traders will remain cautious around the growth-linked currencies for the foreseeable future.
The ride may be a little wobbly and prone to crashes in the coming months, but one hopes that an old skill is relearned by the turn of the calendar year.