USD reserve status will fade
Late last year we identified sovereign risk as being a new driver for the
FX market. It seems to us that the market is, quite sensibly, identifying
UK risk and ascribing risk to a EUR break-up scenario. However, it
would seem the risk to the US is being ignored since its reserve
currency status remains intact for now.
In times of a crisis, the USD’s liquidity premium is an attractive feature.
The idea of steering towards currencies with better liquidity makes
sense; however, some currencies are already starting to deviate from
this relationship. When the link between liquidity and relative currency
performance weakens the USD will be vulnerable.
Will Japan act to halt the yen?
The recent surge in the yen is having a negative impact on an already
weakening Japanese economy, and Japan’s policy options are very
limited. Currency intervention would appear to be a sensible route to
pursue. We ask whether intervention is imminent.

USD reserve status will fade (pg 3)
Late last year we identified sovereign risk as being a new driver for the FX market. However, we never
expected the market to have prejudiced ideas of risk and use it to confirm pre-conceived ideas. It seems to
us that the market is sensibly identifying UK risk and ascribing risk to a EUR break-up scenario.
However, it would seem the risk to the US is being ignored as its reserve currency status remains intact.
In times of a crisis, the USD’s liquidity premium is an attractive feature compared to other currencies.
The idea of steering towards currencies with better liquidity makes sense but some currencies are
deviating from this relationship. If the link between liquidity and relative currency performance was to
weaken on a sustainable basis, consistent with a move back towards a risk seeking environment the USD
could be vulnerable.
Will Japan act to halt the yen? (pg 13)
The yen has been the world’s strongest currency over the past 18 months, rising 40% on a trade weighted
basis. At a time of severe global economic slowdown this is putting Japanese exporters under intense
pressure. The market value of the Japanese transport sector (a major exporter) is more than 60%, and total
Japanese exports fell by an unprecedented 36% in the year to December 2008. Given the economic
pressures from the strong yen, should we expect the Japanese authorities to intervene to try to halt or
reverse its movement?
CAD: Still very much in the woods (pg 19)
USD-CAD has still not managed to generate any follow-through gains after its massive 25-cent-plus rally
seen in the last quarter of 2008. And while trading in the currency pair remains choppy, a consolidation
pattern has developed over the past three months. The fact that USD-CAD has not yet extended that sharp
November rally has not changed our view that the currency pair will eventually move higher. If anything,
the fundamental backdrop for the CAD has turned worse, not better, since the turn of the New Year
Precious metals – Deflated expectations (pg 24)
Gold faces pronounced deflationary pressures, but safe-haven buying due to financial market uncertainty
and potential USD weakness may support bullion, we believe. A sharp drop in growth of silver mine
output should offset declining industrial demand; a rally in silver prices could depend on investor interest,
steady ETF purchases, and robust demand for coins and bars. We expect platinum to move into modest
surplus, based on weak demand for autocatalysts and cuts in mine production; palladium’s surplus is
narrowing due reduced production; dwindling Russian stocks could support prices.

Dollar Bloc (pg 27)
Canada – See CAD: Still very much in the woods
Australia – Not as bad as some
The AUD has suffered since the start of 2009. But the massive downside risks to the AUD seem to have
abated. The rate cutting cycle seems to be at its end and the fiscal stimulus looks like it will work with plenty
of room for more if it does not, the Australian economy and the AUD could have reached their trough.
New Zealand – ...and the winner is the AUD
After cutting the cash by another 150 basis points to 3.5% at the end of January, RBNZ Governor Alan
Bollard avowed there was “plenty of room” for further changes in the cash rate. If the market was trading
solely on interest rate differential and a current account regime then the NZD would be in even bigger
trouble than it is already. With the rate differential drying up, the AUD has a lot of potential to appreciate
against the NZD.