The last few months have born witness to an unprecedented level of volatility in forex markets, to say nothing of the fluctuations in other areas of securities markets. Emerging markets currencies in particular, as well as a handful of industrialized currencies, have crashed violently, as a process of de-leveraging continues to send capital back to the US and Japan. This instability has led some policy-makers to revive an erstwhile exhortation to limit the role of speculators in forex markets, who collectively may account for as much as 90% of daily forex turnover. Specifically, a 1% tax on all forex trades has been proposed, which would be deducted automatically and used to finance infrastructure projects around the world. It has also been suggested that forex markets follow the lead of equity markets by adopting a so-called "up-tick" rule, which would be used to counter sudden waves of predatory short-selling that can cripple a country's currency in minutes. CSRwire reports:

Such bear raids are rarely to "discipline" a country's policies, as traders claim, but rather to make quick profits. In the transparent FXTRS system, traders selling falling currencies begin to see that the rising tax is cascading into the country's currency stabilization fund and cutting into their gains.

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The consensus among economists is now that the US Federal Reserve Bank will lower its benchmark interest rate all the way to 0%. The Fed Funds Rate currently stands at 1%, and two projected 50 basis point cuts within the next two months would bring the rate to its lowest level ever, where it could remain for as long as one year. Apparently, the concern among economic policymakers is that the sagging economy and falling asset prices will ignite a protracted period of deflation. Given the extent to which the Federal Reserve Bank as well as the Federal Government have already moved to stimulate the economy, it's unclear whether any further loosening will have an effect. Currency investors remain unfazed about this prospect, perhaps because the rest of the world is in equally dire straits, and foreign central banks are mulling proportionately drastic measures. Marketwatch reports:

"This [interest rate cut] move confirms a highly pro-active and aggressive central banking community and there will be more to come" from the Bank of England and European Central Bank, said one currency strategist.

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After rising nearly 20% over the last three years, the RMB has virtually stopped appreciating against the US Dollar, perhaps as a result of the credit crisis. At the same time, the US exports sector- previously one of the few bright spots of the sagging economy- has begun to stall. US Politicians have taken note, and are now renewing their efforts to persuade China to allow its currency to rise further. They are also agitated about China's perpetually growing forex reserves (currently estimated at $2 Trillion), which are increasingly being deployed in sensitive areas. Meanwhile, the Chinese economy is growing at the slowest pace in years, and the Chinese government is resorting to desperate measures to prop it up. In short, allowing the RMB to rise, while placating US policymakers, is tantamount to economic suicide, and hence unlikely.

While other sovereign wealth funds have existed for nearly 50 years without controversy, "China appears far less likely than other nations to manage its sovereign wealth funds without regard to political influence that it can gain by offering such sizable investments."

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Since the credit crisis heated up several months ago, the theme of risk aversion has predominated in equity markets. This is also true in forex markets, where deleveraging and a shift to perceived investing "safe havens" has led to a collapse in the carry trade, leading to a sharp rally in both the Dollar and Yen. In fact, the recent rise of these two currencies has coincided remarkably with stiff declines in the prices of virtually every class of risky asset.

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It's a little-known fact that the US Federal Reserve Bank does not actually set interest rates. As a result, there is often a discrepancy between the "suggested" Fed rate and the actual rate. Since the onset of the credit crisis, this gap has widened considerably, such that the "effective" benchmark interest rate is nearing 0%. Some commentators are beginning to draw parallels with Japan, where interest rates have remained close to 0% for several years. If/when the global economy finds its footing, the Dollar could follow the lead of the Yen, and once again find itself a funding currency for the carry trade. The Economist reports:

If the effective rate remains near zero, the Fed will have to turn to more unconventional means of stimulating growth.

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The British Pound has already fallen 25% against the Dollar, since the credit crisis kicked off earlier this year. On a technical basis, therefore, it would seem that the Pound is due for a rally. From the standpoint of economic fundamentals however, the picture is quite bleak. While the Bank of England's recent 150 basis point interest rate cut could help restore the UK economy to solid footing, it sent a massive shock to investors. UK interest rates now stand at a 50-year low, and futures prices suggest that the benchmark rate will fall another 1% in the next 12 months. In addition, the Bank of England has not ruled out ruling interest rates all the way to zero. As unlikely as this scenario may be, investors are now fully aware of the scope of Britain's economic troubles. The next couple weeks could be make-or-break for the Pound, as a series of economic data releases, as well as the minutes from the latest BOE meeting, will help investors craft a more accurate forecast. Daily FX reports:

Housing, industrial trends, consumer spending and public borrowing readings...provide additional confirmation that this evolving recession will be far worse than the slump of 1992.

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In light of the credit crisis, commentators on the Euro have taken to one of two extremes; either they believe the Euro is doomed, or they argue that the Euro represents the key to EU economic salvation. The naysayers point to recent trends in financial markets such as the widening spread between German and Italian bond yields. They further argue that a common monetary policy exacerbated the credit crisis by fomenting real estate booms in overheated economies, namely Ireland and Spain. Supporters, on the other hand, need to look no further than the complete economic collapse in Iceland to understand the advantages of the Euro. Moreover, some of the more fragile EU members (Luxembourg, Belgium) would have witnessed runs on their currencies, if not for their participation in the common currency. In the end, the Euro probably represents a viable investment alternative to the Dollar and it brings the benefit of relative stability to its members. While its supporters are prone to overstating its benefits, it's not likely at risk of crumbling in the next few years. The Economist reports:

The euro's defenders are convinced that the currency will still be there at the end of the crisis. That is a reasonable bet. But public support for the euro may still be painfully tested as economies deteriorate.

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Russia is currently facing its worst currency crisis since 1998, when it defaulted on its debt and the Ruble plunged 71% against the Dollar. This time around, Russia is being attacked on two fronts: the sell-off in emerging markets and the collapse in the price of oil. Both trends occurred suddenly and with such force that the economy swung from current account surplus to deficit in a matter of months. Meanwhile, the Central Bank of Russia has spent nearly 1/5 of its $500 Billion in forex reserves to slow the proportional decline in its currency. If the price of oil and the stock market continue to decline in tandem, the Central Bank will no doubt find it increasingly difficult to defend the currency, and a massive devaluation would inevitably follow. The Central Bank has already hiked rates; it is running out of options. Bloomberg News reports:

Today's central bank decision will prompt "further runs on deposits," wrote [one group of] analysts in a research note today. "Flight from rubles now is the key factor to watch."

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Last week, the Bank of England acquieced to the seriousness of the credit crisis by cutting its benchmark interest rate by 150 basis points- the largest margin in nearly two decades. While the move was intended to restore confidence in the UK economy and its financial markets, the opposite result obtained. In other words, investors interpreted the rate cut as an indication that the UK economic situation is even more precarious than was initially feared. In fact, this bearish sentiment is born out by economic data, which shows falling home prices and rising unemployment. Since peaking against the Dollar late last year, the British Pound has since declined 25%.

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While the Bush Administration nominally embraced a strong Dollar policy, the currency's 20% decline over the last eight years suggests it was actually a low priority. The Obama administration, in contrast, is much more likely to maintain such a policy, a circumstance which could help the Dollar to continue its year-long rally. Obama will assume the office of the presidency at a time when US finances are looking particularly tenuous, with a projected 2009 budget deficit of $1 Trillion. In order to finance the government bailout, as well as an additional economic stimulus plan and a host of other initiatives (let's not forget the two ongoing wars), Obama will need to spearhead an effort to attract more foreign capital. For this to happen, the Dollar's status as the world's reserve currency must be cemented and confidence in the Greenback must be restored. Ironically, Obama may receive a boost in this aspect from the credit crisis. The Guardian reports:

The dollar [rally] is likely to persist as market participants looked to snap up more U.S. assets after the decisive election of a candidate that promised to bring sweeping changes to a country mired in the worst economic crisis since the Great Depression.

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