Asian Central Banks Plot Intervention
Asian currencies, with the exception of the Chinese Yuan and Japanese Yen, have notched stellar performances this
year.  The currencies of Thailand, Malaysia, Singapore, South Korea, to name but a few, have experienced double-digit increases (in percentage terms) against the Dollar. Worried about the impact of a rising currency on export growth, Asian central banks are in the process of intervening in forex markets.  Singapore, which uses currency manipulation as a form of monetary policy, believed to have already made purchases of US government bonds in order to depress the Singapore Dollar. South Korea, as well, has a history of forex intervention, albeit unsuccessful intervention, and may issue currency stabilization bonds before year-end.  The Gulf Daily News reports:

The Bank of Korea has repeatedly stated that it would closely monitor currency markets, expressing concern about the level of the won and money supply growth.

Emerging Currencies at Risk

Most of the world's emerging economies link their currencies to either the Dollar, the Euro or a basket of currencies, through an outright peg or a so-called "dirty float."  These countries have attracted waves of foreign money, with the intent of buying cheap exports, foreign direct investment, and capital/forex market speculation.  As a result, while the upside of these pegs has been seemingly boundless economic growth, the downside has been inflation, since many of these countries have been forced to print money in exchange for foreign currency.  Countries in the Middle East, Asia, and Eastern Europe, especially, have effected tremendous increases in their respective money supplies with double-digit inflation rates to match.  Many savvy investors, namely hedge funds, have begun to target countries with fixed exchange rates that are suffering high rates of inflation, with the reasoning that it is inevitable such currencies will soon be forced into appreciation. The Telegraph reports:

Further east, Vietnam is throwing in the towel as inflation hits 9pc. It said it will no longer hold down the dong by massive purchases of US bonds. Singapore, Taiwan, and Korea have begun to change tack, slowing dollar accumulation before inflation gets out of control.

India's Forex Reserves Top $250 Billion

Among the so-called BRIC developing countries (Brazil, Russia, India, China), India is probably the second hottest economy at the moment, after China of course. And following in the footsteps of other developing countries, it is quickly building a massive stock of foreign exchange reserves in order to hold down inflation. Previously, I resisted covering India, because its reserves were small compared to those of China and Japan and hence its potential impact on the Dollar was limited. However, having set another record, India's forex reserves now top $250 Billion, which rank the country among the highest in the world in this regard. In fact, India is accumulating reserves at the blistering rate of $3 Billion/week!  The breakdown of the reserves (in terms of foreign currency) is unclear, but it seems reasonable to believe that it is dominated by Dollar assets.

Thailand moves to Curb Baht

Nearly one year ago, Thailand’s military overthrew the government in a bloodless coup, and commentators immediately began painting doomsday scenarios around the country’s economy. Since then, the Thai economy has surged, and the Baht has appreciated by over 20% and isn’t showing any signs of slowing. In response to concerns that the rising currency would begin to hinder exports and economic growth, Thailand has introduced a spate of measures designed to hold the currency in check. Namely, Thai businesses and citizens will be afforded more flexibility in transferring money outside of the country and keeping Thai currency in offshore accounts. MarketWatch reports:

“In the absence of a clear softening in the currency's upward momentum, we expect Thai authorities to continue to apply a variety of measures -- including further reductions in interest rates…”

Iceland currency crisis highlights risks of carry trades

One of the most popular types of investments among forex traders is the so-called ‘carry trade,’ in which investors borrow one currency that charges a low interest rate and purchase a different currency that offers a high interest rate. The goal is to profit from the interest rate differential (the gains from lending minus the cost of borrowing). In times of loose monetary policy and simultaneous forex stability, carry traders can extract enormous profits. However, as the current situation in Iceland underscores, when things go wrong, they often go very wrong. Most carry traders buy the currencies of developing countries, such as Brazil, New Zealand, and Iceland, because they offer higher interest rates. However, these currencies are often far less liquid than those of developed countries, which means it can be very difficult to exit quickly and safely from a losing position. Capuchinomics.com reports:

In an environment of rising interest rates, carry trades using the Dollar, Euro and Yen will come under severe pressure.

Investors still see risk in South African Rand

Since 2001, South Africa has been an emerging markets superstar, having seen its currency, the Rand, more than double against the USD. On paper, the Rand’s appreciation seems to be supported by fundamentals. South Africa has narrowed its budget deficit, core inflation is low, and interest rate levels have stabilized around 7%. However, currency traders continue to view the Rand as risky. In most developing countries, high bond premiums are usually attributed to default risk, the likelihood that the government will default on the debt. In South Africa, by contrast, a recent study found 90% of bond premiums could be explained by currency risk. It seems investors are not worried about the government defaulting, but rather they are concerned about the possibility of Rand depreciation. The Economist reports:

Unusually, the Rand is a popular hedging tool for foreigners. The average daily trade in Rand has ballooned since 1998 to nearly $14 billion, most of it by non-residents.

South African Rand settles down in 2005

As 2005 draws to a close, currency traders are taking a collective step back, in order to asses the performance of forex markets. Among the biggest losers, surprisingly, is the South African Rand. Having nearly doubled in value against the USD from 2001 through 2004, the Rand has depreciated 12% against the USD through December. The silver lining, as far as economists and fundamental analysts are concerned, is the marked decrease in volatility surround trading in the Rand, due largely to an increase in liquidity. Rand bulls are already looking to 2006, when GDP growth is expected to exceed 5% on the heels of strong capital inflows and high commodity prices. Reuters reports:

Deepening liquidity also points to growing confidence in an economy which most analysts agree has been well-managed -- especially by emerging market and African standards.