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And the winner is…..

Wed, Dec 31 2008, 16:11 GMT
by Andrew Wilkinson

Interactive Brokers LLC

The clear winner this of the 2008 double-edged sword on the currency front is the Japanese yen. The unwind of the carry trade from which investors sold yen to buy higher yielding currencies continues as does the flight to safety. The yen had its biggest gain in over 20 years against the dollar, while its 36% appreciation against the Australian dollar stands out compared to an appreciation by the US dollar of 21% against the Aussie unit. The problem with being a winner in this sense is that exports become extremely uncompetitive and force domestic growth to grind to a halt. There seems little respite in sight and the worse the situation becomes, the more investors buy Japanese yen.

Heading into the New Year, which presumably can't be as bad as the torrid months we've just encountered, investors are still taking the view that the dollar will lose its de facto safe haven appeal as designated by the fact it's the world's major reserve and the US government the largest issuer of debt. The problem is that investors continue to mistake lower volatility with signs of spring and we're not entirely sure that observation is warranted.

The US economy is undergoing a rude reversal of a scenario that took years to build in which consumers and investors never had it so good. In 2008 the winter storm gave way to a glacial freezing of housing and credit markets, from which it's still too early to see what permanent etchings those glaciers will carve out of the landscape as their hallmarks scratch beneath the surface of the global economy.

In 2008 the dollar weakened against the euro through July and reached $1.6038 before spending three months being the unit of demand racing higher to $1.2330. We made our case recently that the knee-jerk reaction to the Fed's running out of room on monetary policy is far from being a signal that the dollar will weaken from here. Looking at the chart tends to confirm that with what looks like a near term euro slide back to $1.35 on the cards for the first week of January.

The biggest loser of the year was the pound, which lost value on all fronts. We are still unsure why the euro is seen as a better alternative to the pound sterling other than the British like to get all of the bad news on the table. Meanwhile the ECB prefers to talk tough and pretend that even under extraordinary circumstances such as they are facing, that there is some trade off between fiscal and monetary policy. We feel sure that this obfuscation will come back to bite the council in early 2009.

In options trading throughout the week, we note little change in option implied volatility while we observed ongoing purchases of June puts on the euro at the 120.0 strike where investors have increased the number of outstanding positions to 27,671 contracts.
With no signs of alluvial flow from a glacial thawing the bottom line is that the ice age is not yet over, and that should make for some counter-intuitive trading in 2009.

A very happy New Year to all of our readers!

Published on  Wed, Dec 31 2008, 16:19 GMT