RMB may Accelerate Post-Olympics

The first half of 2008 has come to a dramatic end, and it's official: China's stock market was the world's worst performer, finishing down 48%. Ironically, some analysts believe this may be a harbinger for a faster appreciation of the Chinese Yuan. While the global credit crisis cannot be completely disentangled from the Chinese macroeconomic picture, certain conclusions can be drawn that are specific to China. In a nutshell, the party may be over. Inflation has surged to a 10-year high, economic growth is slowing, and stocks are facing a prolonged bear market. The Chinese government will likely continue to bide its time so as not to disrupt the Olympics. After the conclusion of the games, however, the Central Bank may begin aggressively hiking rates in order to tame inflation. While this would adversely affect economic growth, it would cause the RMB to appreciate. Forbes reports:

Maybe that's what Shanghai's decline is really telling us, that the China miracle may be losing some of its luster, as China tries to make the transition from a low-cost exporter to a leading provider of 21st century goods and services.

Yen Back in Vogue

Volatility, the perennial enemy of the carry trade, has returned with a vengeance. The US stock market, a proxy for global risk appetite, has fallen significantly (nearly 20%) over the last six months, a trend that has accelerated over the last two weeks. By no coincidence, the Japanese Yen and Swiss Franc have rallied dramatically over the same time period. On one hand, currency trading is seemingly becoming more cut-and-dried, as correlations strengthen between different sectors of the global capital markets and specific currencies. The respective inverse relationships between the Dollar and oil, and between the Yen and US stocks, have been particularly strong of late. In the end, though, it is anyone's best guess whether the price of oil will continue to rise and stocks will continue to fall. Reuters reports:

"We're back on the brink," said one analyst. "It seems there is a feeling of resignation and helplessness amid this credit crisis."

ECB Hikes Rates

In a move that will shock some investors but please others, the European Central Bank has raised its benchmark interest rate by 25 basis points, to 4.25%. On several recent occasions, Jean-Claude Trichet had alluded to the possibility, in connection to soaring inflation. Critics, including several politicians, have countered that the ECB should also be cognizant of the macroeconomic picture in Europe, which is faltering amid the global credit crunch. But such naysayers should remember that the ECB is mandated to maintain price stability, rather than to explicitly facilitate economic growth. In any event, this move certainly throws a wrench into the forex markets. The Dollar had rallied over the last couple months, as traders had prepared for a narrowing US-EU interest rate differential in the medium-term. So much for that theory, reports The New York Times:

But the sharp rise in inflation has put Europe’s bank into a policy bind because it has been accompanied, in recent days, by evidence that the economy here is deteriorating much like that of the United States.

Vietnam Nears Crisis

In what some analysts have termed 'an act of desperation,' Vietnam has devalued its currency, the Dong, by .5%. Negative pressure had been building above the Dong for months, due to a burgeoning trade deficit, sagging stock market, and a stratospheric inflation rate, most recently clocked at 23%. Unfortunately for Vietnam's economic planners, the black market exchange rate remains nearly 5% below the official rate. In addition, futures prices reflect the expectation that the Dong will lose 30% of its value over the next twelve months. At this point, Vietnam is simply trying to forestall a full-scale economic crisis. This will probably involve further devaluations of the Dong. The Times Online reports-

Analysts said that the rising risk of a sudden and crippling depreciation comes as the cracks in Vietnam’s vaunted “economic miracle” have grown too large to ignore.

Inflation or Economic Growth

Global capital markets remain caught in a tug of war between inflation and economic growth. For most of 2008, the economic growth story prevailed as the Federal Reserve Bank cut interest rates aggressively to cushion the blow from the housing crisis. However, the pendulum soon swung to inflation and the Fed began to worry that perhaps it had lowered rates too far and may in fact need to hike them in response to surging food and fuel prices. In fact, the European Central Bank recently hiked its benchmark interest rates. Now, a slew of negative economic data threatens to shift the rhetoric back to the other corner. Securities and currencies have fluctuated wildly over this period, and investors remain unsure about which side the world's Central Banks will err on. Currency traders need to look no further than credit markets for a snapshot of the current consensus, which often presages changes in currency valuations. A quick and dirty analysis would place American and Euro-zone short-term bonds side by side and compare the yields (or prices), as a proxy for the EUR/USD exchange rate. The Wall Street Journal reports:

Two-year yields in all three markets have been on a wild ride in June, driven up by tough inflation rhetoric from central banks, then down again by renewed worries about the credit crisis and the state of financial markets.

Fed Increases Liquidity

In a bid designed to placate skittish investors, America's Federal Reserve Bank announced that it will extend the duration of its liquidity facilities at least through 2008 and possible into 2009. It is hoped that the continued enabling (which began several months ago) of certain Wall Street firms to borrow on especially favorable terms will prop up faltering credit markets. Given that both credit conditions and the economy at large continue to flounder, this move seems more symbolic than anything. Analysts are divided about whether this increased liquidity will serve as a complement or a substitute for a near-term interest rate hike. Futures prices had previously reflected a 65% chance that the Fed would hike rates in September, but the bet is now closer to even money. Reuters reports:

Others...think liquidity problems and inflation concerns are two separate issues. [One analyst] believes that the Fed is still on track to raise rates in September.

ECB, Unemployment Weigh on Dollar

In the near future, this day may be looked back on as important in the battle between the Dollar and Euro that is currently being waged. The previous month had been relatively kind to the Dollar, which had gradually clawed its way back from a record low against the Euro. Then came yesterday, when Jean-Claude Trichet, leader of the European Central Bank, surprised investors when he announced that not only will the ECB not be cutting rates, but in fact, it may hike them. If enough members of the Central Bank become convinced that inflation is unlikely to abate, the rate hike could come as soon as next month. Today, the knockout punch was delivered, when the US unemployment rate came in at 5.5%. Not insignificant by itself, what was most shocking was that the crucial indicator had risen .5% from last month, its largest increase in more than a decade. Reuters reports:

That should undermine the dollar's prospects..."The focus is on the unemployment rate, as it's obviously starting to catch up with the softening in the payrolls figures...and that's what the market is reacting to."

Shekel is One of the Big Boys

The Continuous Linked Settlement (CLS) Bank, which performs the thankless job of settling the nearly $4 Trillion in currency trades completed each day, recently announced that it will now settle trades involving the Israeli Shekel. This is quite an honor for Israel, as only 16 other currencies can claim this distinction. Implicitly, the Israeli Shekel has been deemed both important and stable enough to be fully convertible. The announcement marks another positive development for the currency, which has appreciated by an astounding 30% against the Dollar over the last year, including 15% since the beginning of 2008. It is unclear when amateur traders will be able to trade the Shekel, but now that it is included in the CLS roster, it probably won't be long. YNet reports:

The Bank of Israel has been in contact with CLS on the matter since 2004 and had consistently pushed Israeli banks to meet the CLS criteria. The induction of the shekel into the CLS system is considered a very important step towards upgrading Israel's financial infrastructure.

How Far Has the Dollar Really Fallen?

Kurt Brouwer offers his take on the falling USD over at Fundmastery Blog:

Let’s start with how far the dollar has fallen. One problem with our media is that the news of the day is often one-sided and it seldom comes with any historical perspective. For example, do you remember hearing that the Euro fell to historic lows versus the dollar? Well, as you will see from the chart below, it happened not too long ago. In fact, the Euro fell steadily versus the dollar for the first five years of its existence, beginning in January 1999. It did not get back to even until mid-November, 2003. At the low point for the Euro you could have bought one for 84 cents. Now, it takes a $1.56.

Talking up the Dollar

When it comes to forex, the old adage actions speak louder than words doesn't always hold. In fact, words can be quite effective on their own in holding down or propping up a currency. For a while, the threat of intervention by the Central Bank of Japan was enough to hold down the Yen, despite a lack of supporting action. With regard to the Dollar, several high-ranking economic officials have recently made unsolicited comments implying that traders should think twice about shorting the Dollar. First, Ben Bernanke worried publicly about the effect of the sinking Dollar on inflation. Then, President Bush suggested that the Dollar was undervalued relative to economic fundamentals. Treasury Secretary Hank Paulson capped the effort by refusing to dismiss the possibility of coordinated intervention on behalf of the Dollar. While it has been eight years since the US last intervened in forex markets, it looks like investors are taking these threats seriously. The Wall Street Journal reports:

Traders seized on the comments as a signal that the administration -- which has never intervened in the markets before -- could do so if a dollar rout gets bad enough.

The Next Reserve Currency is The Rouble

Apparently, Russia has aspirations to turn its currency, the Rouble, into an international reserve currency. Moreover, according to an official with the International Monetary Fund (IMF), this plan is not that far-fetched. Despite soaring inflation and political oppression, Russia's economy is forecast to grow at 8% for the next two years, due primarily to soaring natural resource prices. By its own admission, Russia needs to diversify its economy without inhibiting growth, strengthen its financial system, and conduct monetary policy with price stability in mind. These ambitious steps, combined with continued economic growth, would position the Rouble to be a stable and viable alternative to the Dollar, especially on a regional basis. The Guardian reports:

Russia, with a $1.3 trillion economy at the end of last year, is targeting a place among the world's top five economies by 2020, [President] Medvedev has said. But he acknowledges the rule of law needs to be strengthened and corruption must be rooted out.

Soros Bearish on Dollar

George Soros, one of the most well-respected investors who sits in the same echelon as Warren Buffet, just released his book on the current state of the world's financial markets. His conclusion is that a "super-bubble" is forming. Connecting to all of the major financial markets, namely property, commodities, and equities, Soros outlines how the expansion in credit that has unfolded over the last 30 years has caused an unsustainable run-up in the prices of most investable assets. Due to the resulting inflation, investors are now fleeing en masse from mainstream securities and parking their money in commodities, triggering a super-bubble therein. With regard to the Dollar, Soros expects the currency to fall as the credit crisis runs its course and Central Banks gradually replace it with more stable currencies. CBC reports:

I think that the dollar is probably still, will emerge as the most widely used currency but the United State will have to abide by the limitations that are imposed on it by the willingness of the rest of the world to hold dollar reserves.

Vietnam Devalues Dong

The Central Bank of Vietnam has effectively devalued its national currency, the Dong, to bring it in line with market fundamentals. Pressure had been building under the Dong due to soaring inflation, currently estimated at 25%. While 2% devaluation was small in itself, it caps a 5% drop in the currency since March 25. In addition, the move showed just how seriousness Vietnam is about restoring macroeconomic stability. Unfortunately, Vietnam's balance of trade is probably deteriorating faster than it can be repaired, which means the Dong may slide much further. The black market exchange rate is estimated at 18,000:1, compared to the official rate of 16,461:1. Non-deliverable forward contracts imply a 30% depreciation in the Dong in the next year. The Guardian reports:

Fitch Ratings, which lowered its ratings outlook on Vietnam to negative from stable in May, said policy responses have been too slow and too small to deal with the economic pressures.

EU Weakens Economy

While the credit crisis has ravaged the economies of the US and the UK, the EU has largely been spared. First quarter GDP grew at a healthy annualized rate of 2.8%, helped by a whopping 6% expansion in Germany. However, a number of economic indicators now suggest that all is not well on the European front. Business and consumer confidence indexes are trending downward. Manufacturing output is down. So are retail sales. Spain, which benefited the most during the credit boom, is now reaping the greatest losses during the crunch, and could put a drag on the entire Euro-zone. One prominent economist is predicting that the EU economy won't expand at all in the second quarter.

Unfortunately, the only data point which is trending upwards is inflation. Even though the EU is much more efficient than the US in terms of its use of oil, record oil prices (as well as food prices) are taking their toll. As a result, the European Central Bank cannot (or will not) lower interest rates until price inflation returns to a more palatable level. Accordingly, EU member states are taking matters into their own hands by unveiling economic stimulus plans and tax cuts. As far as the Euro concerned, the ECB's focus on price stability (at the expense of growth) is not hurting the common currency, although if the economy really tanks, the story could change depending on concurrent circumstances in the US. The Economist reports:

The ECB has a strict remit to keep inflation in check, so rising commodity prices are likely to keep interest rates high, lending further support to the euro.

USD Recovers

The greenback kicked off the holiday-shortened week higher against the majors, edging up to 104.32 versus the yen and 1.5703 against the euro on the heels of mixed US economic reports earlier in the session. New home sales in April reversed an 8.5% decline in March, improving by 3.3% to 526k units. However, the Case Shiller home price index in March posted its steepest decline on record, down by 14.4% versus a 12.7% drop in February. Meanwhile, in another sign of the struggling US economy ¨C the Conference Board¡¯s May Consumer Confidence survey dropped to a two-year low and worst than expectations to 57.2 versus April at 62.3.

Chinks in the Euro's Armor

2008 has witnessed a rapid appreciation in the Euro, which recently breached the psychologically important $1.60 barrier. Last week, however, the Dollar dramatically reversed course, leading many traders to speculate that the Euro's best days may be temporarily behind it. There are two ideas underlying this theory. First, the Federal Reserve Bank is probably near the end of its tightening cycle, while the ECB has yet to begin. In addition, recent economic data suggests that the Euro-zone economy, which has appeared recession-proof in spite of the credit crisis, may soon falter. The best-case scenario, according to Dollar bulls, would be a loosening of monetary policy in the EU simultaneous with tightening in the US. If such a scenario were to obtain, it would bridge the interest rate differential between the two economies, which many believe is behind the weakness in the Dollar. The Wall Street Journal reports:

If bad news out of Europe starts to accumulate and the Fed stands pat, the dollar’s slide could taper off.

April Marks Dollar Turnaround

Earlier this week, the Forex Blog speculated that the tide was turning on the Euro, which had retreated from the $1.60 threshold. Sure enough, the month of April saw the best monthly performance by the Dollar in over two years. The sudden about-face by the Dollar stems from changes in interest rate expectations. Only a couple weeks ago, the consensus among investors was that the Fed would cut rates further at its next meeting; the only point of uncertainty was whether rates would be cut by 25 or 50 basis points.

As of today, however, there is only a 25% chance that the Fed will cut rates at all, if you go by futures prices. Regarding the Euro, investors are no longer so sure that the ECB will hike rates in response to surging inflation. In short, the new consensus is that the US/EU interest rate differential has stabilized. Then there is the economic picture; investors have "chosen" to be pleasantly surprised by the most recent economic data. While the economic downturn still seems inevitable, it may not be as severe as investors had previously feared. Reuters reports:

In contrast to slightly stronger U.S. data, the Ifo German business sentiment index this week showed the biggest monthly fall since September 2001.

AUD Nears Parity

AUD Nears Parity

The word "parity" is becoming a mainstay of traders in the forex markets. In 2007, it applied to the Canadian Dollar, which had rallied 70% over the course of five years to reach the mythical 1:1 level against the USD. This year, it is the Australian Dollar that is threatening to surpass the Dollar in value. The AUD has always benefited from general USD weakness, but now the focus is shifting to the AUD, itself. The most recent Australian price data suggests that inflation in Australia remains problematic, which could force its Central Bank to raise the benchmark lending rate to 7.5%. In addition, high commodity prices and consequently strong exports should provide demand for the currency. As always, analysts are divided over the likelihood of parity, but that hasn't stopped them from bandying the term about. The Australian Age reports:

Parity was never a "ridiculous suggestion." "But it's probably a bit tougher going because the Australian economy is slowing," says one analyst. "Then again, if you saw a reacceleration in growth, that might be a different story."

Forwards Gain Retail Appeal

The anecdotal evidence for surging retail interest in forex is cropping up everywhere. Moreover, investors are no longer even limiting themselves to the spot market, utilizing derivatives to speculate on future exchange rates. In the UK, for example, 10% of investors intending to purchase real estate in the EU are utilizing forward agreements to hedge their exposure to the Euro, which has risen 10% against the Pound since the beginning of 2008. Evidently, prospective home buyers are hoping that the Euro returns to 2007 levels, which would significantly lower the cost of buying property there. However, if the Euro continues to appreciate, such investors could end up losing more than they bargained for. Homes Worldwide reports:

Even the movement in the markets over a couple of days can make the difference between owning a property and no longer being able to afford it.

Turkish Lira Set for Decline

2007 was a banner year for the Turkish Lira, which appreciated 21% against the US Dollar. However, in the year-to-date, the currency has returned nearly 10% of this gain, making it the third worst performing currency in the world. Turkey generally, and the Lira specifically, are considered by investors as proxies for emerging markets. The global trend towards risk aversion, as well as skyrocketing inflation, are hurting many such currencies. In Turkey, inflation is so problematic (9.4% at last count) that the Central Bank has raised its benchmark interest rate to 15.25%. Ironically, the more the Lira depreciates, the harder it becomes for the Central Bank to control inflation, causing the Lira to slide further as part of a self-perpetuating free-fall. In addition, the country is beset by political uncertainty, as the courts determine whether the nation's current government can stay in office. Bloomberg News reports:

"The recent political developments are likely to complicate policy-making and the investment climate. The deteriorating political backdrop will in turn undermine the prospects for restoring fiscal discipline and reviving the reform agenda."

Fed Lowers Rates

The Federal Reserve Bank recently lowered interest rates for the seventh, and perhaps final, time, bringing its benchmark federal funds rate to 2.0%. Since inflation is still hovering around the 4% mark, the Fed will probably be reluctant to lower rates further. Thus, the markets have been given all of the boost that they are likely to receive, and it is "fate" that will determine whether the economy will find its footing. (GDP growth clocked in at an anemic .6% for the last two quarters). The most recent data (including the just-released jobs data) indicate that the economy may be stabilizing, although consumption and the employment situation are still deteriorating. As a result, the National Bureau of Research has yet to officially declare the current economic downturn a "recession," since the picture remains nuanced. The New York Times reports:

The recession-or-not question is now almost entirely academic, Mr. Bernstein contended, given the steady erosion of American spending power and soaring costs for food and gasoline.

Korean Won is Worst in Asia

In the year-to-date, the Korean Won has recorded the worst performance of any currency in Asia, having recently fallen to a 6-week low. The story is being driven as much by Dollar strength is by Won weakness. US equities have rallied over the last month, as investors may have been overly pessimistic in the previous months regarding near-term US economic prospects. In addition, the Fed has probably lowered interest rates for the last time, whereas the Central Bank of Korea has held its benchmark lending rate at 5% since the summer. This yield differential, which currently favors Korea, may narrow substantially over the coming months, as the Bank of Korea is forced to reckon with slowing growth and rising inflation. Bloomberg News reports:

Growth, at the slowest in more than three years last quarter, is losing momentum, the Bank of Korea said in a report on May 1. Policy makers next meet on May 8 to decide on the benchmark seven-day repurchase rate.

Yen Carry Trade Under Siege

Volatility levels on JPY/AUD forward contracts recently jumped to 25%, the highest level since the Asian financial crisis of 1997-1998. Combined with other factors, this suggests that the JPY/AUD carry trade, whereby investors borrow in low-yield Yen in order to invest in high-yield Australian Dollars, may be coming to an end. Economic indicators show a faltering Australian economy, sagging confidence, and a record trade deficit. Meanwhile, inflation has moderated, such that it is unlikely that the Royal Bank of Australia will hike rates any further and enhance the nation's comparatively attractive yields. Even though the interest rate differential between Australia and Japan remains a healthy 6.75%, investors may deem this inadequate compensation for the risk implied by weak economic fundamentals. Bloomberg News reports:

"For the next one or two quarters, the Aussie's fundamentals will probably look very soggy. I would suggest the Aussie dollar is expensive. There has been a stunning shift back in favor of the yen," [said one analyst].

G7 Warns of Volatility

For the last few months, EU politicians have whined about the appreciating Euro. Aside from some token comments by the European Central Bank, however, the world failed to pay heed. That changed last week, when the G7 formally and harshly warned that volatility in forex markets risks harming the global economy. But talk is cheap, and the real question is whether it will be backed up by action. Most analysts reckon that it will be difficult and would take time for the governments of the EU, US, and Japan, at the very least, to put together a coordinated plan of intervention. Besides, the window has probably closed on action by Central Banks, which have conducted monetary policy irrespective of currency valuations. Reuters reports:

The U.S. Federal Reserve Board [is] nearing the end of its interest rate-cutting cycle, the European Central Bank [is] likely to reduce rates before the end of the year, and things might not get much worse for the U.S. economy. That suggests the dollar may recover in the coming months, with or without official intervention.

ECB Holds Rates

The European Central Bank (ECB) has decided to hold its benchmark interest rate at 4%. Despite signs that the EU economy is slowing, inflation is hovering around 3.5%, and the ECB has announced that its priority will be to maintain price stability. Jean Claude Trichet, President of the ECB, declared during the accompanying news conference that he "deplores" volatility in the forex markets, an indication that he is concerned that the Euro is appreciating too rapidly. It doesn't help the Euro's cause that the Bank of England lowered its benchmark lending rate to 5% earlier in the week and that the Fed is also in the process of easing monetary policy. Both the US Dollar and British Pound recently touched record lows against the Euro.

Retail Appeal of Forex Grows

With average daily turnover of $3 Trillion, the foreign exchange markets are the largest financial markets in the world. Despite boasting such impressive volume and liquidity characteristics, forex is nonetheless considered extremely risky, and thus viewed as the bastion of experienced traders. This is slowly beginning to change, as investors have moved to diversify their portfolios away from the traditional allocation of stocks, bonds, and cash. Investing directly in forex still not recommended by financial advisers. However, there exist alternative strategies, such as buying CDs denominated in foreign currencies and/or securities that are issued by foreign companies and trade on domestic exchanges. These kinds of "indirect" strategies typically take the form of either "single play" or "double play" strategies. With both strategies, investors attempt to profit through cross-border interest rate disparities, but with "double play" trades, investors seek to profit from currency appreciation as well. The New York Times reports:

Mr. Orr advised currency buyers to research foreign nations and their credit risks, determine at the start their own risk-reward ratio and tolerance to volatility, and have exit strategies, while watching their positions constantly.

Central Bank of Japan Appoints Leader

For several months, the Central Bank of Japan had been leaderless, creating a situation that was politically and economically awkward. Finally, after much debate, Masaaki Shirakawa, a former academic and veteran central banker, was appointed. It is unclear what effect Mr. Shirakawa will have on Japan's economy, which is foundering (for reasons unrelated to the global credit crunch). He is considered highly competent, and analysts have suggested that he could help Japan develop a sensible and focused economic policy, which has been lacking for quite a while. With regard to monetary policy, he is unlikely to either raise or lower interest rates from the current level of .5%. Thus, if he is to return Japan to economic credibility, he will have to use other methods. Nonetheless, analysts are optimistic. The New York Times reports:

Simply having a hand at the central bank’s tiller will do much to restore global confidence in Japan and its ability to manage its $5 trillion economy, economists and former bank officials said.

USD: Where is it Headed?

The last week has seen a spate of positive developments in the financial markets, including reassurances by several bulge bracket investment banks that their respective capital positions are in strong and in no need of shoring up. As a result, some analysts are speculating that the worst of the credit crunch has already been priced into securities and the USD, and that actual write-downs on subprime mortgage obligations won't match the "Himalaya-like guesstimates." At the same time, job losses are mounting and the unemployment rate recently crossed 5% for the first time in two years. Interest rate futures contracts suggest a 20% chance that the Fed will cut rates by 50 basis points at its meeting on April 30. Then, there is the ECB, which has been vocal about fighting inflation and European financial markets, which have benefited from "domestic" investors diversifying within the EU rather than to the US. Thus, there is no definitive answer regarding where the Dollar is headed in the near-term: everyone seems to have their own opinion. Bloomberg News reports:

The Dollar Index traded on ICE Futures in New York, which tracks the currency against those of six trading partners, dropped 0.2 percent to 72.049, its third straight decline. It was at a record low of 70.698 on March 17.

Forex Leads Equities

In recent months, the credit crunch has ignited a global trend towards risk aversion. As a result, a correlation has developed between equities, which serve as a proxy for risk, and certain currencies. The Forex Blog previously covered the link between the S&P 500 and the Japanese Yen, whereby the Japanese Yen moved inversely with the S&P as a decline in risk appetite led carry traders to unwind their positions. Perhaps, this connection can be seen in other currencies. Since the forex markets are open 24 hours a day and are the most liquid financial markets in the world, macroeconomic events are often priced into currencies before they are priced into equities. In addition, carry trading strategies have expanded beyond the Japanese Yen. In fact, the USD is now a decent candidate as interest rates are negative,when adjusted for inflation. Thus, an increase in risk appetite could simultaneously boost the S&P and punish the Dollar!

USD: Worst Quarter in 4 Years

In the first three months of 2008, the USD notched its worst quarterly performance since 2004, falling over 8%. During the same period, the Dollar lost 10% of its value against the Japanese Yen and 6.4% against a broad basket of currencies. Forex analysts reckon the slide was so steep because investors have taken stock of the US economic situation and have concluded that recession is inevitable. The story is also being driven by interest rates. The Fed has already cut rates by 300 bps in the current cycle of easing, making the benchmark federal funds rate the lowest in the industrialized world, in real terms. Meanwhile, the European Central Bank is giving every indication that it will maintain rates at current levels in order to keep a lid on inflation. As a result, the Dollar could fall further, especially if the Fed continues to hike rates and investors use the currency to fund carry trades. Reuters reports:

[According to one analyst], "And to call a bottom now is still a very risky call. It's too early to say the worst is behind us and the dollar's in for a sharp rebound."

Barclays Introduces Carry Trade ETN

Through its trademark iPATH line of funds, Barclays Bank recently introduced a new ETN designed to mimic the carry trade. In accordance with this strategy, this note is linked to the performance of the Barclays Intelligent Carry Index, which aims sell low-yielding currencies and use the proceeds to invest in those that offer higher yields. This index holds varying combinations of the so-called G10 currencies, which includes all of the majors as well as the Norwegian Krona and Swedish Krona. Traditionally, carry traders have sold one specific currency (i.e. Japanese Yen) in favor of another currency (i.e. the New Zealand Dollar). By instead purchasing this note, which will trade under the ticker ICI, investors can buy a share of an entire portfolio, optimized expressly for this strategy. Comtex reports:

The index is composed of ten cash-settled currency forward agreements, one for each index constituent currency, as well as a "Hedged USD Overnight Index" which is intended to reflect the performance of a risk-free U.S. dollar-denominated asset.

How Can An Offshore Company Be Used?

Listed below are just some of the ways our clients use their Offshore Companies. Intended as no more than a general guide, and avoiding technical terms, it is meant to give you an idea of how versatile offshore companies can be. Naturally, we can give you precise advice on how best to achieve your goals by using an offshore company. All you need to do is ask.

International Trading using an Offshore Company

How to use an offshore company

Import and Export transactions can be made significantly more tax-efficient if they're carried out through offshore companies. Using an offshore company as an intermediary between a seller and a buyer of products or services in different countries allows profits to be accumulated offshore. (This is often called Transfer-Pricing.) Such offshore-companies are generally called marketing or export consultancies, and, with nominees handling all offshore company administration such as phone calls, emails or faxes, the appearance of the company is greatly enhanced.

Although invoicing is invariably carried out via the offshore company, the goods can, nevertheless, normally be delivered direct from seller to buyer.

Such devices can be particularly beneficial for transactions between EU countries, with VAT accounting problems solved by registration in a suitable location, such as the UK or Southern Ireland, the onshore company then working in conjunction with another corporate vehicle, for example a Belize company.

Factoring of debts using an offshore company also offers possibilities to move money from a high-tax to a low-tax area.

Manufacturing

Some countries have a preferential tax-rate for manufacturers, and this can be exploited by establishing a manufacturing company in the appropriate jurisdiction and separating the manufacturing parts of the company's operations from its other functions by basing it in such a free-trade zone. Structured correctly, huge savings can be made.

Offshore Investment companies

An Cloud Worldwide Ltd is often used to make investments and accumulate wealth. Just as an onshore company can invest in stocks, shares, property or commodities, so can an offshore company. The only difference is that the offshore company doesn't have to pay tax on its profits, nor inheritance tax when it is passed on to heirs.

In many jurisdictions, Withholding Tax is levied on income remitted out of the jurisdiction, but the careful use of double-tax treaties can reduce or even eliminate tax on the investment income. This may enable the investor to make investments in high-tax countries from an offshore base with minimal tax liability.

In some countries, interest is paid gross on tax-free bonds or bank deposits and this can be integrated into the client's tax planning. In certain circumstances, interest may be rolled up without income being remitted, and, in some jurisdictions, death duties and capital gains taxes are not levied.

Most importantly, the use of an offshore company also protects the identity of the ultimate beneficial owner. Anonymity comes automatically with offshore companies, and is respected by the law in the offshore world

Offshore Holding companies

Offshore holding companies can handle dividend receipts from a spread of subsidiaries. This allows a group to centralise its resources and maximise tax benefits. Careful use of tax treaties is necessary to obtain the best results.

Various locations, both on and offshore, can be used, with the holding company funding subsidiaries in a tax-efficient manner.

Property-owning Companies Registered Offshore

Placing property into the ownership of an offshore company yields many immediate advantages, including the avoidance of Inheritance Tax and Capital Gains Tax. This is because the anonymously-owned offshore company changes hands in the event of death or re-sale, not the property.

Additionally, any subsequent sale is greatly simplified. In some countries the establishment of title is time-consuming and costly; but once title has been established for a company-owned property it never needs to be dealt with again. This is because the sale can be made by transferring the shares of the company, with title to the property remaining vested in the company. In other words, the company can be sold instead of the property.

Sales by share-transfer almost always save on legal fees, together with any transfer or value-added taxes that are levied in some countries. Government stamp-duties and capital gains taxes can also be avoided.

Probate

The ownership of a portfolio of investments through a single offshore holding company greatly simplifies probate procedures upon the owner's death. It is easy and anonymous to deal with an Offshore Banking in this way. Probate can be applied for in one offshore jurisdiction rather than in several different countries where the assets are located.

Legal fees are often significantly reduced and publicity can be avoided for high-profile individuals and families.

Consultancy and services

Consultants, financial advisors, real estate agents, musicians, security consultants, bodyguards and entertainers often receive much of their income from overseas.

This income can be remitted to an offshore company, which is the individual's employer, and, after paying only a modest amount for expenses, thus retains the bulk of the funds in an offshore account.

Employment overseas is often facilitated by the use of an offshore employment company. This can either employ an individual or a group of individuals working overseas. The employee keeps the bulk of his income outside the country of employment. This type of structure can also reduce currency exchange problems and circumvent a number of employment and residency obstacles. For further information on this, please see our Offshore Payroll section.

Offshore Ship and yacht ownership

It's often advantageous to pass ownership of a vessel to an offshore company. As well as securing significant tax benefits, it can also provide an easy registration procedure for yachts, which in certain countries can only be registered on the major national register with onerous compliance requirements.

We can provide a separate offshore company formation to operate or charter the vessel, thus separating ownership and income for additional tax benefits.

Intellectual property

Patents, copyrights, trade marks, franchises and other rights such as those in music, computer software and technical know-how can all be transferred to the ownership of a licensing company, either offshore or onshore. The licensing company enters into licence or franchise agreements with the original company owner and then receives royalty payments and licence fees.

Insurance companies

Most offshore centres will only accept registration of insurance companies which are subsidiaries of existing insurance groups, or which are very heavily capitalised. Nevertheless, in several first-class jurisdictions it is still surprisingly easy to register an insurance company that would not meet the capitalisation requirements of the UK.

Offshore Internet Trading

One of the fastest growing areas of international trade is the Internet. The international nature of the trade and the potential tax complications of dealing across borders can be solved by the creation of a specialist internet trading company offshore.

To obtain favourable tax treatment, it is best to locate the server physically offshore. However, you can still use a normal domain name.Your customers would not notice any difference, no matter where the server was hosted. We can assist with Web Design and Offshore Hosting or simply give you free advice if you require it.

Though the opinion is often expressed that such operations are 'all in cyberspace' and therefore location is not important, it remains a fact that regulation is increasing and planning should anticipate possible future developments. Although the Americans seem determined to keep the internet tax free, no one really knows how it will turn out long term. True to form, EU legislation concerning the sale of downloadable products and services relating to the payment of VAT is making things more complicated. An example of this is eBay: if you live in the EU you have to pay VAT on your invoices, but if your billing address is outside the EU you don't. This is the result of EU legislation which came into force in July 2003.

Asset Protection using an Offshore Company

An offshore company can be perfect for Asset Protection. Transferring title to assets to an offshore trust means that the settlor (the person who gives up ownership in favour of the trust) no longer visibly controls these assets. This means that they cannot be seized in cases of insolvency, marital proceedings, professional negligence, or by the taxman.

However, if the trust was set up intentionally to avoid a known current or future liability it may be set aside by the courts. Particular care is needed in the US and, since the 2004 budget, the UK is also looking closely at trusts.

Regardless of problems in some countries, trusts, when correctly structured, are excellent asset protection vehicles, and are extremely flexible in times of political and economic instability.

A further advantage of trust formation is that 100% anonymity is still possible and a trust can perform all the functions of a company without some of the restrictions that apply to companies.

Family wealth protection

Trusts are often used to safeguard family wealth by imposing conditions on the use and distribution of money and assets by present and future generations. Such arrangements may also replace a will in certain circumstances. Trusts can be used legitimately to avoid 'forced heirship' provisions affecting inheritance. Inheritance, capital gains and income taxes can all be minimised in this way.

Currency Traders Dump Bernanke

On January 31, 2006, Ben Bernanke officially replaced Alan Greenspan as Chairman of America's Federal Reserve Bank. At that time, the EUR/USD and USD/JPY exchange rates hovered around 1.20 and 118, respectively. For the first year of his tenure, Bernanke lived up to investor expectations and burnished his credentials as an inflation fighter by continuing a string of interest rate hikes begun by Greenspan. Fast forward to today, where the US economy is in tatters, inflation is raging, home and equity prices are slumping, and the Dollar has declined to $1.55 against the Euro and 100 against the Japanese Yen. Meanwhile, forex volatility levels are climbing rapidly, suggesting that the Dollar's troubles still havn't reached their climax.

Needless to say, currency traders- and a whole host of other investors and analysts- are furious with Bernanke. Many insist that he misled them, by downplaying the seriousness of housing jitters and insisiting stubbornly that inflation isn't a problem. Even now, he is lowering interest rates in order to spur the economy, but at the expense of price stability. As any experienced currency trader can attest, low interest rates and high inflation are a recipe for a weak currency. Reuters reports:

Bernanke "has sacrificed the dollar in an attempt to save jobs and U.S. business," said one analyst. "He had to do something, but at the same time he is only putting off the crisis. We will face tight credit for a decade and we will have stagflation."

The Yen Marches On

In recent periods of Dollar Weakness, all of the major currencies have been quick to capitalize- all but the Japanese Yen. After a while, it became clear that the Yen was being held down by carry traders, who sold Yen in favor of higher-yielding, more risky currencies. It was long believed that the only thing that would shake the Yen loose from its moorings was not a Japanese interest rate hike or economic growth, but volatility in capital and forex markets. Sure enough, the explosion of the credit crisis induced a rapid appreciation in the Yen. Yesterday, it crashed through the psychological milestone of 100 for the first time since 1995.

But can the Yen sustain this momentum? On paper, if the Dollar continues to fall, it seems the answer is 'Yes.' However, Japan's economy is extremely dependent on exports. In fact, 50% of its 2007 GDP growth can be attributed to exports. With the Dollar crashing, Japan's exports are becoming less competitive, and its exports to the US (estimated at $150 Billion) are in jeopardy. In addition, Japanese consumers are notoriously tight-fisted, so it's unclear who would pick up the slack if the export sector falters. This begs another question: will the Bank of Japan be forced to intervene in currency markets (like it did in 1995) in order to prevent its economy from dipping into recession? The Wall Street Journal reports:

Its big budget deficit makes a stimulus package more difficult. Intervention -- which Tokyo also tried in 2004 during a bout of yen strength -- would fly in the face of efforts by the U.S. and other nations to let markets decide currency values.

Bank Collapses, Dollar Plummets

Over the weekend, Bear Stearns, a prestigious American investment bank, hurriedly scrambled to find a buyer in order to avoid having to file for bankruptcy. While a buyer (JP Morgan) was ultimately secured, investors remained jittery, as the collapse of this magnitude is virtually unprecedented. When forex markets re-opened on Monday, the Dollar crashed against all of the world's major currencies, namely the Euro and the Yen. Furthermore, analysts are now beginning to view forex intervention as increasingly likely. It's still unclear whether the Bank of Japan or the European Central Bank (with or without support from the Fed) would spearhead any such intervention. At the breakneck speed at which events are unfolding, however, no one will be surprised if a plan is quickly cobbled together. The Wall Street Journal reports:

"Were such intervention to be seen, (the euro) could briefly trade down to $1.55, yet unless the (ECB) is prepared to back up such intervention with a rate cut, intervention will be futile," said [one analyst].

BOC to Cut Rates Further

Ironically, the faltering US economy has induced the Dollar to appreciate against many of the world's currencies. The reasoning is that countries whose economies are tied closely to the US will falter even more than the US during a recession. One of those countries is apparently Canada. As a result, the Bank of Canada has already moved to cut rates by 50 basis points in order to mitigate against a full-blown Canadian recession. All of the economic indicators are already pointing downwards and GDP growth is projected to be a paltry 1.8% in 2008. In addition, exports to Canada's largest trade partner, the US, have sagged noticeably, such that its current account recently slipped into deficit for the first time in nearly a decade. The Bank of Canada is busy plotting strategy, with additional rate cuts in the offing. It looks like the monumental run of the Loonie has finally come to an end. Bloomberg News reports:

Canada's dollar will probably remain within the range it has held since the start of the year because investors are still avoiding risk amid the unsettled U.S. economic outlook. It has traded within about 4 percent of parity with its U.S. counterpart, after surging last year as high as 17 percent.

Fed Rate Cut has Small Effect

On Tuesday, the Federal Reserve Bank lowered its benchmark federal funds rate by 75 basis points, its sharpest cut in decades. The markets initially reacted positively to the move, which was intended to shore up sagging confidence in the economy and financial markets. But the next day, most of the gains had been lost, as investors feared both that the recession has already begun and that the Fed is giving up on fighting inflation to battle the lost cause of the economy. In fact, as many analysts feel a recession is a foregone conclusion, the focus may soon turn to inflation, especially given exploding commodity prices and the sagging dollar. The New York Times reports:

"I'm disappointed," said an economist at Citigroup. "It's not as if we're trying to gauge policy priorities on a sunny day. I'd like to know how you're going to get inflation in an environment with suffocating financial restraint and pervasive slowing in demand."

USD: 0 for 3

In a recent commentary piece, the Market Oracle used the analogy of baseball to outline why this will be an "off year" for the Dollar, listing three reasons to support its claim. Consumer spending was listed first because it represents the largest component of US GDP. Since much consumption is financed through borrowing and since the credit crunch has forced banks to rein in lending, the Oracle reasoned that consumer spending will be especially hard hit. Next, there is the worsening employment picture. As its moniker implies, the "jobless recovery" that has characterized the US economy over the last few years did not add many jobs, and due to the economic downturn, jobs are now being shed. Finally, the Market Oracle has identified the Federal Reserve as a primary contributor to the decline of the Dollar. While the Fed is trying to shore up the economy, it is simultaneously enabling inflation. Thus, even if the battle is won and recession is averted, the Fed may still find that it has lost the war- on prices.

Brazil to Alter Forex Rules

In a thinly disguised effort to stem the appreciation of its currency, Brazil has announced sweeping changes to its rules governing forex. Rather than revert to outright intervention in the forex markets, however, Brazil will permit businesses to hold more foreign currency as part of their reserves. In this way, the Central Bank won't have to purchase Dollar-denominated assets directly. Instead, it is hoping that the natural attraction of US and other Western capital markets will be enough to drive private Brazilian companies to increase their holdings abroad. It is intended that this will act against the upward pressure on the Real, which rose 20% against the Dollar in 2007, and 5% already in 2008, and now threatens to drag down the economy. Dow Jones reports:

The strong real has made some Brazilian manufactured exports such as textiles and footwear less competitive. Meanwhile, it also has introduced a boom in imports resulting in a narrowing of the country's trade surplus.

USD Weighed on Bernanke`s Assessment

The dollar fell against the euro and sterling, slipping to 1.4647 and 1.9736, respectively. The greenback was unable to sustain earlier gains following better than expected US economic reports as hints of further interest rates cuts from the FOMC weighed on the currency.

The data included weekly jobless claims, which eased to 348k down from 356k a week earlier. Meanwhile, the December trade deficit shrunk by more than estimates, falling to $58.76 billion, compared with calls for a decline to $61.5 billion from $63.12 billion in November. Also, the deficit with China fell to $18.79 billion versus $23.95 billion from November.

Fed Chairman Ben Bernanke said the outlook for the economy has worsened in recent months and that downside risks to growth have increased. He provided a somber assessment of the housing market, labor market and credit conditions, adding that conditions could worsen more than anticipated. Bernanke expects sluggish growth in the near term but anticipates a stronger pace later as monetary and fiscal stimulus trickle into the economy. He emphasized lags in monetary policy and that stance should be assessed in light of medium term forecasts and risks. Further, Bernanke sees overall CPI easing from recent rates and expectations remain anchored. He said the Fed would closely monitor inflation expectations. Bernanke’s comments reinforce market sentiment that the FOMC will maintain its easing stance, saying it would “act in a timely manner as needed to support growth and to provide adequate insurance against downside risks”.

Weak US Data Drags USD

The dollar eased further versus the euro and sterling following another round of weak US economic data, falling to 1.4708 and 1.9722, respectively. A key indicator of consumer confidence fell to its lowest level in 16-years with the University of Michigan preliminary sentiment survey dropping to 69.6, versus 78.4 from January. Industrial output in January crept up marginally to 0.1% versus a flat reading in December. Meanwhile, capacity utilization also increased slightly to 81.5% from 81.4% a month earlier. Also released was the December net capital flows (TIC), which more than halved to $60.4 billion, versus a revised $150.8 billion a month prior.

The string of soft US data reinforces fears that the economy is headed toward a recession, thereby prompting the Fed to aggressively ease rates over the coming months. Fed funds futures contracts reflected a 60% probability for the FOMC to cut rates by 50-basis points to 2.50% at the next policy setting meeting in March.

AUD Rallies on Hawkish RBA

The dollar is weaker against the euro and Aussie as the US market returns from holiday, falling to its lowest level in 3-months versus the Aussie at 0.9236 and a 2-week low against the euro at 1.4756.

The NAHB housing market index unexpectedly rose to 20 in February, versus 19 a month earlier. Nonetheless, despite the improvement, the index remains mired near record lows. Traders will turn to US economic data slated for release on Wednesday, which include January CPI, building permits, real earnings, and housing starts. Consumer prices in January are largely unchanged, with monthly headline CPI at 0.3% from 0.4% and 4.2% versus 4.1% from the previous year. The core readings are seen at 0.2%, unchanged from a month prior and 2.4% y/y, also unchanged.

FOMC Minutes Suggests Further Cuts

The greenback edged higher against the majors, climbing to 108.36 versus the yen and pushing the euro to 1.4615. A barrage of US economic data was released earlier in the session, with key indicators on inflation and housing giving further clues on the scope for additional easing by the FOMC. Inflation ticked higher in January with the headline consumer price index edging out expectations – at 0.4% m/m and 4.3% from 4.1% a year earlier. The core CPI, which excludes food and energy, stood at 0.4% m/m and 2.5% from 2.4% in the previous year. Housing starts reversed the 14.2% plunge in December, edging up by 0.8% to 1.012 million units in January.

The FOMC released its monetary policy minutes revealing that in addition to the unscheduled meeting on January 21st, in which the board cut rates by 75-basis points, the Fed also met two weeks prior on January 9th. In the minutes from the January 30th meeting, the Fed expects downside risks to remain – lowering its growth projections for 2008 to 1.3%-2% from 1.8%-2.5%. The overall tone from the minutes provided a somber outlook for the economy, with risks for steeper deterioration in the housing market, tighter credit conditions and jobless rate risk tilted to the upside. However, the Fed did note that when conditions improve, “possible rapid reversal of cuts may be needed”.

US economic reports slated for release on the Thursday session will see weekly jobless claims, January leading indicators, and the Philadelphia Fed survey. Weekly jobless claims are expected to edge up slightly to 350k, versus 348k in the previous week, while the leading economic indicators for January are forecasted to dip by 0.1%, improving slightly from the 0.2% a month earlier. The February Philadelphia Fed survey is seen improving to minus 11, from minus 20.9 a month earlier.

USD Slumps on Dismal Data

The dollar fell across the board, slumping to a two-week low against the euro to 1.4837 and relinquishing the 1.96-level versus the sterling. The catalyst for the greenback’s losses was another round of weak US data reigniting fears that the economy is headed into recession.

The Philadelphia Fed manufacturing index plunged to its lowest level since 2001 to minus 24 in February deteriorating further from the minus 20.9 reading a month earlier and defying expectations for an improvement to minus 11. The January leading economic indicators index was in line with expectations, down 0.1% versus a 0.2% decline from the previous month. Meanwhile, weekly jobless claims came in at 349k, versus a revised 358k from the previous week.

Given the current scenario of deteriorating fundamentals and lingering inflationary pressure, we expect the Fed to maintain its focus on growth with inflation reports taking a secondary role. Yesterday’s stronger than expected consumer price index reports failed to deter markets from pricing in further aggressive rate cuts by the FOMC. We look for the Fed to cut rates by 50-basis points when they meet next month, taking their benchmark lending down to 2.5%.