It has been a roller-coaster ride in the Forex Markets at the start of this week.
The main news that caused the big movements in the risk currencies was the fact that Standard and Poor’s downgraded the AAA rating of US debt.
This is the first time that US assets have been downgraded since they won the top ranking in 1917.
"The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilise the government's medium-term debt dynamics," S&P stated in its report.
In short, the S&P was not convinced that the deficit reduction plan passed by Congress last week was sound. When markets opened this week, there was bloodshed everywhere.
World equities plunged, with US leading the way.
The Dow Jones Industrial Average was down 2.53 per cent The broader S&P 500 dropped 3.03 per cent, and the tech-heavy Nasdaq fell 3.08%. Elsewhere, Frankfurt closed down by more than 5.0 per cent, Paris was down by 4.7 per cent and London dived by nearly 3.4 per cent.
Asia was not spared too. Tokyo closed down 2.18 per cent, Hong Kong tumbled 2.11 per cent and Seoul sank 3.82 per cent. Gold surpassed US$1,700 for the first time in history, as investors scrambled for safety.
In the Forex Market, AUD/USD plummeted the most among the risk currencies, falling through the key 1.0000 level for the first time since March this year. NZD/USD was not spared either, falling through the psychological level of 0.8000 to touch 0.7964. USD/CAD came within a whisker of hitting parity, a level not seen since early February this year.
With the downgrade of the triple A credit rating and a further “negative” outlook dished out by S&P, the real question is this: “Why is the US dollar strengthening against the AUD, NZD and CAD?” The answer, lies in risk.
Among all the major currencies, AUD, NZD and CAD are considered by traders as “risk” currencies or “commodity-linked currencies.”
This simply means that when traders are looking to take on “risk”, these will be the first currencies to strengthen. One of the primary reasons is because of the “carry trade”, where traders look to earn a higher-yield. The current interest rates for AUD, NZD and CAD stand at 4.75 per cent, 2.5 per cent and 1 per cent respectively, which are some of the highest in the world.
On the other hand, when there is a bout of risk aversion, the same three currencies will be the first to fall. This is the case now, as the downgrade by S&P has sent shockwaves throughout the financial world, causing traders and investors to dump high-yielding assets in search for safety.
It is this flight to safety which has caused the US dollar to strengthen. The yield on the benchmark 10-year Treasury note dropped today to as low as 2.27 per cent, the least since January 2009.
Hence, when we put two and two together, it is not difficult for us to understand why AUD/USD and NZD/USD have fallen drastically, and why USD/CAD has risen over the last few days.
