Nominal and real exchange rates

• The nominal exchange rate e is the price in domestic currency

of one unit of a foreign currency.


• The real exchange rate (RER) is defined as , where P is the

domestic price level and P * the foreign price level. P and P * must have

the same arbitrary value in some chosen base year. Hence in the base

year, RER = e.


The RER is only a theoretical ideal. In practice, there are many foreign

currencies and price level values to take into consideration.

Correspondingly, the model calculations become increasingly more

complex. Furthermore, the model is based on purchasing Power Parity

(PPP), which implies a constant RER. The empirical determination of a

constant RER value could never be realised, due to limitations on data

collection. PPP would imply that the RER is the rate at which an

organization can trade goods and services of one economy (e.g. country)

for those of another. For example, if the price of a good increases 10% in

the UK, and the Japanese currency simultaneously appreciates 10%

against the UK currency, then the price of the good remains constant for

someone in Japan. The people in the UK, however, would still have to

deal with the 10% increase in domestic prices. It is also worth mentioning

that government-enacted tariffs can affect the actual rate of exchange,

helping to reduce price pressures. PPP appears to hold only in the long

term (3–5 years) when prices eventually correct towards parity.
More recent approaches in modelling the RER employ a set of

macroeconomic variables, such as relative productivity and the real

interest rate differential.

Free or pegged

If a currency is free-floating, its exchange rate is allowed to vary against

that of other currencies and is determined by the market forces of supply

and demand. Exchange rates for such currencies are likely to change

almost constantly as quoted on financial markets, mainly by banks, around

the world. A movable or adjustable peg system is a system of fixed

exchange rates, but with a provision for the devaluation of a currency. For

example, between 1994 and 2005, the Chinese yuan renminbi (RMB)

was pegged to the United States Dollars at RMB 8.2768 to $1. China

was not the only country to do this; from the end of World War II until

1966, Western European countries all maintained fixed exchange rates

with the US dollar based on the Bretton Woods system.

Week of April 6, 2008

Highlights:

1. Rebound in risk appetites looks set to falter
2. EU Finance Minister meeting this weekend; G7 next Friday
3. BOE and ECB interest rate decisions
4. Key data and events to watch next week

Rebound in risk appetites looks set to falter


Friday's NFP report provided further evidence that the US economy remains on weak footing, as if any more were needed. But a strange thing happened on the way to the recession. Market sentiment appears to have embraced the view that the US downturn will be relatively manageable, if not downright mild. I'm not about to embrace that view, but I can understand where it's coming from. In the Week Ahead of March 21, I suggested that risk appetites (and USD/JPY and JPY-crosses) were set to rebound after aggressive Fed actions significantly reduced the potential for a US financial system failure. Indeed, since then risk appetites have come back, with JPY crosses up roughly 8 yen since March 21. Stock markets have recovered and commodities are stabilizing after sharp corrections.

But the horizon for the financial sector is far from clear and many risks remain. Inter-bank lending rates (LIBOR, EURIBOR) are actually making new highs since the credit crunch began last summer, suggesting the root problem—confidence between financial firms based on transparency (who's sitting on what size losses)—has yet to be remedied. Looking ahead, major US banks are set to begin announcing 1Q earnings after the middle of April and there are likely to be additional sizeable losses and disappointments, potentially rekindling fears over financial sector solvency. As a reminder of the potential for unwelcome surprises, as I'm writing this on Friday afternoon, Fitch ratings has just cut its AAA rating on the largest US bond insurer, which only recently avoided downgrades from other rating agencies by raising additional capital. At the minimum, then, I suspect the rebound in risk appetites has likely run its course already and is more likely to fade than extend. In currencies, the proxy for risk appetite is USD/JPY and JPY-cross strength. If USD/JPY falls back below 101.20/50 key support zone (EUR/JPY equivalent support is 159.00/30), it's a good indication risk aversion is re-surfacing and that carry trades are headed south again, pulling stocks and commodities down with them.

The financial sector is only one of the patients in the Fed's emergency room, the other being the broader US economy. Recent data (Chicago PMI and ISM sentiment) have given the 'glass half full' crowd reason to celebrate and expect that the US downturn will be both brief and relatively shallow. Even a larger than expected decline in March NFP jobs was greeted with the view that it was "bad, but not 'that' bad." To me, the market reaction looks more like wishful thinking, and probably a fair amount of willful denial. The headwinds facing the US consumer economy are substantial and show no signs of abating—high energy prices, falling home values, restricted credit, and now rising unemployment. As much as I would like the US downturn to be brief and mild, I have to reckon with further weakness in the immediate future. Perhaps a weekend spent digesting the implications of the NFP report will see a more realistic reaction in markets early next week.


EU Finance Ministers meeting this weekend; G7 next Friday

Eurozone finance ministers are meeting this weekend in Ljubljana, Slovenia for their regular monthly conclave. But this weekend's meeting comes just a week before the G7 quarterly meeting of finance ministers and central bank heads in Washington, DC. Recent comments from European finance sources suggest Eurozone officials want to raise the strength of the Euro as an issue in discussions at the G7. In the run-up to the last G7 meeting in February, US officials effectively refused to even discuss currency issues outside of Asian currencies needing to appreciate. That rebuff was at least partly responsible for the EUR blasting off from around 1.45 through 1.50 up to where we are today. I do not think the US Treasury has changed its stance, so Eurozone officials are left hollering into the wind. Traders should not expect the G7 communiqué to include any new language on currencies.

That the G7 is unlikely to address what is arguably excessive EUR strength does not mean that Eurozone finance ministers are powerless to express dissatisfaction with the strength of the Euro. On the contrary, I get the sense that Eurozone officials might finally embark on a rhetorical campaign to limit additional EUR gains. If this materializes, I would expect comments from key Eurozone finance officials to materialize over the weekend, seeking a 'shock-value' to start the week off in FX. Likely candidates are German Finance Minister Steinbrueck and Bundesbank Pres. Weber, who are scheduled to hold a press briefing on Saturday around 0600ET. Unilateral market intervention still does not seem likely at this stage; further EUR gains above 1.6000 would be needed to trigger that.


BOE and ECB interest rate decisions

The Bank of England (BOE) and the European Central Bank (ECB) are set to deliver interest rate decisions on Thursday of next week, with very different outcomes expected. The BOE is widely expected to cut its benchmark rate from 5.25% to 5.00%, though there are a few dissenters who expect a steady rate. The UK economy is undergoing a similar housing-led downturn, which is already spilling into the broader economy. The credit crunch is also fully evident as UK banks have actually raised mortgage lending rates to cut back on loan demand and preserve capital. GBP should remain on the defensive going into the BOE decision and is most likely to weaken on the GBP-crosses, rather than against the beleaguered USD. Should the BOE hold the line and keep rates steady, I would expect GBP to briefly rally, only to later come under even greater pressure, as continued high rates would be seen as potentially tipping the UK into a deeper slump, requiring even larger rate cuts down the road. I favor selling GBP on rallies, and with positioning likely to tilt toward short-GBP, a short squeeze higher would provide just such a rally to sell into.

The ECB rate decision is expected to see the benchmark rate held steady at 4.00%. With inflation running at 15-year highs and growth holding up for now, there is little else the ECB can do. M. Trichet has been adamant that fighting inflation is the sole task of the ECB and he is likely to retain a hawkish tone in his press conference following the announcement. His comments on the economic growth outlook will be significant, and may undermine his hawkish inflation rhetoric if he expresses a sense of alarm. He is also likely to be grilled by the media on his thoughts on EUR strength. When questioned at the last press conference on March 6, when EUR/USD was around 1.5300, he avoided making any criticism of EUR strength, triggering a rally to 1.5900 over the next 2 weeks. If he decides to take a stand, he may use the term 'brutal' to describe the Euro's gains, and the EUR should weaken. But if he demurs and sticks with the G7 language and refers to the US strong dollar policy, it's another green light for the market to take EUR/USD to 1.6000 and beyond.


Key data and events to watch next week



US data next week kicks off on Tuesday with Feb. pending home sales and April IBD/TIPP economic optimism index in the morning, followed by the minutes from the March 18 FOMC meeting in the afternoon. The minutes are likely to reinforce the notion that additional aggressive easing from the Fed is less likely in the future, but otherwise keep the focus on US weakness ahead. Wednesday sees weekly mortgage applications and Feb. wholesale inventories. Thursday's highlights are the Feb. trade deficit and weekly initial jobless/continuing claims. Friday concludes with March import prices and the preliminary April Univ. of Michigan consumer sentiment survey. US Treasury Sec. Paulson is speaking on Monday and will provide a G7 briefing after the close on Friday. Fed speakers on the US economic outlook include Vice Chairman Kohn on Monday; Dallas Fed's Fisher (dissenter at 3/18 FOMC) on Wednesday; and Fed Chairman Bernanke on Thursday.

Eurozone data sees the April Sentix investor confidence on Monday along with Feb. German industrial production. Wednesday sees German Feb. trade and current account balances and final 4Q Eurozone GDP. Thursday sees French and Italian Feb. industrial production prior to the ECB rate announcement. Friday finishes out with German March wholesale prices and Feb. OECD Eurozone leading indicators.

UK data will see March HBOS house prices sometime during the week, but no fixed time has been established yet. The March Nationwide Building Society consumer confidence index will be released at midnight on Tuesday night UK time. Wednesday sees Feb. industrial/manufacturing production and the March BRC shop price index, a private gauge of retail inflation. Thursday sees the Feb. trade balance report prior to the BOE's interest rate announcement.

Japanese data begins on Monday afternoon Tokyo-time with the preliminary Feb. leading economic index. Tuesday afternoon sees the March Economy Watchers survey. Wednesday afternoon is expected to see the BOJ hold rates steady at 0.50% when the MPC concludes its meeting. Thursday morning sees Feb. machine orders, bank lending data, and the Feb. current account report. Friday sees only the March domestic corporate goods price index (CGPI).

Week of March 30, 2008

Highlights:

1. The Commodity Trend Is Your Friend
2. Is Anybody Home?
3. Singing The Blues or Show Tunes?
4. What’s On Tap For Next Week?

The Commodity Trend Is Your Friend


Last week we saw massive reversals in the two hot commodity markets, gold and oil, as the leverage hedge fund community unloaded massive long positions to book profits as global risk aversion increased. Spot gold put in a $1032/oz high before shedding over $125/oz into the end of the week. NYMEX crude put in a similar 'slide' from $111.80/bbl down to $98.65/bbl. Now because the commodity markets are a natural hedge against the falling value of the USD, rapidly falling commodity prices sent the dollar shorts running for cover sending the USD higher against the G-7. At the start of this week, many traders were expecting this theme to carry into this week. But it's amazing how quickly the old adage 'the trend is your friend' is forgotten by the markets. Starting Sunday night we were in mostly a holding pattern until the underlying themes began to reassert themselves.


Is Anybody Home?


Monday morning saw an unexpected 2.9% increase in February's Existing Home Sales numbers after 6 consecutive monthly declines. The markets took it to heart as the S&P broke the 14-day 1342 resistance level to print the intra-week high on opening trading session. But Tuesday morning's Case Shiller Index brought the bottom-fishing real estate bulls back to earth by printing a 10.7% Year over year decline; the biggest decline on record. The very next day February's New Home Sale saw 578k New Home Sales sold, just below the 590 expected with a 588k prior for January. The most interesting part of this report was the inventory of unsold homes is the highest since 1981. After Monday's 1359 high in the S&P, it was a steady stair step lower for the rest of the week. The bloated inventory of unsold homes combined with depressed consumer confidence is very likely to sustain this economic downturn for sometime to come.


Singing The Blues or Show Tunes?


Speaking of Consumer Confidence, Tuesday morning's reading of 64.5 handily missed the surveyed expectations of 73.5 with a prior reading of 76.4. 64.5 is the lowest reading of Consumer Confidence since March of 2004. To further confirm that the US consumer has the blues, today's University of Michigan Confidence report printed the lowest reading in over 8 years! The reading was expected to come in at 70.00 with a prior reading of 70.5, but also missed the mark by a half point at 69.5.

While the US consumer is signing the blues, we found out that for the 3rd month in a row the Euro Zone business owner is singing show tunes. If you recall last February's IFO reading of 104.1 that beat the expectations of 102.9, you might remember EURUSD breaking free from significant 1.4950 resistance to trade 1.5000 for the first time ever in the product's history. On Wednesday we got the March IFO Business Climate index that again beat the 103.5 survey with a 104.8 reading. And again, EURSUD caught a huge bid to approach the 1.5905 March 17th highs, but failed at 1.5858.

The major theme of the week is that while the Fed is focused on easing monetary policy and preventing further effects of the credit crisis in the financial markets, the ECB is more focused on pricing stability and inflation concerns. On Wednesday Jean Claude Trichet noted fundamentals are "sound" while the labor markets remains strong. EURUSD will do well against the low yielders such as the USD and CHF on higher risk appetite, but faces downside risk from hedge funds de-leveraging out of commodities should global markets shown further signs of slowing as a result of the US sub-prime meltdown.

Once we hit the mid-point of last week, we began to see that the outlook for the global economy is still positive as the underlying themes I mentioned in the first paragraph began to take hold. Gold and Oil slid into Monday's session as a result of carry over from weakness seen last week, but quickly regained footing at the 50% retracement in oil after clearing stops blew $100/bbl and the 61.8% retracement in spot Gold. Crude dealt to a weekly high of $108.22/bbl today as Gold set in a $954/oz on Thursday. In response to firming commodity prices Australian and Canadian Dollars were both strong against the USD and will look for this theme to continue into next week.

Risk aversion has been driving the Yen higher as those who have borrowed cheap Yen to fund speculative positions in global markets area closing those positions. But now, there might be actual value seekers flowing into Tokyo after Thursday's CPI showed inflationary pressures most likely as a result of increasing energy costs for the highly oil-dependant nation. Lastly, Japan's fiscal year is coming to a close as local investors repatriate Yen back home to close outstanding positions.


What's On Tap For Next Week?


Looking ahead to Sunday night, we have Japanese Industrial Production for February expected to come in at -2.0% M/M and 2.9% Y/Y. On 3/31 we'll get the Euro-Zone Consumer Confidence reading expected to come in at -12 with a prior reading of -12. Then Monday morning in Canada look for the GDP surveyed to come in at 0.5% with a -0.7% prior, followed by the Chicago Purchasing Manager Index at 9:45 AM EST expected to come in at 46.0 with a 44.5 reading from February. But that night in Tokyo at 7:50 PM EST is the big one. We are expecting the Tankan report that will be very telling to learn just how much the strengthening Yen, as well as higher energy costs, have affected Japanese businesses. Tuesday morning in Germany we are expecting February's Retail Sales and the Euro Zone's Unemployment Rate expected to come in at 7.1% with the a Jan reading of 7.1%. Tuesday morning in NY at 10:00 AM EST is ISM Manufacturing expected at 47.5 for March with a prior reading of 48.3. Wednesday afternoon at 5:00 PM EST we get valuable pricing data in the Euro Zone with Feb PPI expected at 0.6% M/M and 5.2% Y/Y with prior readings of 0.8% and 4.9% respectively. Back in the Euro Zone on Thursday we get Retail Sales for Feb, which sets up the big one on the first Friday of every month: the US Employment Situation numbers Non-Farm Payrolls and Unemployment Rate for March. As of now, economists are expecting us to lose 40k jobs after last month's loss of 63k jobs. Of the last 52 months there has been only one negative reading, and last month was it.

With Consumer Confidence so low in the US and Euro Zone growth and inflationary pressures ever present with strongly rebounding commodity prices, we look for EURUSD to achieve 1.6000 while 1.5400 supports the market. USDJPY has a bit of its own wood to chop to break through 98.50 support and then on down to 98.00, which would bring an all but certain test of the mid-March lows of 95.50. If both EURUSD and USDJPY head towards these levels, that will most likely leave the cross, EURJPY, flopping around in the 153.00-159.00 range while the focus shifts away from carry trade/risk aversion theme, and towards the commodity/USD theme

Week of March 30, 2008

Highlights:

1. The Commodity Trend Is Your Friend.
2. Is Anybody Home?
   
3. Singing The Blues or Show Tunes?
4. What's On Tap For Next Week?

The Commodity Trend Is Your Friend

Last week we saw massive reversals in the two hot commodity markets, gold and oil, as the leverage hedge fund community unloaded massive long positions to book profits as global risk aversion increased. Spot gold put in a $1032/oz high before shedding over $125/oz into the end of the week. NYMEX crude put in a similar 'slide' from $111.80/bbl down to $98.65/bbl. Now because the commodity markets are a natural hedge against the falling value of the USD, rapidly falling commodity prices sent the dollar shorts running for cover sending the USD higher against the G-7. At the start of this week, many traders were expecting this theme to carry into this week. But it's amazing how quickly the old adage 'the trend is your friend' is forgotten by the markets. Starting Sunday night we were in mostly a holding pattern until the underlying themes began to reassert themselves.


Is Anybody Home?


Monday morning saw an unexpected 2.9% increase in February's Existing Home Sales numbers after 6 consecutive monthly declines. The markets took it to heart as the S&P broke the 14-day 1342 resistance level to print the intra-week high on opening trading session. But Tuesday morning's Case Shiller Index brought the bottom-fishing real estate bulls back to earth by printing a 10.7% Year over year decline; the biggest decline on record. The very next day February's New Home Sale saw 578k New Home Sales sold, just below the 590 expected with a 588k prior for January. The most interesting part of this report was the inventory of unsold homes is the highest since 1981. After Monday's 1359 high in the S&P, it was a steady stair step lower for the rest of the week. The bloated inventory of unsold homes combined with depressed consumer confidence is very likely to sustain this economic downturn for sometime to come.



Singing The Blues or Show Tunes?



Speaking of Consumer Confidence, Tuesday morning's reading of 64.5 handily missed the surveyed expectations of 73.5 with a prior reading of 76.4. 64.5 is the lowest reading of Consumer Confidence since March of 2004. To further confirm that the US consumer has the blues, today's University of Michigan Confidence report printed the lowest reading in over 8 years! The reading was expected to come in at 70.00 with a prior reading of 70.5, but also missed the mark by a half point at 69.5.

While the US consumer is signing the blues, we found out that for the 3rd month in a row the Euro Zone business owner is singing show tunes. If you recall last February's IFO reading of 104.1 that beat the expectations of 102.9, you might remember EURUSD breaking free from significant 1.4950 resistance to trade 1.5000 for the first time ever in the product's history. On Wednesday we got the March IFO Business Climate index that again beat the 103.5 survey with a 104.8 reading. And again, EURSUD caught a huge bid to approach the 1.5905 March 17th highs, but failed at 1.5858


The major theme of the week is that while the Fed is focused on easing monetary policy and preventing further effects of the credit crisis in the financial markets, the ECB is more focused on pricing stability and inflation concerns. On Wednesday Jean Claude Trichet noted fundamentals are "sound" while the labor markets remains strong. EURUSD will do well against the low yielders such as the USD and CHF on higher risk appetite, but faces downside risk from hedge funds de-leveraging out of commodities should global markets shown further signs of slowing as a result of the US sub-prime meltdown.

Once we hit the mid-point of last week, we began to see that the outlook for the global economy is still positive as the underlying themes I mentioned in the first paragraph began to take hold. Gold and Oil slid into Monday's session as a result of carry over from weakness seen last week, but quickly regained footing at the 50% retracement in oil after clearing stops blew $100/bbl and the 61.8% retracement in spot Gold. Crude dealt to a weekly high of $108.22/bbl today as Gold set in a $954/oz on Thursday. In response to firming commodity prices Australian and Canadian Dollars were both strong against the USD and will look for this theme to continue into next week.

Risk aversion has been driving the Yen higher as those who have borrowed cheap Yen to fund speculative positions in global markets area closing those positions. But now, there might be actual value seekers flowing into Tokyo after Thursday's CPI showed inflationary pressures most likely as a result of increasing energy costs for the highly oil-dependant nation. Lastly, Japan's fiscal year is coming to a close as local investors repatriate Yen back home to close outstanding positions.



What's On Tap For Next Week?


Looking ahead to Sunday night, we have Japanese Industrial Production for February expected to come in at -2.0% M/M and 2.9% Y/Y. On 3/31 we'll get the Euro-Zone Consumer Confidence reading expected to come in at -12 with a prior reading of -12. Then Monday morning in Canada look for the GDP surveyed to come in at 0.5% with a -0.7% prior, followed by the Chicago Purchasing Manager Index at 9:45 AM EST expected to come in at 46.0 with a 44.5 reading from February. But that night in Tokyo at 7:50 PM EST is the big one. We are expecting the Tankan report that will be very telling to learn just how much the strengthening Yen, as well as higher energy costs, have affected Japanese businesses. Tuesday morning in Germany we are expecting February's Retail Sales and the Euro Zone's Unemployment Rate expected to come in at 7.1% with the a Jan reading of 7.1%. Tuesday morning in NY at 10:00 AM EST is ISM Manufacturing expected at 47.5 for March with a prior reading of 48.3. Wednesday afternoon at 5:00 PM EST we get valuable pricing data in the Euro Zone with Feb PPI expected at 0.6% M/M and 5.2% Y/Y with prior readings of 0.8% and 4.9% respectively. Back in the Euro Zone on Thursday we get Retail Sales for Feb, which sets up the big one on the first Friday of every month: the US Employment Situation numbers Non-Farm Payrolls and Unemployment Rate for March. As of now, economists are expecting us to lose 40k jobs after last month's loss of 63k jobs. Of the last 52 months there has been only one negative reading, and last month was it.

With Consumer Confidence so low in the US and Euro Zone growth and inflationary pressures ever present with strongly rebounding commodity prices, we look for EURUSD to achieve 1.6000 while 1.5400 supports the market. USDJPY has a bit of its own wood to chop to break through 98.50 support and then on down to 98.00, which would bring an all but certain test of the mid-March lows of 95.50. If both EURUSD and USDJPY head towards these levels, that will most likely leave the cross, EURJPY, flopping around in the 153.00-159.00 range while the focus shifts away from carry trade/risk aversion theme, and towards the commodity/USD theme

Nominal and real exchange rates

• The nominal exchange rate e is the price in domestic currency of one unit of a foreign currency.
• The real exchange rate (RER) is defined as , where P is the domestic price level and P ^* the foreign price level. P and P ^* must have the same arbitrary value in some chosen base year. Hence in the base year, RER = e.

The RER is only a theoretical ideal. In practice, there are many foreign currencies and price level values to take into consideration. Correspondingly, the model calculations become increasingly more complex. Furthermore, the model is based on purchasing Power Parity (PPP), which implies a constant RER. The empirical determination of a constant RER value could never be realised, due to limitations on data collection. PPP would imply that the RER is the rate at which an organization can trade goods and services of one economy (e.g. country) for those of another. For example, if the price of a good increases 10% in the UK, and the Japanese currency simultaneously appreciates 10% against the UK currency, then the price of the good remains constant for someone in Japan. The people in the UK, however, would still have to deal with the 10% increase in domestic prices. It is also worth mentioning that government-enacted tariffs can affect the actual rate of exchange, helping to reduce price pressures. PPP appears to hold only in the long term (3–5 years) when prices eventually correct towards parity.

More recent approaches in modelling the RER employ a set of macroeconomic variables, such as relative productivity and the real interest rate differential.

Free or pegged

If a currency is free-floating, its exchange rate is allowed to vary against that of other currencies and is determined by the market forces of supply and demand. Exchange rates for such currencies are likely to change almost constantly as quoted on financial markets, mainly by banks, around the world. A movable or adjustable peg system is a system of fixed exchange rates, but with a provision for the devaluation of a currency. For example, between 1994 and 2005, the Chinese yuan renminbi (RMB) was pegged to the United States Dollars at RMB 8.2768 to $1. China was not the only country to do this; from the end of World War II until 1966, Western European countries all maintained fixed exchange rates with the US dollar based on the Bretton Woods system.

Quotations

An exchange rate quotation is given by stating the number of units of “term currency” or “price currency” that can be bought in term of 1 unit currency (also called base currency). For example, in a quotation that says the EURUSD exchange rate is 1.3 (1.3 USD per EUR), the term currency is USD and the base currency is EUR.

There is a market convention that determines which is the base currency and which is the term currency. In most parts of the world, the order is: EUR-GBP-AUD-NZD-USD-***( where *** is any other currency).

Thus if you are doing a conversion from EUR into AUD,EUR is the base currency, AUD is the term currency and the exchange rate tells you how many Australian dollars you would pay or receive for 1 euro. Cyprus and Malta which were quoted as the base to the USD and *** were recently removed from this list when they joined the euro. In some areas of Europe and in the non-professional market in the UK, EUR and GBP are reversed so that GBP is quoted as the base currency to the euro. In order to determine which is the base currency where both currencies are not listed (i.e. both are ***), market convention is to use the base currency which gives an exchange rate greater than 1.000. This avoids rounding issues and exchange rates being quoted to more than 4 decimal places. There are some exceptions to this rule e.g. the Japanese often quote their currency as the base to other currencies.

Quotes using a country's home currency as the price currency (e.g., EUR 1.00 = $1.45 in the US) are known as direct quotation or price quotation (from that country's perspective) and are used by most countries.

Quotes using a country's home currency as the unit currency (e.g., £0.4762 = $1.00 in the US) are known as indirect quotation or quantity quotation and are used in British newspapers and are also common in Australia, New Zealand and the eurozone.

· direct quotation: 1 foreign currency unit = x home currency units

· indirect quotation: 1 home currency unit = x foreign currency units

Note that, using direct quotation, if the home currency is strengthening (i.e., appreciating or becoming more valuable) then the exchange rate number decreases. Conversely if the foreign currency is strengthening, the exchange rate number increases and the home currency is depreciating.

When looking at a currency pair such as EURUSD, the first component (EUR in this case) will be called the base currency. The second is called the term currency. For example : EURUSD = 1.33866, means EUR is the base and USD the term, so 1 EUR = 1.33866 USD.

Currency pairs are often incorrectly quoted with a "/" (forward slash). In fact if the slash is inserted, the order of the currencies should be reversed. This gives the exchange rate. e.g. if EUR1 is worth USD1.35, euro is the base currency and dollar is the term currency so the exchange rate is stated EURUSD or USD/EUR. To get the exchange rate divide the USD amount by the euro amount e.g. 1.35/1.00 = 1.35

Market convention from the early 1980s to 2006 was that most currency pairs were quoted to 4 decimal places for spot transactions and up to 6 decimal places for forward outrights or swaps. (The fourth decimal place is usually referred to as a "pip.") An exception to this was exchange rates with a value of less than 1.000 which were usually quoted to 5 or 6 decimal places. Although there is no fixed rule, exchange rates with a value greater than around 20 were usually quoted to 3 decimal places and currencies with a value greater than 80 were quoted to 2 decimal places. Currencies over 5000 were usually quoted with no decimal places (e.g. the former Turkish Lira). e.g. (GBPOMR : 0.765432 - EURUSD : 1.3386 - GBPBEF : 58.234 - EURJPY : 165.29). In other words, quotes are given with 5 digits. Where rates are below 1, quotes frequently include 5 decimal places.

In 2006 Barclays Capital broke with convention by offering spot exchange rates with 5 or 6 decimal places. The contraction of spreads (the difference between the bid and offer rates) arguably necessitated finer pricing and gave the banks the ability to try and win transaction on multibank trading platforms where all banks may otherwise have been quoting the same price. A number of other banks have now followed this.

Exchange rate

In finance, the exchange rates(also known as the foreign-exchange rate, forex rate or FX rate) between two currencies specifies how much one currency is worth in terms of the other. For example an exchange rate of 123 Japanese yen (JPY, ¥) to the United States dollars (USD, $) means that JPY 123 is worth the same as USD 1. The foreign exchange market is one of the largest market in the world. By some estimates, about 2 trillion USD worth of currency changes hands every day .

The spot exchange rate refers to the current exchange rate. The forward exchange rate refers to an exchange rate that is quoted and traded today but for delivery and payment on a specific future date.

Why Forex?

Why opt for Forex trading?

With more than $1.5 trillion USD being traded daily, the foreign exchange market has managed to become the world's largest financial market, over the last three decades. With the large minimum deal sizes and rigid financial requirements, the Forex market, till recently, was not explored by the common trader or individual investor. But now the average investors can also engage in Forex trading. Some of the advantages of Forex trading are as follows:

24 hours trading

Forex gives its traders a 24 hour trading opportunity. Being a Forex trader, you can trade 24 hours a day from Sunday 5:00 pm (ET) to Friday 4:30 pm. This gives traders an opportunity to trade according to their convenience, going by their own schedule and also a chance to react instantly to any breaking news of the markets.

High levels of liquidity

Also, acting as a huge attraction is the high liquidity. With almost 90% of all the currency transactions consisting of 7 major currency pairs, helps these currencies display price stability, smooth trends, narrow spreads and high levels of liquidity. This liquidity mainly comes from the banks which offer cash flow to companies, investors and market players.

No commission

With “free of commission” trading, Forex trade lets you keep 100% of your trading profits. This makes Forex trading even more attractive as a business opportunity, especially for those who want to deal on a regular basis.

Steady trading prospects

The market is constantly moving and since Forex trading involves buying and selling of currencies, so traders can easily operate in a rising or falling market. This is because, there are always trading prospects, whether a currency is rising or deteriorating in relation to another currency. So there is always profit potential in the Forex market, whether it’s a rising one or a falling one.

Along with these major advantages, the Forex market also has some other merits such as, Forex trading gives its traders, an opportunity to bigger profits as returns on their invested money. Also, since the market is open 24 hours a day, 5.5 days a week, it gives the investors can make their deals anytime they want to.

With such superior speed of the market, and fine liquidity, even the largest of transactions are conducted within a few seconds.

Forex Basics

What is Forex?

The largest financial market in the world, Foreign Exchange market, Forex or FX market, all the terms are used to describe the business of trading of the world's various currencies, with more than $2 trillion changing hands every day. Being an international foreign exchange market, Forex is a market where money is sold and bought freely. FOREX was launched in the 1970s, to become the biggest liquid financial market today, dealing in more than hundred times the daily trading on the New York Stock Exchange.

FOREX is a perfect market to invest in, as it is free from any external control and free competition. Mostly, all Forex trading are tentative and unlike the stock market trading, the Forex market is not conducted by a central exchange, but on the “interbank” market, which is thought of as an OTC (over the counter) market. The trading takes place between the two dealers, either over the telephone or through Internet, all over the world. The major trading centers are the ones at Sydney, London, Frankfurt, Tokyo and New York, making Forex a 24-hour market.

Forex Trading requires the employing fundamental as well as technical analyses. These analysis help a trader to foresee and determine the development in the price trends of currencies, based on which, he attempts to predict market changes and make profits. Fundamental analysis can be said to use techniques to analyze the value of a state’s currency with the help of its economic indicators, quality markets and political events and associations. Political stability also influences the exchange rate at Forex. Its not just that Forex trading is intutive, rather it's technical.

While Technical analysis engages the study of patterns of price trends and movements, making it easier for the trader to predict the path of the future developments in the Forex market. The primary data for a technical analysis are values, be it the highest or the lowest values, the price of opening and closing in a definite period of time, and the amount of transactions taking place. Any factor, be it economic, political or psychological, having little or some influence on the value or the price, has already been measured by the market to be included in the price.

Daily Report

Dollar Up Modestly - Is This The Week of the Rebound?

Talking Points

• Japanese Yen: hovers near 100 as equities stabilize
• Euro: Drops below 154.00 on Swissie sell-off
• Swiss Franc: sells of sharply on news of UBS offering
• Pound: marks time around 1.9800
• US Dollar: Existing Homes on tap

Another very quiet night in the currency market as Easter holidays continue in Europe leaving both UK and EZ calendars essentially empty. The dollar however, received a modest boost against the Swiss franc on announcement that UBS is gearing for a major rights offering, only several months after securing a massive capital injection from Sovereign Wealth funds. After so much focus on the problems in US capital markets in the past several weeks, the currency traders may be turning its attention to Europe as they take a more skeptical view of the European financial sector.

The UBS announcement along with the news that CSFB will register its first quarterly loss in 5 years, dented the franc’s reputation as a safe haven currency and the decline in the Swissie dragged EURUSD along with it below 1.5400 figure. Overall however, as we noted last week, “The market appears at a standstill as EURUSD consolidates its gain in the 1.5300-1.5500 area and traders wait for the next theme to develop.”

With US financial markets pacified for the time being, the currency market will cast its eye on European data, the most important of which will be the IFO survey on Thursday. Any serious weakness in the report is likely to push the EURUSD lower on concerns that the ECB may have to finally relent and consider a rate cut in H1 of this year.

The US calendar today carries only Existing Homes Sales data. The markets expect yet another decline to 4.85MM units from 4.89MM the month prior. However, the greenback may benefit from low expectations, and is unlikely to react negatively to the data unless the number shows massive deterioration in demand.

With markets at full force tomorrow, the true tone of trade should become more evident by then. With EURUSD having run out of stream at 1.5900 early last week, near term momentum has shifted to dollar bulls. They will however, need further negative surprises out of the Eurozone in order push the pair to 1.5000 level of support. Otherwise, assuming there are no additional exogenous shocks, the currency market may simply meander aimlessly for the rest of the week in very narrow trading range.

Week of March 23, 2008

Highlights:

• The Buck bounces, but outlook remains uncertain.
• Is the credit crunch over?
• Japanese gloom deepens, JPY is vulnerable.
• Key data and events to watch next week.

The Buck bounces, but outlook remains uncertain

It was an eventful week to put it mildly: the fifth largest US investment house effectively vanished overnight; the Fed cut rates another 3/4%; US stocks fell to new lows but then recovered sharply; commodities fell back to earth in the largest weekly decline since 1956; and even the lowly USD managed a solid bounce. For the USD, the recovery looks to be mostly based on profit-taking on short dollar positions after the FOMC cut rates by 75 bps, in a classic 'sell the rumor, buy the fact' reaction. The Fed statement also suggested that additional rate cuts are unlikely to be as aggressive, leading to an overall reduction, at least for now, in expectations of how low US rates will ultimately fall. The USD was also supported by the chicken-and-egg relationship with commodities-as the USD strengthened, commodities came under profit-taking pressure as hedges for a weaker USD were taken off. Finally, the USD also gained support as the US slowdown increasingly looks set to drag down other major economies in the months ahead, a re-coupling I have been expecting for a while now.

In short, the USD rebound looks to have been mostly driven by short-term market positioning adjustments and assorted inter-market relationships after a likely excessive decline, rather than any sudden improvement in the fundamental US outlook. That conclusion makes the USD recovery highly suspect, but at the same time there are significant technical indications that the USD rebound may have some more room to go. Keep in mind that US data next week focuses on housing (existing home sales, new home sales) and personal spending (durable goods and personal spending), neither of which are expected to be USD positives any time soon. Turning back to the technicals, The EUR/USD drop through 1.5600 broke below trendline support that guided EUR/USD higher since the break over 1.5000. Daily and weekly candlestick charts also show 'shooting star' patterns representing the sharp rejection from just below key psychological/round number resistance at 1.6000. Momentum studies have all crossed over to the downside from overbought territory, validating the price reversal lower. On Ichimoku charts, EUR/USD has fallen below the fastest line (Tenkan/conversion line), last at 1.5593, which should now act as resistance, and opens up potential for a move to the rising Kijun/base line, last at 1.5257. EUR/USD weakness below there opens up potential all the way back to the cloud down at the 1.4630/50 level. But let's not get ahead of ourselves just yet. For next week, I'm content to expect EUR/USD to be toppish in the 1.5550-5600 area and bottom-ish in the 1.5200/50 area, and I prefer to sell EUR/USD on strength until 1.5700 is surpassed. Traders will need to closely monitor commodity market developments next week to gauge the extent of the USD-upside. Further sharp declines in metals and oil could provoke a larger than anticipated recovery in the USD.

Is the credit crunch over?

The short answer is: No, not by a long shot. But, is the worst likely past? There, the answer is a cautiously optimistic 'yes' and that shift may hold the keys to a larger improvement in the USD outlook. It's clear to me that a large part of the USD's decline in recent weeks was due to fears of a systemic failure in the US financial sector. Various bullets were dodged along the way-bond insurers maintained their ratings, banks raised sufficient capital-but the outlook now is rapidly improving. US investment banks reported better than expected 1Q earnings this past week, suggesting that key firms have managed to get a handle on toxic debt and restructure holdings. The Fed has introduced multiple programs to increase financial market liquidity, with the latest initiative, the Term Securities Lending Facility (TSLF), set to debut on March 27th. The decision by the Fed to allow financial firms to post mortgage-backed securities as collateral is a key step to getting financial markets back in working order. Also, OFHEO (Office of Federal Housing Enterprise Oversight) this past week reduced the reserve margins that Fannie Mae and Freddie Mac are required to hold, freeing up $200 bio that can be used to purchase mortgage-backed securities, further lightening the load of banks down the road. The sooner the financial sector begins lending again internally, the sooner Main Street consumers and firms are likely to see an easing of credit conditions. We are by no means there yet, but it appears that the lending gears may finally be unstuck, which is the first step to ending the credit crunch.

Restoring financial market conditions to normal is a process that will likely still take many weeks and months, and the next few weeks are particularly sensitive. The end of the calendar quarter at the end of March is the nearest hurdle and European money markets seized up this past week as liquidity remained strained over that period, prompting the ECB and the BOE to inject billions more in liquidity operations. Much of the demand was for USD borrowing, which also likely contributed to better USD spot performance, as borrowers would fund in other currencies, sell them and buy USD's to satisfy USD obligations. I am also aware of the minefield of surprises markets have been exposed to over the last few months and the risk remains that additional unknowns will surface. But I think it's time to begin shaking off the paralysis of doom that has dogged the market since last year.

In terms of the overall market environment, I think we are on the verge of a significant improvement in risk appetites. For currencies, that means a return to buying the JPY-crosses (EUR/JPY, AUD/JPY and NZD/JPY) and otherwise focusing on higher yielding currencies. The short-term risk is that the USD rebound obscures or delays a recovery in the JPY-crosses. The way to work around that is to focus on buying USD/JPY on further weakness ahead of 95.00 or on a breakout to the upside.

Japanese gloom deepens, JPY is vulnerable

The USD staged a significant recovery against all major currencies with the exception of the JPY, which remained buoyant as risky trades were taken off in a relatively illiquid, pre-holiday market. The economic outlook in Japan, however, has deteriorated rapidly in recent weeks, with the latest monthly Tankan readings falling further. The US slowdown will eventually affect other major economies, and Japan is among the most vulnerable in relative terms to weaker US demand. Domestically, the Japanese government is facing an embarrassing episode where the opposition party has rejected the government's two nominations to replace retired BOJ Gov. Fukui. The Bank of Japan is currently headed by acting Gov. Shirakawa, this at a time when global financial markets remain in disarray. The MOF is unlikely to tolerate additional JPY-appreciation at this juncture, which would further de-stabilize domestic stock and bond markets. In addition, JPY-repatriation flows, where Japanese asset managers sell foreign-denominated assets and buy JPY for financial year end (March 31) window dressing, have likely come to an end. In the Week Ahead of Feb. 24, when USD/JPY was around 107, I headlined a section "JPY-repatriation has begun" and suggested the JPY would be bought through the third week of March. That window has now passed and it's time to start looking at selling the JPY on remaining strength toward 95-97, or on a break higher in USD/JPY over roughly the 100.50 area. Please see the Weekly Strategy for further discussion of this.

Key data and events to watch next week

Last week I cautioned that liquidity conditions would worsen toward the end of the week due to the Easter Holidays and price action was pretty jumpy from Wednesday onwards. Monday of next week will remain exceptionally thin and overall liquidity for the week will remain sub-par as UK and European markets remain short-staffed. Traders should expect further erratic price behavior next week and should adjust their trading strategies accordingly.

US data begins on Monday with Feb. existing home sales as the sole release of note. Tuesday sees the Jan. S&P/CaseShiller home price index, March consumer confidence, March Richmond Fed manufacturing index and the OFHEO Jan. house price index. Wednesday sees Feb. durable goods orders and Feb. new home sales. Thursday will see the final 4Q GDP estimate along weekly jobless claims and continuing claims. Friday finishes up with Feb. personal income & spending, Feb. core-PCE inflation, and final March Univ. of Michigan consumer sentiment. Multiple Fed speakers are on tap-please see the Economic Calendar for exact times.

Eurozone data begins on Wednesday with March French business confidence and March German IFO business climate. Thursday sees the April German GfK consumer sentiment survey. Friday sees Feb. German import prices, March French consumer confidence, and preliminary March German CPI.

UK data begins at midnight GMT on Monday with the release of the March Rightmove house price index. The next data is on Thursday which sees final 4Q total business investment, BBA home loan data for Feb. and the March CBI distributive trades report, a private measure of retail sales. Friday sees March Nationwide Building Society house prices and the final 4Q GDP estimate.

Japanese data begins on Monday morning in Tokyo with the release of 1Q BSI Large All Industry index. Wednesday sees the Feb. merchandise trade balance and Feb. corporate service prices. Thursday afternoon sees March small business confidence. Friday's data schedule is heavy with Feb. jobless data, Feb. household spending, March Tokyo CPI, Feb. national CPI, Feb. large retailers sales and Feb. retail trade.

2008 Forex Market Predictions

What does 2008 hold for forex traders like you?
See what FOREX.com's trading team thinks.

2008 has opened with several bangs: unexpected rate cuts, a volatile stock market, recession concerns, and a Presidential race that's truly up for grabs. What does it all mean for forex traders? Straight-shooting, unfiltered, and direct from the FOREX.com trading desk, we wanted to share our top 10 market predictions for 2008 with you.

These predictions shouldn't be a substitute for your own research -- but we do hope they'll give you informed food for thought about your forex strategy this year.

• In 2008, the Yen will be king. The year opens with an unwinding of the Japanese Yen Carry Trade due to broad-based risk aversion. Global investors have been borrowing Yen cheaply for years to invest in global markets, which has only added fuel to the speculative fire. We predict spiraling high-risk markets (equities and commodities) force investors to close their positions and repurchase Yen in 2008, pushing the currency higher across the board.
  
  By mid-year, we predict it will take only 140 JPY to purchase a Euro, nearly 20% off the peak levels. Consequently, the rise of the Yen versus the U.S. Greenback may set the currency pair back to its 2005 lows at 101.70.
• The US Federal Reserve may continue to cut interest rates aggressively during the first half of 2008 in reaction to the credit crisis, housing pressure and political pressure. We see US Fed Funds trading at 3%, and then reversing direction during the second half of 2008 as inflation pressures mount and must be addressed. Fed funds could trade at 4.25% in 4Q08.
  
  Meanwhile, we expect the European Central Bank (ECB) will continue to favor an increase on interest rates well into the latter stages of the second quarter. During the summer of 2008 we see this trend reversing dramatically and the dollar regaining some of its previous status as the world's reserve currency.
  
  By year end 2008 we predict the Euro will be trading below US$1.20.
• We see the global credit crisis growing and spilling over from mortgages into credit cards, auto loans, and student loans. The US economy is forced into a recession with the Fed rate cuts providing ineffective in stimulating the overstretched U.S. consumer.
  
  The Bank of England is pushed to cut rates aggressively as a slump in housing prices and over stretched consumer forces their hand. We may see rates dropping to 4.00% and cable (GBP/USD) falling back to 1.7000.
• Contrarian public sentiment barometers suggest that the crowded short-USD trade will soon come to an end. Magazine articles, advertising and pop culture decrying the weak U.S. dollar is proven wrong in 2008. Supermodel Gisele Bündchen has been rumored to request payment in "only Euros please". Music mogul Jay-Z flaunted a fist full of Euros in a video. Lastly, McDonalds placed a dollar menu commercial where a group of office workers' attitudes are changed about the USD based on a double cheeseburger. We feel the US dollar may have an explosive year against all of the majors.
• Heading into the Beijing Olympics, we expect the Yuan will finally be revalued as a signal by the PboC (The People's Bank of China) that China respects the wishes of fellow financial superpowers. The Olympics are an enormous success for the developing nation, as a revered culture showcases itself and its recent economic revolution.
  
  After the Games close, however, we predict the PBoC will turn reluctant again to dampen its exporting power and will remain large buyers of U.S. Treasuries.
• We anticipate sovereign wealth funds will continue their buying binge, especially in the financial services sector. However, we see xenophobes sounding the bell against them, drawing unnerving parallels to pre-bust Japan in the 1980s. Ironically, we predict the capitalist ideas of the funds will prove a stabilizing force in the world, buying distressed assets and giving a boost to the U.S. Dollar.
  
  When the dust settles, we predict these funds' purchases will turn out to be ideal for world markets: the foreign funds own from bargain prices while the institutions utilize the liquidity and leverage the political relationships to make profitable inroads into growing nations.
• Google or Gold? We see the race to $1000 being won by Gold. As "stagflation" becomes the economic catch-phrase of 2008, we see investors flocking back to the precious metal. Reluctant to own Dollars or Euros, global central banks may quietly purchase Gold as the "World's 3rd Currency".
• In the midst of a recession in developed nations and the environmental "Green Movement", we predict crude oil will temporarily declines to $80/barrel. Unfortunately, we don't expect to see any relief for the ordinary consumer in 2008. Oil-refining capacity will probably tighten and crack spreads may rise, keeping gasoline prices at lofty levels.
  
  To the delight of Bank of Canada Governor David Dodge, USD/CAD may increase 10% by summer—but the move will be short-lived. In the second half of '08, we believe Middle East tensions will heighten as the Democratic Party's nominee will struggle against looking "inexperienced" in foreign affairs. We predict crude futures trading back over $100/barrel, confirming the long-term trend higher.
• We foresee Barack Obama becoming the first African-American President of the United States. As a result, the U.S. Dollar retains its euphoric glide higher into year-end, but as uncertainty surrounds this "leader of change" and the Democratic platform of raising taxes on both corporations and individuals, we imagine this stifling US growth prospects. This double whammy may raise the red flag on U.S. equities and the U.S. Greenback into 2009.
• In 1999, tech stocks were red-hot. In 2002, real estate took over. In 2006, commodities were king. We expect the currency market will hit mainstream in 2008. In the growing theme of globalization, where the internet and mobile devices have made the world a much smaller place, interest in the assets of other nations continue to soar. Already the world's largest market in dollar volume, currency trading may double as "Main Street" meets "Wall Street" and the individual investor could become an integral part of the FX world.

The opinions the FOREX.com Forecasts for 2008 are not trade recommendations. In addition, GAIN Capital has not taken trading positions based on the views in the FOREX.com Forecasts for 2008.

Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase of sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.