The forex markets are struggling to work out what that global banking crisis and related Government bail-outs mean for medium to longer term currency values. In the short-term at appears no-one really knows as the NZ dollar, in particular, is tossed about like a cork in a turbulent sea. The NZD/USD foreign exchange market continues to trade in a highly volatile fashion, straddling wide daily trading ranges as fresh news enters the market that influences the levels of risk aversion from investors and the direction of the USD globally. Many international FX market commentators are too hastily concluding (in my opinion) that the financial troubles in the US must lead to a weaker USD on international currency markets. Their view is that the USD700 billion bank bail-out package adds to the already USD11 trillion of Government Debt and that this must send the USD down. My view is the opposite i.e. a stronger USD from here, for the following very good reasons:- - The US cannot cut their interest rates any more and arguably they need slightly higher interest rates to attract foreign investors to fund their internal and external deficits. The US cut their rates to records low levels of 2.00% a year ago to assist the credit crunch and clogged-up inter-bank moneymarket, further reductions in interest rates from here will do nothing to rectify the toxic mortgage-backed securities that are sending the weaker US banks to the wall. Higher US interest rates and lower Euro interest rates suggest a stronger USD, weaker Euro. - The Europeans will be forced to cut their interest rates as the Euro-zone economy heads into recession. The Euro has already weakened from $1.60 to $1.40 as the FX market priced-in an expectation of upcoming Euro interest rate cuts. The EUR/USD rate has since rebounded to $1.46, but there does not seem much conviction by global investors to buy the Euro any higher. The European economies are in worse shape than the US. - The US economy is in not bad shape outside the residential real estate market and related bank mortgages. A strong US export performance has materially reduced their Current a/c deficit. The banking crisis will make debt more expensive, but corporate America is not over-leveraged and can wear the extra costs. - Two weeks ago the "flight to quality" by investors around the global demonstrated that the USD is still the currency of choice and safety (along with the Japanese Yen) The Euro doers not have that status as yet. The extension of the global credit crunch over recent months into a fully-fledged banking crisis does mean tighter credit conditions for longer and this must slow global economic growth further. However it is not the end of the world, investor confidence will return and many global sharemarkets are looking cheap on a historical price-earnings measurement basis. ------------------ *Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com.