Another Roller Coaster Ride for Exchange Rates in 2009?

CAMBRIDGE – 2008 has been an exceptionally tumultuous year for exchange rates. The American dollar soared, the Japanese yen went into orbit, the euro fell to earth, and the British pound crashed, leaving a giant crater. Emerging-market currencies were hammered, as were “commodity currencies” such as the Canadian, Australian, and New Zealand dollars, and the South African rand. Indeed, the currency of any country that is significantly dependent on commodity exports has suffered.

So, what will the New Year bring for exchange rates?

While the only safe bet is continuing high volatility, we are at an unusual juncture where the short- and long-term trends appear to be very different. In the short run, the yen and the dollar continue to benefit from a flight to safety, as panicked investors seek a place to hide. The yen and dollar are also being bolstered as central banks elsewhere continue to cut interest rates towards zero, territory that the yen and dollar policy rates already occupy.

Thus, even though the United States and Japan will not be raising interest rates anytime soon, lower foreign rates still make the dollar and yen relatively more attractive. Commodity prices will continue to be soft, pulling down commodity currencies, and bolstering the yen especially, since resource-poor Japan is so reliant on commodity imports.