The western world is mired in debt and on the cusp of recession, but US Treasuries are rallying (yields falling to record lows) and even the euro - the epicentre of the current financial market problems - is holding up fairly well. There may be an imminent banking crisis in the Eurozone, but that isn't being reflected in EURUSD right now. But at the same time FX investors are flocking to safe havens and the Swiss franc and Japanese yen are hitting record highs.

It's complicated in the FX space right now, and some of the price action is hard to explain. Thus it can be useful to go back to fundamentals to try and get a grip on the markets.

A traditional driver of FX is a country's financial position. So richer countries tend to see their currencies appreciate and vice versa. This is often measured using relative current account positions. The current account measures income from trade, financial investments such as stocks, foreign bonds and currencies and transfer payments like foreign aid. Thus relative changes in the current account position can impact FX.

The chart below shows current account as a % of GDP for: US (yellow), UK (orange), EU (green), Japan (red), China (purple), Switzerland (blue).


There is a clear grouping here between countries with strong current account positions - China, Japan and Switzerland - and those with weak positions - the US and the UK - the Eurozone is somewhere in the middle although its CA position has deteriorated in recent months.

Switzerland has the strongest position of all, hence the Swiss franc has rallied strongly along with the yen vs. the dollar, the pound and the euro. China doesn't allow the renminbi to float freely, but one can imagine that if it did the yuan would also be considered one of the safe havens.

But what about the price action between the pound, the dollar and sterling? This has been labelled the battle of the ugliest for good reason. As you can see, Europe's current account position is better than that of the UK and US, which goes some way to explain the single currency's resilience against the dollar and the pound in recent months even as the sovereign debt crisis continues to rage on.

Although there are plenty of reasons to support a lower EURUSD, in the current economic climate investors go back to fundamentals - they want to own currencies with good financial plumbing, and sell those that have sprung leaks. This means that the Euro is the prettiest for now.

However, the US's current account position, although weak has improved markedly in recent years. This compares with the Eurozone, which has seen its current account fall into deficit once again. This is a development worth watching. Fundamentals like current account positions tend to have a more medium-term impact on the market and don't tend to move currencies in the short-term. We believe the euro won't start to meaningfully decline against the dollar and the pound unless its current account deteriorates rapidly in the coming months. However, with the US and the UK also on the cusp of recession, it will be hard for both any of the majors to improve their finances any time soon.


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