Market focus has been shifting gradually from the financial markets to the global economy, and investors do not like what they see. The credit crunch is hurting consumers and investors everywhere, putting a damper on global growth. In fact, many industrial economies are already in, or close to recession, and the emerging economies, including mainland China, are showing rapid signs of slowdown.

Governments around the world are likely to adopt fiscal stimulus to stave off a recession. Even Fed Chairman Ben Bernanke recently endorsed additional stimulus for the US, after the impact of a USD168 billion package in February faded. In addition, central banks are likely to resort to monetary easing to stimulate growth. After the Bank of Canada lowered rates by 25 basis points on October 21, the Reserve Bank of New Zealand cut its benchmark rates by a full percentage point to 6.5% on October 23. The European Central Bank and the Bank of England are also likely to cut rates aggressively. In contrast, with interest rates in the US and Japan already among the lowest in the industrialsed world, the room for aggressive easing in the US and Japan is more limited.

Recession fears, hence, heightened risk aversion, and interest rate expectations both worked in favour of the dollar and the Japanese yen. The dollar gained 7% against the euro and 9% against both the British pound in the past week alone. The commodity currencies were particularly hard hit with commodities being sold off. The price of crude has fallen below USD65 a barrel, some 55% lower than its peak of USD147 hit on July 11. Hence, the Australian, New Zealand and Canadian dollar all lost significant ground against the greenback. The trend of risk aversion is likely to support both the dollar and the yen, but short term pull back from their over bought positions could not be ruled out.

Click here to download full report.