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The global currency market dynamics have changed rapidly from the beginning of August. After pushing up to 1.60 on the back of economic woes in the US (and sentiments that the ECB could go for further rate increases), the Euro crashed against the dollar from the first week of August.

The first trigger for the depreciation of the Euro came on August 7th with Trichet acknowledging a slowing EU at the press conference after ECB’s rate setting announcement. On July 11th, when the global crude oil prices were at their peak, the dollar-Euro was quoted at around 1.59. As Euro started to lose its strength against the dollar, the global crude oil prices also started to fall; a direct realisation of the fact that slowing economic activity would inevitably lead to demand erosion in crude oil. After the ECB’s rate setting meeting on August 7th, the Euro had depreciated by nearly 4% to 1.5325 and moved on rapidly to depreciate by a further 9% to 1.3944 by September 11th.

What is surprising is that the US dollar has mostly held on to its recent gains even as the financial market stress reemerges. Kenneth Rogoff, former Chief Economist at the IMF had pointed out recently that the worst is yet to come in the US and may topple some of the biggest banks in the US. May be the Fed would not be willing to let any bank fall easily, but the same is not true for the investment banks as the recent evidences show. With the housing market showing no signs of having yet bottomed out, the stress on the financial system continuing, with the unemployment rate high at above 6% and also possibly inching up, the next reaction from the Fed could well be a reduction in the policy interest rates.

However, what is probably safeguarding the dollar is the news that major central banks have announced massive injections of dollar liquidity and that the Treasury and the Fed would establish a fund to buy bad debts off the financial system. Thus the assumption is that the financial market uncertainty will soon evaporate.