Impact on FX market

Uncertainty means conservatism remains the name of the game in the forex market. And that has a couple of big implications for currency traders.

“What’s accompanied this disinflationary cycle is an elevated level of risk aversion,” notes David Gilmore, partner at Foreign Exchange Analytics. “Investors are more likely to hold currencies they feel safer with.”

In recent months, the yen and the dollar have been the globe’s safe-haven currencies. Also, Gilmore says the U.S. dollar has been underpinned by the “first-in, first-out” idea: that the U.S. will be the first major nation to emerge from recession because of its swift and massive policy response.

“We are kind of witnessing an ugly contest — who has the least-ugly currency,” he says. “But no [country] has a good story to sell. Everyone needs a weak currency right now because global demand has fallen off a cliff.”

Looking ahead, however, if persistent deflation were to emerge, Gilmore advises watching the “anti-currency” — gold.

“It’s a hedge against both deflation and inflation,” he says. “Gold has a better chance of holding value when people lose faith in paper money.”

Also, most currency watchers seem to agree the U.S. dollar will lose some of its recent safe-haven luster as the year progresses.

“It is still the reserve currency and has some safehaven status, but once the financial markets start looking longer term, the dollar is likely to go lower,” Bangalore says. “We are increasing the deficit and debt levels, which are not favorable factors for the currency over the longer-term.

Credit Suisse currently does not forecast any rate hikes from the Federal Reserve through 2010.

“Our house view is that the dollar will weaken over the course of the year,” Basile says. “We still have a big current account deficit to finance.