Most of Forex traders are used to the fact that, over time, interest rates are the biggest drivers behind currencies. After all, money tends to flow where biggest returns are possible. Most of fundamental news releases also are viewed as indicators of future direction of interest rates, and thus influencing currencies. Employment, trade and similar data causes changes and adjustments in economic policies, which is often reflected in interest rates. This premise seems to hold water, except for times of crisis, like in 2008. Or right now.

Recent fall from grace of the Euro, can be directly attributed to budget deficits of some member states. Credit rating agencies downgraded sovereign debt of few countries, citing risks in ability to repay it. So, currently, budgetary shortages appear to be biggest reasons behind large Forex swings. Problem is, that many other countries, not yet effected, also have colossal deficits, so one could argue that their currencies will also come under strain, sooner or later. The list is long and distinguished and includes practically all other major world economies. Both US and Japan are either already in similar shape as Greece, or projected to be at that level soon.

Does it mean that S&P, Moody and Fitch will start downgrading issues of Japan, UK and US soon? Or everybody else’s for that matter. Virtually no country on this list is expected to start closing deficit gaps any time soon. This means that sovereign debt risks have nowhere to go but up. Right now, money is flowing from Euro to Dollar and Yen, because it “has to go somewhere”. However, by existing “logic” of risk, these countries should eventually come under pressure, for exactly same reasons as EU. What will rating agencies do?

We might have an idea this week about just important budgets and deficits have become. On May 20 government of New Zealand is scheduled to release its new budget. Like many other countries, NZ is trying to cut individual taxes, while raising them elsewhere. While New Zealand is a small economy, situation is very interesting. Few months ago Fitch Ratings assigned negative outlook to NZ and threatened to lower debt rating. Based on the new budget, Fitch is expected to either go through with the warning, or remove the negative outlook. Reaction of NZD should give us good idea about how important budgets are right now. This could set a precedent for other countries in months ahead.

After good trades in AUD-JPY, I’m taking a look at Canadian Dollar, which started to lose some ground late last week. We’ll have to see if this trend continues. Monday is very light when it comes to fundamental announcements, so trading should be largely technical and breaking news driven. For now I’d like to sell CAD-JPY at 88.40, targeting 200 pips. On the upside, 91 level might also be a good place to go short, pending emergence of solid reversal pattern. Other than that, opening gaps are always a possibility, something to look for.

Mike K.