INTEREST RATES AND FOREX MARKETS

Interest rates and Forex market

As I mentioned previously in cyberspace somewhere, I believe currency movements in the medium to long term to be largely dictated by what belief the market has on where interest rates will go. Often, there is a clear disparity between what the market believes and what really happens, and I'm wondering if this is happening again.The EUR rise in the last week (though still range trading) has the potential to explode out of it's summer range to the upside, and I believe that any such explosion that would occur in the next few weeks will be premature. The belief, you see, is that the ECB is "talking tough" on inflation, and that rates are set to go up in December. I think this is a mistake.The ECB, Trichet in particular, always talks tough. They use the "Strong Vigilance" phrase when talking about inflation, even though inflation is actually within the ECB's tolerance levels (albeit on the high side of those levels). The market frequently misreads the ECB president, as it had earlier this year in the April/May timeframe. I think the EZ is set to slow, and that it's growth period - what I'd call a short spurt - is done with. It will begin to echo a slowing shown in the U.S., as there always seems to be a slight delay in what happens in the U.S. versus Europe. A higher Euro will offset prices, oil is coming down (though still high) and the recent tightening going on around the globe is beginning to take a bite.I think the ECB will not hike in December, though they will continue to talk tough. The market is in for a rude surprise, but this surprise - in my opinion - is not set to come for some time. During that time, it's all Euro.A similar problem exists in Australia and New Zealand. The market is waiting for next week's hike by the RBA, and calling for next month's meeting to show similar results with the RBZ. With New Zealand, I think this is sheer folly. Alan Bollard, the RBZ's governor, is perpetually plagued by the thought of a high kiwi placing more stress on NZ than it can handle. He has repeatedly stated not to expect a hike or a cut "this cycle", yet the market believes he will change his mind. A higher kiwi (off the low of 60) has helped inflationary pressures, and again, petrol prices have receeded. I think the market has this one wrong too.The RBA is a different story, and one I believe that can go either way. Personally, I am again calling for them to stay put and not hike, though the market is screaming that a hike is "in the bag". It probably is, though I see the case for staying loud and clear. It's just that the signs of global slowing have not quite reached the ears of Macfarlane just yet, and as a result, they might think there's room for one more hike to squeeze by. I think this is a mistake, but then again, I'm not on the board of any Reserve Bank (maybe that's a good thing!). Hiking now is premature, especially since they just hiked. Continuous tightening in the face of potential global slowdown without waiting to see the lagging effects of this type of policy is inherently dangerous, and will result in the long term stress to the economy.But again, maybe I'm wrong.All that matters for the moment is to follow the market's belief on interest rates - because that's how we make money day to day. It's better to be right for the wrong reason, then wrong for the right reason. At least around here.