After such an aggressive rally over the past three months, it is growing increasingly difficult for the US dollar to sustain its climb. Nonetheless, should the benchmark currency’s safe haven status gives way, there may still be strength to be had in interest rate expectations. This may seem counter-intuitive considering Fed Fund futures are pricing in a 90 percent probability that the December 16th meeting will end in another 50 basis point rate cut (and 10 percent that it will be 75bps) which would take the benchmark lending rate to its lowest level in over three decades. However, currencies move on relative speculation. While the FOMC may lower rates to levels plunged only by the BoJ in the last decade, there is no room for further cuts from there (whereas other central banks can still cut dramatically). What’s more, this aggressive policy puts the US well ahead of the financial crisis / recession curve.

Once again, the normal functioning of the financial markets is in jeopardy. Today, Treasury Secretary Henry Paulson laid out his plans to stabilize the markets and economy in his limited capacity to address a global problem in an update to the public. His announcement that he would purchase preferred shares in financial institutions rather than draw out troubled asset backed securities (ABS) was met with skepticism. With Moody’s forecasting an incredible 10 percent default rate on all junk bonds within the next year, this policy shift may be turning away from the next trigger for a panicked wave of risk aversion.

The economic outlook has lent optimists few footholds. This past week, the ISM released measure of factory and service sector strength in the US. The former hit a 26-year low while the latter dropped to its lowest level on record. With housing, business activity and trade offer little hope to turn such an aggressive recession, the only hope for a rebound in growth lies with the consumer. However, after the biggest two-month drop in NFPs since 2001 and the jobless rate at a 14-year high, it seems Americans will contribute to the decline as they rein in spending and try to pay off near-record levels of debt.  

After two week’s of congestion – which no doubt led many investors and analysts to believe a bottom was forming – risk aversion has once again swept over the capital markets. It is clear that the balance between risk appetite and demand for return have not yet come to a level of equilibrium with the outlook for a global recession growing more severe with each day. However, the drop is not just a US market problem, but rather a global one. With demand and production drying up in most major industrialized economies, general investment has plummeted and prices for raw materials has also tumbled. This is increasingly looking like a natural bear market considering the consistency with which investor sentiment is contracting along with growth; but it is certainly being fueled by abnormal sources. As long as liquidity is an issue, the markets will suffer from high volatility and steady declines.

Over the past week, the world’s equity markets have turned lowed; but it has been the US benchmark indexes that have really built up bearish momentum. With the outlook for revenues among consumer discretionary and staples still adjusting for the deepening recession (and its subsequent impact on the holiday season), many consider US shares to still be overvalued. However, growth isn’t just a concern for equities. Crude oil – the yardstick for commodities and growth – has hit a fresh 20-month low around $55 despite cuts to output.

While a general drop in economic growth provides its own burden to expected returns, it also has its influence over risk sentiment. Under normal, bear-market conditions, the appetite for risk will contract as investors look to preserve their capital. However, conditions are far from normal this time around. There is still concern that bulwarks of the investment world are still in jeopardy. With the threat of major bankruptcies and sudden seizures in liquidity, there is little room for optimism. Until leverage is worked off, this danger will remain.