Risk aversion flows dominated trading in the currency market in the first month of the year. More bad news emerged from the subprime and economic front. Financial institutions have already written down over USD130 billion of assets and much more may be needed with bond insurers facing possible downgrades by major rating agencies.
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Troubles in the financial industry are also gradually spreading to the broader economy, with US economic reports mostly coming in on the weak side. President Bush introduced a USD150 billion fiscal stimulus and the Fed cut rates aggressively to forestall a recession.

The Fed's 125 cumulative rate cut in less than 10 days brought the fed funds target rate to 3%, the lowest since June 2005. At current level, the US benchmark rate is only higher than those in Switzerland (2.75%) and Japan (0.5%); and is a full percentage point below that of the euro, and well below those of the yield-yielding currencies.

The loss of yield advantages put downward pressure on the dollar. Investors also became more risk averse as the financial and US economic outlook became more uncertain. They sold stocks and unwound carry trades, pushing the Japanese yen and Swiss franc higher against the dollar and other majors.

For the month of January, the Dow lost 4.6%. The yen was up about 4.7% against the greenback, 2.9% against the euro and 2.6% versus the Australian dollar.

Looking ahead, dollar sentiment remains negative, but the euro's prospect is also dented by concerns about the euro zone's economic outlook. While the European Central Bank remains focused on inflation, it may have little choice to cut rates later this year as more disappointing data emerge.

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