Another year, another market theme. This is especially true in the foreign exchange market.

2009 was a year in which the various authorities salvaged, revived and drove the financial markets to normal through injection of funds and low interest rates regimes. The main theme of the forex market was therefore one of "risk on/off", whereby foreign exchange rate movements moved in tandem with the performance of the asset classes - equities, commodities and debts.

2010 will have an entirely different theme. Foreign exchange rates movements will be following what the market will predict and think about whoever will reach the top of the "economic growth ladder" in the race toward economic growth. Going into 2010, I categorize the different currencies into groups when making foreign exchange investment decisions:

The first group is a superior group which we call the "Dollar-Bloc currencies" or simply "commodities currencies". Commodities will still be king of the asset classes in 2010. This group of currencies includes the Australian dollar, the New Zealand dollar and the Canadian dollar.

This group will "shine" once again - especially the Australian dollar, since the country is presenting encouraging various growth initiatives: a commodity-based and recovering economy, with an anticipation of higher interest rates later the year, plus growing trade relations with China that will generate domestic benefits. The money-printing quantitative easing (QE) by the three countries in the second group below has exported their inflation east and has also impacted their currencies. The Australian dollar, New Zealand dollar and Canadian dollar will have no choice but to continue raising their interest rates to combat inflation and to have an appreciated currency.

What some market participants do not realize is that only the Canadian dollar among the three belongs to the "USD Index", so even if the Australian dollar, and the New Zealand dollar rise sky-high against the US dollar, it will not be affecting the Index US dollar's performance at all as neither is included in the Index weighting.

Market participants, who have gotten used to seeing the "US Dollar Index" as a guide to the "strength and weakness" of the US dollar and to gauge the performance of the equities and commodities market to decide whether the market is "risk on/off", will find themselves losing their way when the Australian dollar and New Zealand dollar keep appreciating without affecting the US Dollar Index weighting.

The second group of currencies includes the US dollar, the euro, the British pound and the yen. These countries have been most active in adopting "quantitative easing" monetary measures plus "close to zero" low interest rates regimes.

This group is concerned about growth while pondering the timing of "exits" from their quantitative easing. For the time being, the US appears to be the front-runner as its economic data continues to surpass market expectations. This will make the US dollar a better performer than the euro, pound and yen at the start of the year.

Ironically, although all four were heavily "debt ridden" across both the government and private sectors, it appears the market lambasted Europe, the UK and Japan more than the US. Furthermore, the Federal Reserve and European Central Bank are the ones that continue using the rhetoric of "QE exits" or tightening up of interest rates. This, for the time being, has prompted the market to have a "slightly better expectation" for the US dollar and euro than the pound and the yen. In reality, if they "exit" at the wrong time, or too early, that may create a worst-case scenario for the economies and their currencies. Although this is not what the market is dwelling on at the moment, investors should always think a step ahead.

As for the UK and Japan, they have never mentioned "QE exits" seriously, and, in fact, the market is expecting a further QE from the UK. Just a month ago, Japan suddenly increased their QE, albeit only slightly, in order to reclaim its throne of "carry trade funding currency status" from the US and its dollar.

Therefore, in terms of rating this group of currencies, the US dollar should come first, then the euro, pound and, finally, the yen. As the euro, pound and yen belong to the six currencies which make up the US dollar Index, one should not be surprised to see the US Dollar Index rise within the first part of 2010 due to the perceived weakness of the pound and the yen.

Now, putting the two groups together, the rating order, from good to bad, would be Australian dollar, New Zealand dollar, Canadian dollar, US dollar, euro, Swiss franc, pound and yen. It is not difficult then to decide what to do in the first quarter of 2010: Buy the highest-rated and sell the lowest-rated.

In other words, the investment combinations should be BUY AUD/JPY, SELL GBP/AUD and so forth. By mid-2010, AUD/USD is likely to be at 0.9500 or above, NZD/USD at 0.7600, USD/CAD at 1.0000, USD/JPY at 95.00, whereas cross pairs AUD/JPY will be over 90.00.

Victor Ho is a Senior Vice President at MF Global HK Ltd, which is involved in derivative products and non-derivative foreign exchange, equities, and fixed income products. Opinion expressed in this article are entirely those of the contributing author.

(HK Edition 01/08/2010 page3)