What happens in a world without yield?

As 2009 begins to unfold the biggest story in the FX market is the inexorable movement of all G-7 interest rates to zero percent. ZIRP, as a monetary policy is no longer the sole province of BOJ. US rates are now 0.25%. UK rates are 1.5% and moving towards 1% by next week. Canadian rates are 1.5% and will no doubt drop to 1% by the next meeting of BOC. And just last week ECB President Trichet telegraphed to the market that he intends to take rates European rates below the vaunted 2% line at the meeting in March.

Even high yielders like the kiwi dropped rates by much larger than expected 150bp last week taking the RBNZ yield to a paltry 3.5%. This week the RBA is expected to follow suit taking rates to 3.25% for the Aussie. Everywhere you look in the currency market yield is disappearing faster than an ice cube at the Australian Open where temperatures yesterday hit 109F (43C).

As all industrialized economies continue to battle the growing global economic crisis by further easing their monetary policies, what becomes the dominant value to drives trade? Survival. In world where consumer demand has fallen off a cliff, investors aren’t seeking a return ON capital, but simply just a return OF capital. Sovereign debt risk becomes the primary concern of currency valuation.

Ironically enough, US with its massive twin deficits and its FIRE (Finance, Insurance, Real Estate) based economy burned to the ground has become the repository of safe haven investment flows. The strength in the dollar is not a reflection of optimism in the US economy, but rather a vote of total no-confidence in Euro-zone system. With European union beginning to fragment under the pressure of escalating economic problems. traders are flocking to dollars as the only alternative left.

If the market truly loses faith in the euro experiment the pair could slice through the 1.2500 handle and even approach 1.2000 as panic liquidation will begin to set it. We haven’t reached that point yet, but next week could prove to be pivotal in determining just how fragile the support for the single European currency has become.

Boris Schlossberg serves as director of currency research at GFT, and runs bktraderfx.com.