The Reversal Of Dollar Carry Trades

Last updated 9/24/2009 5:39 PM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• THE REVERSAL OF DOLLAR CARRY TRADES
• EUR/USD: IFO GOOD BUT NOT GOOD ENOUGH
• GBP/USD: BOE LIKES THE POUND WEAK
• USD/CAD: FLAHERTY PROPOSES AN EXTENSION TO ASSISTANCE FOR BANKS
• AUD/USD: NEW HOME SALES RISE
• NZD/USD: CONSUMER CONFIDENCE IMPROVES
• USD/JPY: YEN CROSSES HIT BY RISK AVERSION

EXPECTATIONS FOR UPCOMING FED MEETINGS

THE REVERSAL OF DOLLAR CARRY TRADES

For the second day in a row, the U.S. dollar strengthened against all of the major currencies except for the Japanese Yen. It has been a very volatile trading day in the foreign exchange market as the dollar originally sold off during the European trading session but surged significantly when U.S. traders joined the market.  The rally in the dollar happened in conjunction with the sell-off in U.S. equities which indicates that risk aversion drove traders into the safety of the greenback.  The reason why equities and currencies are correlated is because over the past month investors funded their equity purchases by selling dollars while others sold dollars to buy higher yielding currencies.  Either way, we are seeing that flow being reversed today.  

G20 Meeting: What to Expect

The price action in currencies reflects unique amount of nervousness in the financial markets before the G20 releases their final statement on Friday.  On the first day of the meeting in Pittsburgh, there is already evidence of friction between the leaders of the world’s largest economies.  President Barack Obama’s priority is to push for rebalancing of the global economy through its “Framework for Sustainable and Balanced Growth”  while other leaders like Germany’s Angela Merkel believe that financial regulation requires greater urgency.  Aside from these 2 hot topics, the G20 will also be discussing the state of the world’s recovery, limitations on executive compensation and climate change. However as the EU Ambassador to the United States said in an interview, “G20s don’t make the detailed decisions…But they can create the conditions for reform.”  Therefore we do not expect any blockbuster announcements and in fact believe that all of the buildup to G20 will prove to be a big disappointment.  For currency traders, the only thing that matters is whether the G20 leaders comment on foreign exchange fluctuations or the dollar.  Although there has been some speculation that currencies could be mentioned, we do think it is likely unless China leads the charge.  Talk of exit strategies will also be dodged as each countries wants to control their own policies.  If nothing much comes out of the G20 meeting, the dollar may give back its recent gains.  

Economic Data Review and Preview

In addition to the outcome of the G20 meeting, there are also a number of U.S. economic releases due scheduled to be released on Friday.  This includes durable goods orders for the month of August, new homes sales and the final report on consumer confidence for September from the University of Michigan.  New home sales could fall after the 2.7 percent drop in existing home sales.   This was the first drop in 5 months, bringing the absolute amount of homes sold down to 5.1M from 5.24M. Although the drop came after a sharp surge in sales the previous month, the decline in house prices indicates that there is still underlying weakness in the housing market.  Meanwhile jobless claims increased by 530k, the smallest amount since July. Continuing claims also dropped from 6.261M to 6.138M which most likely represents a reversal from the prior week. The latest jobless claims report is in line with the overall improvements in the labor market and suggests that we may see a stronger non-farm payrolls report for the month of September.

EUR/USD: IFO GOOD BUT NOT GOOD ENOUGH

Traders have not been kind to the euro this week.  The single currency was sold against the U.S. dollar 3 out of the last 4 trading days and appears poised for further losses.  The German IFO report increased from 90.5 to 91.3 in September but the rise fell short of market expectations.  As we wrote in yesterday’s report, recent economic data suggest that the pace of improvement in the Eurozone economy is slowing.  Both the current assessment and expectations component of the report also saw only a limited rise.  In France, the number of people seeking jobs rose to the highest level in 4 years.  According to Finance Minister Christine Lagarde, “the deterioration has slowed significantly since the beginning of the year” but “nonetheless, the negative trend will probably continue for several months.”  Meanwhile we are still watching the Swiss Franc very closely.  So far, the Swiss National Bank has not intervened in the currency and we suspect that this is partially because they are far more concerned about the value of EUR/CHF than USD/CHF.  This is not a surprise considering that the Eurozone is their largest trading partner.  However now that EUR/CHF broke below 1.51, the risk of intervention has increased.  We would be shocked if the SNB did not come into the foreign exchange market to sell Francs if EUR/CHF fell below its 5 month low of 1.50.  

GBP/USD: BOE LIKES THE POUND WEAK

Of all the major currencies, the worst performing today was hands down the British pound.  As a consequence of jawboning by the Bank of England, the pound lost value against every major currency.  The relief that came from yesterday’s not so dovish Bank of England minutes was short-lived after BoE Governor Mervyn King supported the weakness of the currency by saying that it is helping to rebalance the U.K. economy by making it more focused on exports.  This sentiment was echoed by BoE Chief Economist Spencer Dale who said that a weak sterling, monetary and fiscal stimulus is supporting the economy.  The bottom line is that the central bank wants the pound to fall because of the benefits mentioned above and their words represent a clear motivation to keep the pound weak.  Although the GBP/USD fell aggressively, the 1.6 percent move in the currency pair is not rare.  EUR/GBP on the other hand staged its strongest rally on a percentage basis since the first quarter.  Adding to the pressure on the pound was the warning from Moody’s Investors Service that British banks face “very notable” credit rating cuts. With the lack of any important economic events for the next 24 hours, further weakness in the pound will be contingent upon the outcome of the G20 meeting.

USD/CAD: FLAHERTY PROPOSES AN EXTENSION TO ASSISTANCE FOR BANKS

The Australian, New Zealand, and Canadian Dollars all tumbled against the greenback as investors took profits ahead of G20 meeting. Oil prices also fell more than 4 percent while gold prices closed below $1000, providing no support for the commodity currencies.  The Canadian government returned to easier monetary policy after Canadian Finance Minister Jim Flaherty proposed an expansion of mortgage buy-backs to C$125 Billion or $116.4 Billion. The proposal comes on the midst of yesterday’s comments by Governor Mark Carney who claims the recovery is not “self-sustainable” and is a mere consequence of unconventional measures.  If they proceed further with this, we could see a turnaround in the Canadian dollar.  Meanwhile New Home Sales in Australia rose by 11.2 percent, the largest margin in three and a half years.  The local market has been on a tear thanks to incentives for first time home buyers and demand from China.  Adding to prior optimism in New Zealand, Consumer Confidence surged to a four year high in the third quarter. Despite a contracting labor market, record-low interest rates and rising value of homes boosted sentiment. Roughly 60 percent of New Zealand’s economy depends on domestic demand and thus, a rise in spending generally follows a rise in consumer confidence.       

USD/JPY: YEN CROSSES HIT BY RISK AVERSION

Japanese Yen crosses fell victim to another day of risk aversion.  However unlike the other yen pairs, USD/JPY managed to recover most of its intraday weakness.  This suggests that the sell-off in the yen crosses is due primarily to the weakness of the majors ex dollar and not demand for the yen.  Japanese traders returned from their holidays last night and with that came a series of economic reports.  In the month of August, the trade surplus increased thanks to a smaller decline in exports and imports.  Supermarket sales also fell at a slower pace.  Both of these reports confirm the recent optimism of Japanese officials including the upgraded assessments from the Bank of Japan.  Not only did the strength of the Yen only have a limited impact on the Japanese economy, but the pickup in the global economy is restoring export demand.  This evening the BOJ Meeting Minutes are expected to be released and we expected continued optimism from the BoJ.

USD/JPY: Currency in Play for Next 24 Hours

USD/JPY will be the currency in play for the next 24 hours.  The Bank of Japan Meeting Minutes is due for release at 23:50GMT or 9:50PM EST. The following morning, U.S. Durable Goods Orders are due out at 12:30GMT or 8:30AM EST followed by New Home Sales and the University of Michigan Consumer Confidence report at 14:00GMT or 10:00AM EST. After a prolonged downtrend, USD/JPY finally managed to solidify its presence in the Range Trading Zone which we determine using Bollinger Bands. Now that USD/JPY has exited the Sell Zone, a bounce in the pair from current suppressed level is likely but, USD/JPY needs to first break the upcoming resistance in order to push higher. Current resistance hovers at 92.00 which is the 23.6% retracement of September’s low and Augusts’ high and the 20-day SMA. If the pair manages to drop back into the Sell Zone, expect USD/JPY to test previous lows of 90.20.

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.