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The month of July was characterized by a massive exodus out of U.S. dollars.  If you can remember back to those warm days of summer, the dollar was taking a beating.  July was the month when USD/JPY fell from a high of 81.45 to a low of 76.75, breaking a 3 month consolidation that triggered intervention from the Bank of Japan.  July was also the month when we saw non-farm payrolls was reported at 20k (for June), creating widespread fear that the U.S. economy would fall into another recession. However most importantly, the debt ceiling debates intensified in the month of July as investors counted down to U.S. Treasury Secretary's August 2nd deadline for raising the debt ceiling.  As we got deeper into the month of July, the prospect of the U.S. losing its prized AAA rating became real and investors started to dump dollars in anticipation of a downgrade.

According to the latest Treasury International Capital flow report, net foreign demand for U.S. dollars fell $51.8B in July, which was the largest one month outflow in exactly 2 years. Although central banks around the world continued to buy dollars as a sign of solidarity and commitment to U.S. Treasuries, private investors who have no allegiance whatsoever sold dollars in size.  Net private TIC outflows topped $44.4B while net official flows declined by $7.4B. The details of the report showed the greatest outflow from the Caribbean, Luxembourg and Russia.  The first two countries are well known tax harbors and home for many hedge funds who were perhaps positioning for a downgrade. Both official and private demand for Treasuries on the other hand remained positive with net long term TIC flows rising by $9.5B.  Although this sum was less than a third of what economists had anticipated, it implies that investors still believe their dollars will be safe in the long term, but are worried about its security in the short term.  It is also worth noting that despite their open criticism, China never wavered in their support for the U.S. dollar because they continued to buy dollars.

The greenback sold off against most of the higher yielding currencies in reaction to the TIC report but despite the downward surprise in the data, the overall impact should be limited because Treasuries have recovered since then and investors resumed their purchases of dollars even after S&P downgraded the U.S.' sovereign debt rating. Risk appetite in general also benefited from the improvement in investor confidence.  According to the University of Michigan, the mood in America has finally improved after falling for 3 months straight.  The UMich survey rose from 55.7 to 57.8 in the month of September, reinforcing a similar uptick seen in the IBD consumer optimism index.  However it is important to differentiate relief from optimism.  Investors were clearly relieved that the world did not come to an end in U.S. after S&P stripped the country of its AAA rating. 

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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.