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Central Bank Intervention Drives Major Purchases of USD

Last updated 10/18/2011 9:40 AM ET (GMT -5) 3 Comments

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Kathy Lien

Director of Currency Research, GFT

The U.S. government may have lost its AAA rating, but the dollar has not lost its luster. According to the Treasury International Capital flow report, foreign demand for U.S. dollars rose $89.6B in August, with purchases of long term assets rising by $57.9B. Despite the overall weakness in the U.S. economy, the prospect of more stimulus from the Federal Reserve and the downgrade by S&P, the uncertainty in the global economy drove investors into the arms of safe haven currencies. In August, the dollar fell to a record low against the Japanese Yen and Swiss Franc, prompting aggressive action by the Bank of Japan and the Swiss National Bank to stem their currency's rise. Both the BoJ and the SNB came into the markets in August to buy dollars with hedge funds and other speculators piggybacking on the move. The largest purchases came from the U.K., Switzerland, Caribbean and Japan. Normally there is barely any change in Swiss demand for dollars but in August, Swiss investors purchased $39.1B worth of dollar denominated investments. The Japanese also came into the market in size ($21.8B) but considering that central bank purchases only accounted for 33 percent of the flow and the $32.5B investments made by hedge funds in the Caribbean, there is no question that speculators joined in on the move. For the U.S. government, this was the best case scenario because the greatest risk of a downgrade is a massive exodus out of U.S. Treasuries. Even though China was a net seller of U.S. Treasuries which was probably their way of opposing the U.S.' fiscal policies, other central banks were far more worried about the negative impact of their rising currencies than the credit worthiness of U.S. Treasuries. At the end of the day, we know that the downgrade did not cause a massive collapse in the market and for the time being Treasuries are still viewed as one of the safest investments in the world.

U.S. inflation is also on the rise in - Producer prices rose 0.8 percent in September, with core prices rising 0.2 percent. Higher gasoline, food and truck prices have increased bottom line costs for production activity, leaving producers with the tough choice of raising prices on consumers or taking a cut to margins. For the Federal Reserve, higher inflation is problematic because it adds to the strain on consumers. It also makes the decision to increase Quantitative Easing more difficult because additional asset purchases could boost prices even further. The U.S. dollar has traded slightly higher against the euro and other currencies following this morning's economic reports but for the most part, risk flows will continue to dominate. Unless we have some positive comments out of the Eurozone, expect high yielding currencies to trade heavy for most of the North American session.

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Comments (3)

mbrad77

October 18, 2011 at 11:22 AM ET

also it should be noted CPI data comes in tomorrow
and AUD/USD is sitting right now in the upper bound from the march 2011 range

traderwillie

October 18, 2011 at 10:40 PM ET

I am starting to create a longer term position in US dollars against the Aussie. It has risen 1000 pips against the USD in the latest run up despite more dovish commentary from the RBA. If the markets are right in pricing in a decline in rates for the A$, we should see it well below parity in the next 12 months. My last short position against the euro had six positions total with a break even at 1.4050. Once it broke down to 1.3300 that pretty much made my year.

FXTC

October 19, 2011 at 03:49 AM ET

I’ll wait till this choppy trading settles and go short when audusd breaks below its last support 1.01260

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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.