NEWS / Foreign Exchange

Unwinding of Carry Trades May Slow Dollar Decline

Reports of Russian accounts exiting out of yen shorts and Middle East accounts paring their long plays in high yielding FX is unwinding some of the carry trades seen in GBP, AUD and NZD. Rumors of further sub-prime troubles and a troubled hedge fund resulting from the soaring sterling have also helped weigh on USDJPY sentiment. This is also weighing on EURUSD, GBPUSD, GBPJPY while helping USDCAD and EURGBP. USDJPY sentiment could especially decline in the event that US stocks sell off on currency worries by foreign holders of US equities. 200 day moving average stands at 118 yen.  

The dollar??™s decline had turned a new page earlier, extending to 26-year lows against sterling at $2.013 and 3 ?? year lows against the euro at $1.3615. Fresh data supporting the case for a May tightening in the UK coupled with deteriorating dollar sentiment resulting from Tuesday??™s data showing slower US inflation (core CPI at 2-year lows) and weak industrial production boosting expectations for a Fed cut. The speed of the slide in the dollar is brought about by contrasting evidence of higher economic growth and inflation in Europe, relative to the US . The dollar shows a little more composure against the Japanese yen, but is well off the 7 ?? week highs seen on Monday. Failing to close above the 119 level, the dollar may risk extending its slide towards the 118 figure in the event that carry trades begin to unwind.

One way to gauge the extent of negativity in dollar sentiment was the failure of USDJPY to rally during yesterday??™s stock rally. The positive correlation between US stocks and USDJPY has grown increasingly strong over the past 7 weeks. Tuesday??™s declines in USDJPY, however, were not accompanied by any retreat in US equities or commodities. The rationale is explained by Tuesday??™s softer than expected US inflation, weakening the case for the Fed's inflation stance, while negative industrial production validates the case for deepening weakness in US manufacturing. Strong inflation and growth in the Eurozone and the UK completes the foreign exchange equation for protracted dollar sell-offs.  

With the US fed funds rate currently at 5.25% and annual core CPI at 2.5%, the real fed funds rate is now at 2.7%, the highest level since March 2001. This runs counter to claims from investment strategists indicating surging financial liquidity via the pace of mergers and private equity deals, and underlines the fact that borrowing costs may be too high for the current economic climate. This is already shown by the fact that the Fed funds rate has been above 10-year yields for over a year.

Sterling breaks to 26-year highs, but caution on unwinding plays

USDJPY nears 200 day moving average at 118

EURUSD to extend amid unwinding