US Dollar Woes

The problems with sub prime mortgages might not be as contained as some observers have tried to claim.  The S&P announced yesterday that they may cut the credit ratings on $12 billion worth of bonds backed by sub prime mortgages.  And it is increasingly likely that if this decision is made, it will force a reevaluation of all similar assets in the US market.  Rather than have the crisis confined to a particular sector, the mortgage situation reveals a poor and rotting basis for the entire economy.

This is bad news for the US dollar.  The sub prime fiasco will spill over into the overall market for US securities and bonds.  With US dollar-denominated assets less attractive, demand for the US dollar in the forex market goes down.  The domino effect does not end there, however.  The US market is the most important one globally, and problems there will trigger another bout or world-wide risk aversion.  What that means for currency traders, primarily, is an unwinding of the carry trade.  The problems with sub prime mortgages and CDO’s in the United States have some currency analysts suggesting that it may not even take an interest rate hike by the Bank of Japan to end the carry trade.  Investors have even started to abandon US assets for Japanese ones, driving Japanese bond prices to their highest levels since last August, with USD/JPY nearing 122.00.

Dollar weakness is running rampant throughout the currency markets today.  EUR/USD is approaching stratospheric heights with concerns in the dollar compounded by the likelihood of higher interest rates in Europe.  A similar situation (although with better fundamental data) is playing out with the cable, as it crashes through 2.0300.  And the irony is this entire situation is that the US economy is generally pretty healthy.  According to Bloomberg, growth is at the moderate target level and inflation is under control.  Economically, the country is humming along like a trusted old car; it is not going to impress anyone but it isn’t going to give you any problems either.  Despite all that, you might want to stay away from the greenback until further notice.