Posts from — August 2007

After modest gains this week, the U.S. dollar fell against the yen and euro on news of poor U.S. jobs growth. A government report today showed 92,000 jobs added for July, falling well below expectations as 126,000 jobs were added in June. Economists at Bloomberg predicted 127,000 new jobs for the past month. In addition, the unemployment rate rose unexpectedly to 4.6 percent up from 4.5. These are signs the U.S. economy is still hurting from the subprime crisis as investors are losing this week’s earlier appetite for risk. The dollar fell to $1.3727 against the euro this morning in New York, down from $1.3703 yesterday. The increase in risk aversion has also caused the dollar to fall against the yen from 119.21 yesterday to 118.93 this morning.

Poor U.S. job growth and resulting increase in unemployment may prompt the U.S. Federal Reserve to lower interest rates this year to reboot growth. This may be a sharp change in monetary policy as rates have been kept strictly at 5.25 percent for 2007. Mathew Strauss, a senior currency strategist at RBC Capital Markets Inc. in Toronto, comments: “The payroll number raised concern that the slowdown in housing may start to affect growth. It seems one supporting factor for U.S. consumers may start to lose ground—a strong labor market.” Investors betting on futures contracts on the fed fund rate due in December changed forecasts on the yield to 5.02 percent, down from 5.21 percent from a month ago. The Fed will next meet on August 7^th.

Currency Outlook and Forecast:
The decisive factor for the future U.S. dollar movement is the subprime crisis. The big question bothering investors is whether the U.S. housing slump will spill over into the rest of the U.S. economy. Speaking on this issue, Jim Rogers, co-founder along with George Soros of the Quantum Fund, believes losses from the subprime-market have a long way to go. According to Rogers: “This [subprime defaults] was one of the biggest bubbles we’ve ever had in credit.” He forecasts U.S. investment banks and homebuilders will take further hits. Bear Stearns stock fell 13 percent last week. Shares in other investment banks such as Merrill Lynch and Lehman Brothers also fell this week.

Kathy Lien, chief currency strategist at FXCM, forecasts August to be a tough month for the U.S. dollar. She believes tighter credit and the housing blowup will have significant negative effects on the U.S. economy this month (see her article at dailyfx.com). Don’t expect steady long term gains in the dollar anytime soon, especially as the Fed may be lowering the borrowing rate later this year.

The US Non-Farm Payrolls report disappointed the forex market this morning, listing only 92K new jobs.  We should have expected this based on the dreadful ADP survey, but ADP has a history of missing the mark on Non-Farm Payrolls.  And so economists were actually expecting 127K new jobs, and the US labor market did not deliver.  With less than 100K new jobs, the NFP puts the Fed on track to cut interest rates in early 2008, which may benefit the equities market when it happens but it kills the US dollar in the meantime.

The US dollar has benefited from risk aversion recently (or at least been sheltered from the turmoil in the equities markets) by its status at a store of value.  People find US assets safe, and so those traders invested in riskier environments (the carry trade) have parked their money in dollar-denominated assets for the time being.  But the euro is also safe, and right now there is great opportunity to trade EURUSD with this morning’s jobs report.  A general description of how that trading should be done can be found on DailyFX.com.

The important thing to consider is that most currency traders had already priced in high expectations for US payrolls.  Had the economy met those expectations (or even exceeded them) the market would have just yawned.  But the downside disappointment is surprising and so the negative FX reaction to the NFP should be steep.

The foreign exchange market should not destroy the US dollar, at least in the short-term, because of the inherent value that many traders place in the stability of the US currency.  But the American economy is reeling from the housing and mortgage crisis (exacerbated by the falling stock market), and the news will provide impetus for many traders to move out of dollar-denominated assets.  One place to move into is Europe, because as Kathy Lien of FXCM notes, the surprise press conference for the ECB yesterday almost certainly confirms an interest rate hike in September.

Jim Rogers, the man who made billions with George Soros in the 1980s and correctly predicted the commodity boom in 1999, calls the US housing market one of the biggest credit bubbles ever.  The US economy may not be able to just absorb the shock and move on.  Manufacturing will not be able to sustain its strength forever.  There are even reports in Bloomberg that risk appetite is returning to the market.  If this continues, then the US dollar will fall even more, as the ability of US Treasuries to store value will no longer be as prized.  There does not seem to be much good news for dollar bulls in the current FX environment, and the future does not look much brighter.

We’ve been talking about the carry trade unwind for the past couple of days.  The moves in the forex market yesterday and during Asian trading last night ran counter to that assumption.  There was a reversal upwards in the yen crosses, especially CADJPY, AUDJPY and NZDJPY.  The late rebound in the Dow also buoyed USDJPY, as that currency pair has assiduously followed the ups and downs in the equities markets for some time now.  But I am here to tell you that the prognosis with regards to the currencies in the United States and Japan is still yen-positive and dollar-negative.

Let’s starts with the bad news for the US dollar.  The bond market is pricing in a 100% chance of an interest rate cut in January.  DailyFX.com has a fascinating take on the interest rate speculation through a look at the comments of various US monetary policy makers, with the ultimate scenario suggesting a more dovish outlook for the Fed.  The ADP survey shows terrible job growth numbers, coming in at only 75K.  Earnings for most US corporations continue to be relatively stellar, but the money refuses to trickle down, and dollar bulls may have to come to terms with a slowdown in US expansion.

Coming to the yen, most currency analysts see still more room for the room to grow.  The Chicago Board Options Exchanges’ market volatility index (VIX) hit a yearly high yesterday, and greater volatility is a death knell for the carry trade.  Kathy Lien of FXCM posts a two-year chart of USDJPY that will not provide comfort for yen bears.  The interesting thing about the chart is not that it necessarily signals a move downward in the currency pair but that it demonstrates the potential of a possible drop.  And that drop would be disastrous for those still long on the carry trade.

For some months now, dips in the yen crosses have not really been something to worry about; rather, these dips have been seen by Japanese retail investors as opportunities to short the yen.  There has been talk all over the market about “Japanese housewives” beating the pros and serving to stabilize the market by keeping carry trades alive.  But a recent Bloomberg report claims that the risk appetite for Japanese traders is dropping.  They are wary of selling the yen now because they anticipate still more appreciation for the currency, which has the potential to be a self-fulfilling prophecy.  And contributing to the growth of the Japanese yen are the losses all over the hedge fund market in the United States.  The hedge funds were some of the primary drivers of the carry trade, and their exits from the forex market (at least in this limited capacity) might serve notice to the rest of the market that the carry trade is, indeed, unwinding.

A worldwide credit crunch and economic problems (mainly in the United States) have torched the equities markets for the past two weeks.  There are fears that the subprime mortgage crisis and the housing problems will escape their respective sectors and infect the market as a whole.  The losses are magnified by the uncertainty of many traders, exemplified by the VIX volatility index surging past previous levels.  As is usually the case in a situation like this, risk aversion is controlling the market.  With regard to foreign exchange trading, two phenomena emerge: a flight to safety for capital and a carry trade unwind.  As Boris Schlossberg of DailyFX.com notes, the only winners in this scenario are the US dollar and the Japanese yen.

Flight to safety in the forex markets is beneficial to the US dollar, at least temporarily.  This is because investors pare back from riskier investments and park their capital in dollars for the time being.  The result is a peculiar situation where the crumbling of US markets is actually a boon for the US dollar.  But traders should realize the dollar strength will not last.  As for the US stock market, there is a sense that the credit crisis is reaching other areas; there are reports in Bloomberg that situation with subprime mortgages are hurting the earnings of companies across the spectrum.

And the economic reports have been mixed.  The regional manufacturing surveys (Philly Fed and Chicago PMI) have disappointed, confounding observers who thought the weak dollar would allow exports to support the manufacturing sector.  But unemployment is in line to grow by 100K for the NFP report later this week.  How traders react to that data will determine the long-term direction of both the US economy and the US dollar, but on a short-term basis, the dollar looks good.

Growing risk aversion also creates problems for carry trade longs.  Yen bulls have killed the fx market for the last two weeks.  There has been a 1000 pip decline in GBPJPY (from its record high), and the yen has also gained 700 points against the three commodity currencies.  In fact, the yen improved against all 16 most highly traded currencies last night.  Carry trade lovers cannot start crying over their losses yet, however; Kathy Lien of FXCM claims there is still plenty of room for the yen to appreciate.  Fear is the dominant factor ruling the currency market right now, signaling a strong near-term weakness in the Australian dollar and the New Zealand dollar, two currencies that have gone up significantly on the back of the yen-based carry trade.  I am not one who believes that the credit crunch puts us in line for a global slowdown (and the great thing about trading currency is that it doesn’t matter—there is the same opportunity for profit in a bear market as there is in a bull market).  But I think traders should be wary of high risk investments and focus instead on more stable currencies and economies.