Yen-funded carry trades are not finished, despite reports to the contrary. To paraphrase Mark Twain, reports of its death have been greatly exaggerated. All three commodity currencies, the Australian dollar, the New Zealand dollar and the Canadian dollar, gained against the yen last night. High oil prices and bad Japanese economic data spurred the poor results. Even the US dollar was able to pick up value against the yen yesterday, despite the inaction by the Fed. The yen gains in the forex market earlier in the week now look like a bout of international risk aversion. But with the momentary blip over, yen shorting should resume with a vengeance.
There are many reasons for the current yen weakness. The data released earlier this week was fairly yen-positive. Retail Sales and some investor indices proved encouraging for yen bulls. But the name problem with the Japanese currency has always been the country’s battle with deflationary pressures. The interest rate has been so low for so long, and economic policy makers in Japan are powerless to raise interest rates until growth picks up and inflation returns to the economy.
But the last couple of reports coming out of Japan do not leave much hope for the country. On the growth front, Industrial Production fell 0.4% when most forex analysts were predicting a 0.9% gain. And even more damaging for those predicting an interest rate hike, the CPI report this morning showed a drop in prices of 0.1%. Before final decisions on the yen are made, there is still some data on tap, including overall household spending, the jobless rate and manufacturing PMI. But if deflation persists, the Bank of Japan cannot raise rates in July or August, further dooming the currency.
The yen is easily the most undervalued currency in the forex market, at least among the most highly traded currencies. It has lost 4.3% against the US dollar this quarter. That puts it on track for its biggest quarterly loss against the dollar since 2001. Most of that is due to the popularity of yen-funded carry trades, fueled by the low interest rates in Japan. The majority of currency analysts expect those carry trades to continue to outperform. With the growth and inflation outlook in Japan looking as dire as it does right now, it would be foolish to predict the end of the carry trade wave and the end of the yen slide.
June 29, 2007 No Comments
The United States Federal Reserve’s interest rate announcement and accompanying statement is scheduled to be released today at 2:15 PM Eastern Standard Time. Barring a complete surprise, the Fed is likely to leave interest rates at 5.25% and issue a statement hawkish on inflation. With contradictory data regarding economic growth and interest rates, the bank cannot do any more. A move in either direction would prove harmful.
Economic growth in the United States is actually rather sluggish and does not bode well for the US dollar. In today’s GDP report, we saw that the economy grew 0.7% in the first quarter of 2007, the slowest pace in four years. This number was higher than the estimates last month of 0.6% but lower than the forecast of 0.8%. The economy certainly is not growing at the pace it was last year, when the last quarter of 2006 registered growth of 2.5%.
Various sectors of the economy have felt the effects of the economic slowdown. The housing market is undergoing it biggest slump in two decades. Demand for housing seems to fall with every new report, and the sub prime woes have led to the number of foreclosures reaching record highs. Consumer spending, which makes up the largest portion of the US economy, is cooling, mainly due to higher energy prices. Its growth this quarter is half what it was last quarter. Business investment is also falling, suggesting that the slow growth this quarter may not be an aberration. Yesterday’s durable goods report showcased a larger than expected drop in May.
But even considering all this bad news, the FOMC cannot lower interest rates to stimulate the economy. And the reason why is rising inflation. Prices continue to rise, at a pace with which the Fed is certainly not comfortable. Today’s numbers showed a 2.4% rise in core inflation, stripping out food and energy costs. That is certainly discomforting to policy makers, especially compared to the 2.2% rise that was expected. And when you consider that the Fed under Chairman Bernanke has professed to prefer inflation within a 1-2% range, you further get the sense that inflation is a big worry. That is why interest rates are not likely to change, and the statement from the Fed is bound to be tough on inflation (Kathy Lien has a more detailed discussion of the Fed’s decision on interest rates).
What does the Fed’s announcement mean for the US dollar? The cable should continue to rise, especially in anticipation of the likely interest rate hike in the next BoE meeting. GBP/USD should not have much trouble staying above 2.000. The euro should see some gains as well, with similar expectations on the interest rate decision of the ECB. The yen is a little bit more interesting. With core prices falling yesterday, the country’s battle with deflation is not yet over. As long as the Fed remains consistently hawkish in its statement, we might see a reversal of yen gains against the dollar with USD/JPY testing 125.00 soon.
June 28, 2007 No Comments
Both U.S. and European equities markets have taken a fall with the news of disappointing durable goods and weak new homes sales still fresh in trader’s minds. The European Dow Jones Stoxx 600 Index fell 0.8 percent to 386.38, the Euro Stoxx, decreased 0.8 percent, and both the U.S. Dow Jones Industrial and S&P 500 fell 0.4 percent. Â
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The fall in U.S. and European equity markets have pushed forex traders to buy Swiss francs. The franc has gained on the euro for the fourth straight day. Against the euro, the franc is up 0.2% to 1.649, the strongest since June 8th. Diminishing confidence in the U.S. and European equities have sent investors are looking for security. As in the past, as general risk aversion increases, the Swiss franc gains in value as well as more investors are looking for a low risk investment. With a weakening of the European market, long euro positions have been liquidating and flooding the market for Swiss francs.
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Other factors that have contributed to the rise in demand for Swiss francs include news of increasing borrowing rates by the Swiss National Bank. This increase in turn makes a currency more attractive in value as room for arbitrage is created against another currency with a relatively lower borrowing rate. The European Central Bank has also indicated a desire to further increase interest rates to combat inflation which will likely hurt their already weak equities market.
June 27, 2007 No Comments
Recent developments in the foreign exchange market prove that it is not just interest rates that drive action in the currency market. Expectations of future interest rates also matter.  The currencies with the greatest chance of higher short-term interest rates are the currencies receiving the most support from traders. The few currencies with bad prospects for an interest rate hike are getting hammered, and that will continue as long as expectations stay the same. Just look at the results in the last 24 hours. The pound and the Aussie have been the best performers while the Japanese yen continues to sink.
Much of this kind of activity is indicative of a strong carry trade. Economic policy makers in Japan have been clear in their refusal to raise rates, at least until there are stronger signs of consumer recovery in Japan. And when the Bank of Japan does start raising the overnight lending rate, they have committed to doing it as gradually as possible. Japan’s rates are low, and people (investors) are encouraged to seek higher yields. The can find those higher yields in other currencies, in the US stock market (witness the steady resilience of the market to any drops) and in foreign bonds.
The carry trade is simply an interest rate differential story. There is a concern as it becomes more popular because that makes it inherently riskier (see Bloomberg’s stories on Japanese and Hungarian housewives engaging in the carry trade and beating the market). But until the carry trade bet becomes untenable (and that will happen at some point), forex traders continue to reap their gains and push the yen lower. The euro is at its highest level ever again the yen. AUD/JPY is at a 15 year high and USD/JPY is at a 4 year high. And perhaps most interestingly, the New Zealand dollar, the currency with the highest yield, is back to the rarefied levels it occupied before the RBNZ intervention. The bank would like to push it down again, but it is running out of funds. And central bank interventions do not usually work anyway. The bottom line is that as long as the global market stays calm, carry traders will profit on the interest rate differentials. But world-wide inflation, political uncertainty, a slowdown in the United States or anything else that throws the forex market into flux will put a wet blanket on the carry trade.
June 22, 2007 No Comments
The most important news today (at least in terms of the foreign exchange market) is the release of the minutes of last month’s BoE Monetary Policy Committee meeting. The release surprised most of the market with a more hawkish-than-expected stance. The Committee did vote to keep interest rates steady in June, but the vote was much closer than many traders had predicted. Most market analysts had expected a 7-2 vote against a rate hike last month, but the actual vote was 5-4.
In addition to that, Governor Mervyn King was one of the four dissenters calling for a rate hike. The bank’s governor has only been overruled twice in the 10-year history of the Monetary Policy Committee. Many traders today feel that with King now calling for a rate hike, the decision is almost a done deal. Today’s release of the meeting’s minutes only confirms forex market speculation that began with hawkish comments earlier in the month by Governor King and others.
There are other important currency market considerations regarding interest rates besides the comments of the Committee members. Money supply growth has reached its fastest annual pace in seven months. Oil prices are still at $69/bbl. Other inflation indicators are also robust, including the British housing market and the index of prices in shops.
It is difficult to predict the actual actions of central banks (that doesn’t stop currency strategists from trying). But the various exchange markets have already felt the impact of the release of the Committee vote. Futures market traders are betting on a rise in rates to 5.75% at the next meeting. In the forex market, the future rate hike is being priced into the value of the pound right now. For example, GBP/USD easily cleared 1.9900 after today’s minutes release, and it is likely not to encounter much resistance at 2.000. The pound has also risen against the Japanese yen, climbing to its highest level since 1992. Look for strong support for pound long bids in the coming day as the forex market prices in the likely BoE rate hike.
June 20, 2007 No Comments
The yen carry trade remains strong in the foreign exchange market, but before analyzing why that is the case, let’s look at some specific exchange rates. The US dollar has fallen in recent trading versus the euro (EUR/USD) and the pound (GBP/USD). Bond yield in the US have declined from their record highs. Home builder confidence is at its lowest in sixteen years. And the CPI numbers last week (with core prices rising only 0.1%) demonstrate the slowing pace of inflation. Put those factors together, and you get weak support under the dollar.
The pound and the euro, however, continue to receive strong bids in the currency market. Much of this has to do with a growing consensus among traders concerning the likelihood of a rate hike by both the ECB and the BoE. President Trichet of the ECB recently came out and said the new emergence of many fast-growing economies around the world is creating a upward pressure on prices. These hawkish comments were coupled with remarks by other ECB members asserting the ability of other European economies to withstand a future rate hike.
The flipside of this strength is the persistent weakness of the Japanese yen. There is optimism among Japanese policymakers (after the GDP and Industrial Production data), but the growth is still not robust enough to survive higher interest rates. This is especially true with regard to the Japanese consumer. And the low interest rates in Japan prove irresistible to carry traders.
Take the EUR/JPY pair. It hit an all-time high of 166.12 yesterday eventually settling at 165.91. The euro-yen has been a one way bet recently, and the tame US inflation reports will keep it that way. The carry trades are unlikely to be interrupted in the near future considering the low risk of global inflation in the current currency market. The US inflation data signals lower volatility in international exchange rates in the future. So traders have more confidence that they can capture the differences in yields in two countries without the risk of losing those gains thorough market swings in the exchange rates.
But there is one important caveat for enthusiastic carry trades. BoJ governor Fukui has said that it is important for the country to raise real interest rates to help domestic pension plans. There is also a concern for political repercussions in Europe and the United States if the continuing devaluation of the yen proves to be too much of an advantage to Japanese exporters. Lastly, 10 year bond yields in Japan have reached 1.935%. Yield levels of 2.00% or higher could lead to a return to the domestic bond market for Japanese institutional investors. That by itself could push the Japanese currency up, destroying carry trades.
June 19, 2007 No Comments
The defining action this weekend had traders basing their decisions almost entirely on yield differentials between countries. In many cases, broad economic data was ignored in favor or inflation expectations and interest rates. That’s why it is so important for foreign exchange traders to study the futures charts and determine which central banks the market thinks are likely to raise interest rates. Example number one is the state of the US dollar. Friday’s CPI report drove the market for the dollar. Core prices rose only 0.1% in May, signaling that inflationary pressures were under control and in line with the growing economy. As such traders in the forex market see no reason for interest rate hikes in the near future, and the dollar has suffered as a result.
The Japanese yen and the Swiss franc have also fared poorly in the currency market mainly due to interest rates. The economic situation in Japan and Switzerland is completely different. The Swiss economy is robust and growing at a rapid pace, while the Japanese economy, despite satisfactory GDP growth, still has to contend with weak consumer demand. Yet both currencies are experiencing a similar freefall; low interest rates in both Japan and Switzerland make carry trading especially attractive.  The Bank of Japan not only did not raise rates in their meeting last week, but its comments suggested that it was unlikely to raise rates next time either unless consumer demand picked up. The Japanese economy is simply not ready for interest rate hikes.  In Switzerland, despite much stronger economic data, the SNB chose to only raise rates by 25 basis points. This did not do nearly enough to cut the rate differential between the franc and the other European currencies.
The situation is only exacerbated by the possibility of interest rate hikes by both the Bank of England and the European Central Bank. The currency market is loading up on both the pound and the Euro in anticipation of in anticipation of those future rate hikes. Hawkish comments about inflationary pressures by European Central Bank council members continue to bid up support for the Euro (EUR/USD at highest in two months) despite poor Industrial Production and Retail Sales data. In England, BoE Governor Mervyn King is as hawkish as ever concerning rising inflation. The likelihood of rate hikes is being priced into both currencies, leading to gains across the board, especially against the US dollar, Japanese yen and Swiss franc.
June 18, 2007 No Comments
The Yen was hammered last night in the forex market. In the Bank of Japan meeting there was a decision to keep the overnight lending rate at 0.5%, the lowest among all the major currencies. All the major currencies increased against the Japanese yen as it became obvious that rate differentials were not going to compress. But as Boris Schlossberg of DailyFX.com points out, the losses probably had as much to do with the bank’s reluctance to commit to a rate hike in August as they had to do with today’s decision. The policy makers in Japan admitted that they were more worried about the still-lagging domestic consumer demand than they were about the admittedly undervalued currency.
Carry traders continue to rejoice with the non-move in interest rates. With no danger of a US rate cut, USD/JPY reached a fresh 5-year high. There is cause for some worry for carry traders in the currency market. The undervalued yen has led to an advantage for Japanese companies overseas. There has already been complaining in Europe about this advantage. If policy makers in the US jump on this bandwagon as well, it could lead the BoJ to institute a preemptive rate hike.
Going back to the dollar, there are a few signs of continuing dollar strength. On June 14, we saw PPI numbers that positively surprised the forex market. Almost all recent data that has come out the US has been higher than expected and supported dollar bids. And in the last week, high bond yields have continued to suggest an interest rate hike by the Fed.
But today’s data shows creeping signs of dollar weakness. Home mortgage rates last month reached record highs, as did foreclosures. With that kind of negative push on the US economy, it might be unwise to raise rates at the time. In addition, today’s CPI report came in surprisingly tame, with a lower-than-expected rise in prices. Production at factories, mines and utilities declined last month, and consumer expectations have been underwhelming. A repeat of this kind of performance in coming days might give the Fed some cover for a rate cut. And it is that fear that allowed EUR/USD to gain so strongly yesterday.
June 15, 2007 No Comments
US Dollar growth is the primary market mover today. Bonds continue to fall in the US, driving yields to their highest level since 2002. And that has significant repercussions for all other currencies in the foreign exchange market.Â
Despite strong economic data for the yen, the strong dollar growth continues to dominate. Japan came out with great e data yesterday as the current account surplus blew past expectations of 1948 billion yen, arriving in at 2279 billion yen. The weak yen proved beneficial to Japanese exports. But US bond yields are at their highest level in five years causing Japanese investors to continue to buy US bonds, for which they need US dollars. So despite the positive economic results in Japan, in the forex market, USD/JPY continues to be bought, keeping it above 122.00.Â
In Europe, the Euro has been sold for seven straight days now, putting it at a new two-month low against the dollar. This is on the basis of not only overall dollar strength but also bad economic data. As we stated previously, industrial production in Germany and France has plummeted. But despite the data, the European central bank has continued to be hawkish. If the ECB follows through on its rate hike promise, or at least if the market believes it will follow through on the promise, then that could limit dollar growth.  It is important in the currency market because the Fed is certainly not going to raise rates at its next meeting.
In the UK, we also have evidence of broad dollar strength. But the pound has done well against the dollar in past couple of days, on the back of a narrowing trade deficit and a very slight rise in core price inflation. But today’s slower than expected wage growth has put a slight hold on the Bank of England’s plans for a rate hike. When combined with the bid support under the US dollar, that has driven GBP/USD under 1.9700.Â
The Australian, New Zealand and Canadian dollars also suffered yesterday. The strong dollar was a factor, but so was the decline in carry trading. With the US stock market falling again, carry traders were looking to liquidate. Markets are interlinked, and if the current condition in the US equities market continues to hold, then that could put a damper on carry trading.Â
It certainly looks as thought the rise of the US dollar will continue for now. This morning, US retail sales rose 1.4% beating estimates of 0.7%, and last moth’s sales data were revised upwards as well. Import prices did rise, but that was expected considering the weak US dollar in April and May. The sales data demonstrates that consumers are hanging in there, and that is definitely bullish for US yields. As long as the US consumer continues to hold off his long-predicted fall, dollar bulls will continue to rule the market.Â
June 13, 2007 No Comments
The New Zealand dollar and Australian dollar are seeing record highs at Wednesday’s closing versus the United States dollar.
After unemployment rates bottomed to less than 4%, a 33-year low, the Aussie reached a point it had not been to in 17 years. It closed yesterday up 0.5% to 0.8444 against the dollar and 0.6 per cent to Y102.46 against the yen. This raised much speculation that Australian interest rates will be raised in the near future.Â
Reserve Bank of New Zealand, its central bank, surprisingly raised interest rates yesterday from 7.75 to 8%, the highest rate since induction in 1999, in order to limit inflation. Inflation was hovering around the 4% mark, while the government wanted that rate between 1-3%. As the market closed, the kiwi rose 0.7 per cent to $0.7555 against the dollar, reaching 22-year highs, and 0.9 per cent to Y91.63 against the yen.Â
As the kiwi, as termed by New Zealand’s locals, and Aussie were hitting new heights, the dollar held its ground against the euro, yen, and pound, respectively. The dollar advanced, rising 0.3 per cent to $1.3465 against the euro, 0.3 per cent to Y121.40 against the yen and 0.6 per cent to SFr1.2235 against the Swiss franc.
Although the dollar was successful yesterday against the euro, yen, and pound, it is still below value against many of the other popular and heavily traded currencies in the forex market. For more coverage of the forex market and recent currency trading news, check out dailyfx.
June 7, 2007 No Comments
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