IB FX View

Dollar bows to carry trade pressure as funding costs slide

Wednesday September 9, 2009

A decline in the cost of borrowing dollars through the interbank market accompanied by the fading memory of stock market losses are conspiring this week to undermine the ailing health of the U.S. dollar. A drop to an all-time low for the three-month dollar Libor has justified the ultra-loose monetary policies pursued by the Fed by effectively thawing the cash freeze. That action now appears to have revived the dollar’s role as global reserve currency yet unwittingly puts its neck squarely on the chopping block as the next victim as the carry trade makes a return to town.


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Global stock indices have rebounded by 60% from a March 9 low. Confidence has come back form the brink of desperation and activity has admittedly picked up. As equity prices rally further away from those gloomy days investors assume it’s safer today to buy into a rising market than it was to buy when they were sliding.

In recent days analysts at two major investment houses lifted their predictions for the price of metals and lowered forecasts for the dollar. Both of these events have the potential to feed on each other, even magnifying the reality that rising commodity prices are based on firmer demand. Of course, higher prices could be a simple play on a weaker dollar and might not be rooted at all in strengthening industrial or manufacturing activity.

Yet today, as the firm tone to European stocks sends another buy signal to North American investors, the dollar faces another meltdown. In both Tuesday and Wednesday’s session the early movement at the start of New York trading saw clear cut dollar selling. It’s apparent that large houses are either unloading for their own or customer accounts or simply leaning on the market to see just what damage they can cause by inciting other sellers. It’s easy money if you know how!

The fact that the funding cost for dollars has slipped might be good news for borrowers, but it’s bad news now for the dollar. On the flip side it’s better news for the Japanese yen, which possibly quite gladly hands over its mantle as currency of choice for the carry trade. Today the dollar is weaker across the board including against the yen at ¥92.10. But the yen is falling against both the pound at ¥152.40 and the euro at ¥134.15 as investors continue to position in favor of higher yields and riskier equity-loaded returns.

The dollar has slipped against the euro today to $1.4568 after German consumer price data continued to show deflationary pressures yet at a 0.1% annualized pace through August. Through July the data showed a 0.7% decline.

In Britain the Nationwide Building Society noted the highest consumer sentiment reading since May 2008 according to one of its indices. The pound rode that crest against the dollar rising to $1.6550 today as once again, risk appetite pervades.

Neither commodity-linked dollars are currently able to achieve what the euro, yen and Swiss franc have done so far this morning. Both Canadian and Aussie dollars are constrained by yesterday’s rally and need to break higher in order to continue the positive tone. Some of the restraint is possibly due to rallies earlier in the summer, which were based upon firmer manufacturing data.

Having outpaced the dollar for several weeks investors are perhaps simply pushing the more obvious laggards ahead. Canadian housing starts in August were firmer than forecast and have served to reverse earlier in the day losses for the Canadian dollar, which currently buys 92.76 U.S. cents. The Aussie unit buys 86.60 U.S. cents.

Andrew Wilkinson                                                                    

Senior Market Analyst                                                               ibanalyst@interactivebrokers.com       

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