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Fed Hawkish, Yen Crosses Rise as Carry Back in Vogue

Wednesday, 22 August 2007 10:58:16 GMT  |  Boris Schlossberg, Senior Currency Strategist

Both currency and equity markets stabilized overnight with Nikkei down only marginally and the general calm helped to support carry trades as various yen crosses firmed in Asia and early European trade.

·          Japanese Yen: some flow back in the carry as yen crosses firm

·          Pound: CBI Industrial Trends best in 12 years

·          Euro: CA,Industrial orders all better than forecast

·          Dollar: MBA Mortgage applications on tap

T

he shift in sentiment was due to relatively hawkish statements by current and past Fed officials who hinted that the US central bank may chose to leave the fed funds rates unchanged in September in contrast to wide market expectations of a rate cut.

 

In an interview with Wall Street Journal, former Fed official Peter Fisher noted that the  FOMC would rather not cut rates in September unless facing clear evidence of a sharp increase in unemployment. His comments were echoed by Jeffrey Lacker, the Richmond Fed President. Mr. Lacker is a non-voting member of the FOMC but he too  suggested that the Fed may hold rates steady, noting, "Financial market volatility, in and of itself, does not require a change in the target federal funds rate."  Mr. Lacker further stated that he saw little change in the outlook for incomes, consumption and GDP growth despite the downturn in the sub-prime sector. The change in tone from what seemed like near crisis conditions only last Friday, helped soothe the currency markets as players saw some signs of return to normalcy.

 

As a result the euro, the pound and the commodity dollar high yielders firmed overnight, with some marker players reporting that Japanese retail investor began rebuilding their carry trade positions in a round of bargain hunting. Tomorrow, the BOJ is expected to announce its interest rate policy decision and most analysts predict the Japanese central bank will keep rate at 50 basis points given the turmoil in global financial markets and the generally lackluster pace of Japanese economic growth. The reasoning therefore of the carry trade buyers is that if markets return to stability, currency traders will once again focus on interest rate differentials and USDJPY along with other yen crosses should rise once again.

 

Whether the carry trade bulls are correct remains to be seen. The Fed may in fact may be making a critical mistake if the unemployment rolls begin to swell in aftermath of the layoffs in the real estate industry, and the US consumer retrenches under the growing burden of higher debt service.  For the time being however, calm has returned to the markets. Furthermore on the economic front the news was highly supportive of the pound and the euro  In UK The CBI Industrial Trends survey hit a 12 year high while in Eurozone both the Current Account and the Industrial New Orders beat expectations.  If US equity markets remain steady, both the euro and the pound could see more buying in the US session as risk appetite slowly make sits way to back to the currency market.

Boris Schlossberg,  Senior Currency Strategist

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