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Forex Carry Trade Bounce Leaves Bearish Outlook For US Dollar

Wednesday, 22 August 2007 17:42:21 GMT  |  David Rodriguez, Currency Analyst

The US dollar dropped against all major currencies except the Japanese Yen, as an ease in risk aversion led the forex carry trade higher on the day. No news was bad news for the greenback, with forex traders leaving the safety of the world’s foremost reserve currency in favor of more speculative counterparts.

The Euro rallied for the first day in three, adding as many as 80 points off its open to $1.3530. British Pound bulls finally saw relief, as a positive CBI Industrial Trends report forced a similar rally in the recently downtrodden currency. Cable added 90 points off of yesterday’s close to $1.9904. Renewed interest in high-yielding forex carry trade pairs made the Japanese Yen the biggest decliner on the day, with the similarly weak US dollar improving ¥0.50 to ¥114.96.

New economic data was limited to the non-market-moving MBA Mortgage Applications release, which predictably showed that demand for home borrowing declined in the week ending August 17^th. Dollar markets simply ignored the report, and the US equity market open remained the main focus of the day’s trade. The Dow Jones Industrial Average showed triple-digit gains through 09:30 EST—easing investors’ concerns over the state of risky asset classes. Analysts claim that the Fed’s decision to drop its discount rate gave hope that credit markets would soon return to normalcy, with a drop in Treasury Bond yields likewise showing renewed confidence in corporate lending markets. 

The improvement in credit conditions was indeed enough to renew speculation of potential mergers and acquisitions—boosting outlook for financial shares and other interest-rate sensitive firms. Most notably, the CEO of Nymex Holdings reported that the world’s largest energy exchange may be bought through the coming months. Such a high-profile move has the potential to reignite similar acquisitions interest on what is perceived to be a “cheap” stock market. Given recent tumbles, many shares are now more than 10 percent off of their recent peak. Though liquidity is increasingly hard to come by, many corporations have held cash on the sidelines that could be used to fund a new wave of share buybacks and outright purchases in the market.

It is subsequently little surprise that the Dow trades 0.6 percent improved to 13,171, leaving the index 5.7 percent improved on a year-to-date basis. The broader S&P 500 Index fared slightly worse at 7 points higher to 1,454, while tech stocks were the largest percentage gainers through the afternoon. The NASDAQ Composite climbed 0.7 percent to 2,538.  

A drop in risk aversion was clearly seen in US Treasury markets, with the short-term yields rallying significantly following yesterday’s tumble.  The benchmark 2-year yield added an impressive 9 basis points to 4.12 percent, while the 10-year saw a more moderate 3bp advance to yield 4.62 percent.

Written by David Rodriguez, Currency Analyst for DailyFX.com

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