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Forex Carry Trade Rebound Leaves US Dollar Lower

Wednesday, 08 August 2007 19:06:22 GMT  |  David Rodriguez, Currency Analyst

The US dollar traded sharply lower against major counterparts, as a pronounced rebound in the global carry trade cut risk-sensitive dollar demand. The greenback likewise declined on news that Chinese officials discussed selling US Treasury Bonds in retaliation for protectionist legislation from Washington. (See more on China here) The trade-weighted Dollar Index briefly broke yesterday’s lows before a small bounce through the afternoon.

The Euro rallied near all-time highs in response to the dollar tumble, hitting intraday peaks of $1.3825 before settling to trade at $1.3800 through time of writing. The British Pound likewise saw pronounced rallies, challenging the psychologically significant $2.0400 mark and changing hands at $2.0371. The carry trade-favorite Japanese Yen was the only major currency to fall against the greenback, with the dollar adding ¥1.00 to ¥119.72.

New York session trading was almost devoid of noteworthy economic event risk, leaving the dollar to trade off of broader risk sentiment. Equity market gains indicated that risk appetite had temporarily returned to global asset classes, forcing a sharp rally in the forex carry trade.  

A portfolio that held the three highest-yielding major currencies and remained short the three lowest produced its strongest gain since mid-June. Though the simple buy-and-hold strategy remains over 3 percent below its all-time high, today’s price action certainly bodes well for the future of carry trade strength. Helping to boost high-yielders was an overnight interest rate increase from the Reserve Bank of Australia, with the central bank signaling that monetary policy will remain restrictive through the medium term. Likewise of note, the Bank of England remained steadfast in its stance on inflation and hinted at a further rate increase through the end of the year. Prospects of continued rate increases boosted both currencies against major trading counterparts.

US stock markets continued their recently volatile price action, with the Dow Jones Industrial average nearly 200 points higher before coming to +123 an hour ahead of the close. The NASDAQ Composite was the largest percentage gainer of the three major indices, adding 2.2 percent to 2,618.83, while the S&P 500 was similarly bid at 1.33 percent improved to 1,496.36. Stock markets showed clear hesitation before continuing strong gains, but the late retracements had little effect on the fast-dropping Japanese Yen. 

Fixed income markets took a sharp drop on the day, as threats of an official Chinese government divestment in US Treasuries left yields significantly higher through the session. Ironically risk-averse bond traders quickly sold the benchmark 10-year Treasury Note and left prices an impressive 2/3 point lower to 97 and 5/32. Yields on the 10-Year subsequently rose to their highest since July 26, adding 10 basis points to 4.86 percent.

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