Further Carnage For the Carry But Could Dollar-Yen Soon Find Support?

Overnight the Nikkei dropped another 2% and both DAX and Footsie opened markedly lower as fear dominates financial markets against the backdrop of mounting credit market problems and anticipation of a slowdown in global economic growth.

The net result is that the dollar now finds itself in a bifurcated market – weaker against the yen but stronger against all other G-10 currencies. It has become the primary beneficiary of the carry trade unwind as currency traders sell the high yielder’s and park their assets in dollars for the time being. Much like the carry trade before it, the unwind has taken on the look of a one way move with wave after wave of relentless selling hitting the market from the start of Tokyo trade.

USDJPY broke below the 116.00 level and now appears to have the 115.00 figure in its sight.  Should US equity markets continue to fall the pair may well reach that target later today. However, after a nearly a week of panicked selling, the equity markets may be due for a bounce especially if today’s housing data surprises to the upside calming fears of a full meltdown in that sector. Furthermore, part of the reason for such a rapid assent of the yen has been the fact that most of Japan was away for the traditional Odon holiday, creating very thin trading conditions.  With many Japanese participants now back at their desks USDJPY may find support as some Japanese investors try to bargain hunt the carry trade.

Certainly the Japanese monetary and fiscal authorities are becoming concerned with yen’s sudden strength as the unit’s 800 point gain on the dollar and more than 1300 point gain on the euro in the past two weeks will negatively impact profit margins of the Japanese multi-nationals.  Shares of Toyota fell nearly 3% on expectation of slowdown in demand and lower profits for the world largest automaker. Should this trend continue Japanese officials may try to jawbone the market in order to slow the decline in USDJPY. In short 115.00 is setting up as a pivotal point in this week’s trade. If USDJPY breaks that level with assurance volatility could spike above already heightened levels as full capitulation will sweep the market  and traders rush to liquidate positions at any price.