Japanese Yen Crosses Get Decimated, but is the Sell-off Over? (page 1 of 2)

DailyFX Fundamentals 08-16-07

By Kathy Lien, Chief Strategist of DailyFX.com

Dow stages impressive comeback

Volatility rocked the markets as the Dow plummeted as much as 340 points intraday before reversing to settle down only 15.69 points. Today's move is nothing short of impressive and suggests that at least for the time being, US stocks and carry trades have hit a short term bottom.

However everyone from hedge funds to Mrs. Watanabe has probably been shaken out. Given the massive losses incurred over the past few days, speculators may simply not have enough money or the stomach to get back into the markets and try to pick a bottom especially since the CME and CBOT increased margin requirements on some currency, interest rate and stock-index futures.

These days, cash is a valuable commodity since a liquidity crisis means a lack of cash. The sharpness of recent moves and the lack of liquidity have probably pushed more traders to liquidate positions than to add funds. Flight to safety continues to send the dollar higher against every major currency with the exception of the Japanese yen as more victims of the sub-prime and liquidity crisis surface.

First Magnus Financial Corp, the nation's 16th largest mortgage lender announced that it stopped taking mortgage applications. National City Corp shut down its home equity unit while Countrywide Financial tapped its entire credit facility in order to continue operations. The Federal Reserve, Reserve Bank of Australia and Bank of Japan have all responded with liquidity injections today.

Even the Russian central bank added reserves to their financial system. Despite the sharp reversal of earlier losses in stocks, the biggest question on everyone's mind is when the Federal Reserve will cut interest rates.

The market is current pricing 75 base points of easing by the end of the year. There has also been speculation of an intermeeting rate cut. Like many central banks around the world, the Fed has been reluctant to lower rates because it feels that the markets need to be punished for their excessive risk appetite. Furthermore, it has said that it needs to see market volatility have a "real impact" on the economy.

Between now and the next Fed meeting on September 18, there is plenty of economic data due for release. With major losses and bankruptcies reported throughout the financial sector, we expect companies to layoff staff left and right. Even Biotech giant Amgen announced today that it is reducing its workforce by 12 per cent.

For the people in the "real economy," their 401ks have taken a harsh beating while their mortgage interest payments are on the rise. It is only a matter of time until we see economy reflect that.

The bad news is already pouring in with housing starts hitting a 10 year low and manufacturing activity in the Philadelphia region stagnating. Since the beginning of the year, the weak dollar has provided a big boom to the manufacturing sector. Now that the dollar has strengthened significantly, activity in the manufacturing sector should also begin to slow.

Japanese yen crosses decimated; is the sell-off over?

The Japanese yen surged to fresh monthly highs against all of the majors. The last time we saw trading ranges of this magnitude was back in October 1998 which was the year that Russia defaulted on its debt and Long Term Capital faced major losses.

At the time, the Federal Reserve responded with multiple interest rate cuts.