Is it Time to Go Long Dollars? (page 1 of 2)

DailyFX Fundamentals 03-19-08

By Kathy Lien, Chief Strategist of DailyFX.co

Is it Time to Go Long Dollars?

As we warned in yesterday's Daily Fundamentals, dollar weakness is not over. However that statement is only true for the US dollar against the Japanese Yen, Swiss Franc and to some degree the Euro. This is because the US dollar actually strengthened against the commodity currencies and the British pound as risk aversion triggers dominates the currency market. Even though we expect the US dollar to continue to weaken against the Euro, Japanese Yen and Swiss Franc, we could see a further recovery against the high yielders. Being long dollars may not be the wrong trade if it is against the right currencies. Triple digit swings in the US stock market and 300 pip swings in currencies will make it very difficult for carry trades to recover. In fact, we are more bearish carry trades than we are the US dollar. Since the AUD/USD and NZD/USD are also carry trades, they are vulnerable to further weakness. The US dollar is now a funding currency for carry trades and it is important for traders not to forget that. Thankfully the Federal Reserve is not alone. According to Barney Frank, the Chair of the Financial Services Committee, the Treasury department is finally willing to discuss ways to help the hundreds of thousands of Americans facing foreclosure. Proposals by Frank include forgiving a portion of some of the remaining principal and insuring up to $300 billion in refinanced, affordable-cost mortgages. Capital requirements have also been cut for Fannie Mae and Freddie Mac, which will allow them to use some of their excess funds to buy mortgages. This would add up to $200 billion of immediate liquidity into the mortgage backed securities market and hopefully the combination of efforts from the US government and the Federal Reserve will put an end to the market's misery. Realistically, it will be some time before these plans are passed and any stimulus will also need time to filter into the markets. In the meantime, the Philadelphia Fed manufacturing survey and leading indicators are due for release tomorrow. The drop in the Empire State manufacturing survey to a record low suggests that we could see a similar move in the Philly Fed index. Leading indicators should also be dollar negative given the sharp deterioration in the US economy and in the stock market.

Impact of Japan's Fiscal Year End on the Yen

US stocks gave back close to three quarters of Tuesday's gains as risk aversion seeps back into the financial markets. USD/JPY plunged below 100, dragging pairs like AUD/JPY, GBP/JPY and CAD/JPY down with it. The futures curve is still pricing in a strong probability that US interest rates will fall to 1.75 percent by the end of June which means that traders expect another 50bp of easing from the Federal Reserve. Toshihiko Fukui is no longer the Governor of the Bank of Japan. His term officially ended today and Masaaki Shirakawa is expected to serve as acting Governor until two opposing parties in the government can agree to a new central bank leader. This is the first time in the country's post war history that there is no permanent Bank of Japan Governor. Under a calmer market environment, this may have mattered for the Japanese Yen, but these days, risk aversion dominates. It is also important to mention that March 31st is the fiscal year end in Japan. Repatriation flow may help to explain the recent pressure on USD/JPY.

Dovish BoE Minutes and Weaker Employment Numbers Drive GBP Lower

The British pound tanked against all of the major currencies today.