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Tuesday February 5, 2008 - 23:13:36 GMT
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Forex Research - Currency Traders are Snapping Up Dollars Left and Right

Tuesday, 05 February 2008 22:51:55 GMT

Written by Kathy Lien, Chief Strategist

• Dow Drops 300 Points, How Did Carry Traders React?
• Euro Hit By Weak Economic Data

Currency Traders are Snapping Up Dollars Left and Right
It has been a long time since we have seen a broad based dollar rally. Over the past few weeks, whenever the dollar would rise against the Euro for example, it would fall against the Japanese Yen or British pound. Today was different. Despite a widespread liquidation out of carry trades, USDJPY barely budged. Aside from a brief run up to 107.70, it remained trapped within a 50 pip range for most of the US trading session. This tells us three things. The first is that the market is very risk averse and rushing into the safety of US dollars seems to be the preferred trade of the day. The second is the possibility of Bank of Japan intervention while the third is that there aren’t any sellers of USDJPY left in the. The US economy is in deep trouble and there is no point arguing whether or not we are in a recession because for the labor market, housing market and now the service sector, it certainly feels a recession has hit. Service sector ISM caught the market completely by surprise, not only because it was released 1 hour early but also because it fell to the lowest level in 7 years. In the month of January, the service sector contracted for the first time in 4 years. To our disbelief, the manufacturing service is actually now doing better than the service sector. The largest contractions came in the new orders, employment, imports and business activity. This data validates the Fed’s decision to cut interest rates by 50bp last week and has boosted expectations for a half point move in March. We expect the Fed to cut interest rates to 2.00 percent before this easing cycle is over. The service sector accounts for 90 percent of the US economy which makes the latest contraction extremely troubling. Even Federal Reserve President Jeffrey Lacker warned that further easing may be warranted. He thinks that if we fall into a recession, it will be a quick and shallow one that is similar to the last two the US economy has experienced – in our opinion that would be the best case scenario.

Dow Drops 300 Points, How Did Carry Traders React?

The Dow dropped over 370 points today and even though some currencies behaved the way that FX traders have become accustomed to when there is a big sell-off in stocks, some didn’t. With risk aversion sweeping across the markets, the dollar rallied against every major currency including the Japanese Yen. Typically, USDJPY falls in lockstep with all of the other yen crosses, but today, it barely budged. We believe that the resilience of USDJPY is tied to positioning. According to the latest Commitment of Traders report, everyone who wants to be short USDJPY already is. Yen long positions are at extreme levels suggesting that there are no more sellers left in the market. Also we are nearing potential intervention levels by the Bank of Japan. The 105 price level is suspected to be the first line in the sand. In the second half of the US trading session, USDJPY rallied 30 pips in a blink of an eye (it quickly reversed those losses) and as tempting as it may be to label this rally BoJ intervention, it isn’t. The last time that the BoJ intervened was in March 2004 and for those traders who have lived through BoJ intervention, we would have to see a 100 to 150 pip move in a matter of seconds to consider calling it intervention. Yet caution is warranted at current levels because as USDJPY falls closer to 105 and below, the risk of intervention will grow exponentially.

Visit the Japanese Yen Currency Room for resources dedicated specifically to the Euro.

Euro Hit By Weak Economic Data
The Euro fell over 200 pips today against US dollar, the biggest move in the currency pair since the Federal Reserve surprised the markets with a 75bp intermeeting rate cut. Yesterday we said that Monday’s inside day candle in the EUR/USD indicated that there was going to be a big breakout. This was triggered today by the combination of weak Eurozone economic data and a 370 point drop in the Dow. Eurozone retail sales fell short of expectations in the month of December as weak consumption in Germany offset stronger spending in France. Service sector PMI also dropped from 52.7 to 51.8 in the month of January, led by decelerating activity in Germany, France and Italy. There is no economic data due for release from the Eurozone tomorrow but the French are complaining once again about the strength of the Euro. After months of silence and letting the ECB have their way, Sarkozy is now saying that the strong euro is hurting industry.

Visit the Euro Currency Room for resources dedicated specifically to the Euro.

Stronger Economic Data Fails to Lift the British Pound
The British pound continued to sell-off despite stronger UK economic data. Service sector PMI rebounded from 52.4 to 52.5 thanks to improvements in average prices, business activity and employment. According to HBOS, house prices also stabilized. The market was looking for prices to drop by 0.4 percent last month, but instead, they remained flat. Is the UK economy recovering? It is too early to tell, but what we do know is that the latest information will reduce the Bank of England’s urgency to cut interest rates. They are still expected to bring rates down by 25bp on Thursday, but the recent data should trigger a more neutral statement that signals a hesitancy to reduce interest rates further in the coming months. Nationwide consumer confidence, BRC shop prices and leading indicators are due tomorrow.

Visit the British Pound Currency Room for resources dedicated specifically to the Euro.

Australian, New Zealand and Canadian Dollars Hit by Carry Trade Liquidation Despite RBA Rate Hike
The Reserve Bank of Australia raised interest rates to 7 percent, leaving Australia as the only country raising interest rates since the Fed delivered their emergency rate cut. The Australian dollar sold off on the announcement because the statement suggested that the RBA will be on hold for a few months before making another move. With 7 percent rates, the Australian dollar is still one of our favorite currencies from a fundamental and technical perspective. The Canadian and New Zealand dollars will be the currencies to watch over the next 24 hours with Canada releasing IVEY PMI and New Zealand releasing their employment numbers.

Tell us what you think on the Canadian dollar Forum.

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By Kathy Lien, Chief Strategist of DailyFX.com
Contact Kathy Lien about this article at klien@dailyfx.com



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