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Friday July 23, 2004 - 11:42:03 GMT
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Forex - US OPEN MARKET POINTS 07-23-04

Death of the Carry Trade?

In today’s note Thompson’s John Noonan writes, “There was large liquidation of currency carry trades on Tuesday and
Wednesday after Greenspan’s more hawkish than expected testimony. A large amount of carry trades that were liquidated were only put on in the past few weeks after it appeared that the Fed was going to be "measured" at this end of the tightening cycle. The summertime FX, bond and equity markets were showing no signs of trending and the income flow from currency carry trades were a compelling alternative to chasing trends that weren’t there. Some analysts feel that a lot of these trades have been liquidated or will be in the very short future.”

Is the market correct in abandoning the carry trade? Only if the dollar bulls are right in their assumption that real US GDP will grow 4.5% this year and 3.7% next. As we have pointed out ad nausea this week, most recent eco data offers little evidence to support that view. Yesterday, after the close of US equity markets both Microsoft and Amazon reported in-line revenue but noted that forward sales growth would slow. More tellingly, current revenue growth was highly depended on favorable currency exchange rates. In Microsoft’s case fully 12% or $1.1Bn of $9.3Bn was the result of positive FX conversion. While MSFT and AMZN are hardly proxies for the whole US economy, their guarded guidance speaks volumes about the quality of future demand.

Against the USD - which presently yields 1.25% - the three best cross candidates for the carry trade are; the Kiwi with its 5.75% yield, the Aussie with 5.5% yield and the Pound with 4.5% yield. Although it has the lowest rate differential, cable may offer traders the most interesting opportunity. UK is experiencing the longest period of uninterrupted growth in 200 years. It enjoys some of the best fundamentals in the G-7 block including 2.7% unemployment 3.7% GDP and relatively tame 1.6% CPI. Tonight’s UK GDP which, as expected, printed 0.9% reaffirms analyst’s expectation that BOE will raise rates at the August MPC. meeting. Should the GBP/USD rate differential continue to widen and should UK maintain its pace of growth the GBP/USD cross may bring the carry trade back in vogue. In short, absent some near term proof of strong US economic growth, reports of the death of the carry trade may be greatly exaggerated.

Key Overnight Developments

- JPY Tertiary Index disappoints but analysts assign drop to one-off factors such as poor May weather
- GBP UK GDP increases as expected by 0.9% affirming potential for August BOE rate hike

FX Spot Overnight

- EUR break the 22 handle on weak ITL data and relentless stop running by dealers
- JPY breaks 110 buoyed by weak Tertiary Index data but stalls 20 pips above
- GBP fades all night long despite solid eco data
- CHF trades above 2550 as USD strength continues

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