Why has the Dollar Strengthened as the Stock Market Falls?

Reports of more subprime related losses have sent the markets tumbling once again. The stock market is down another 100 points, putting this week’s losses in the Dow close to 500 points. Carry trades and other high yielding currencies have followed suit as more victims of the subprime fallout surface. Domestically, Sowood Capital Management, a hedge fund founded by a former Harvard Management executive suffered bond losses in excess of 10%. A Citigroup analyst also released estimates of the potential losses at Fannie Mae and Freddie Mac, whose bond holdings are estimated to have dropped by $4.7 billion. Internationally, Australian hedge fund Absolute Capital group suspended withdrawals from two of its funds as a direct result of subprime contagion. The problems have now gone global which means that the age of easy money is over. Investors and lenders in general will be far more careful about who and what they are willing to fund. Even if the markets do rebound, sentiment has shifted so dramatically that we probably won’t see 14,000 in the Dow or fresh highs in carry trades again this year. The most common question that we are being asked right now is why is the dollar rallying? The answer is because now that the global liquidation has deepened, investors are steered back into the US dollar because of its safe haven status. Many US investors have exposure abroad and when they cut their risky trades, they are also repatriating their funds back into US dollars. Only a recovery in risk appetite will save the markets at this point. Although the Dow could bounce given the strength of its recent moves and the fact that prices are nearing key levels of previous support, keep an eye on bond yields because if they continue to remain weak or sell-off, more losses in carry trades and equities is possible. Meanwhile, today’s data gives traders no reason to be optimistic. Even though GDP rose by a more than expected 3.4 percent in the second quarter, the drop in prices as well as slower personal consumption growth still give reason for concern. Looking ahead, next week is busier than ever. Not only do we have non-farm payrolls on Friday, but service and manufacturing sector ISM is due for release along with personal income and personal spending. Even if we get stronger outcomes, the market may still look for the Federal Reserve to cut interest rates at the end of the year.

Carry Trade Unwinding Continues, More Losses in Store
High yielding carry trades continued to perform horribly today with AUD/JPY and NZD/JPY falling another 300 points. The Chicago Board of Trade’s Volatility Index continued to rise and is less than a point shy of its 52 week high. Carry trades only perform well in low volatility environments. The fact that volatility shot up so much so rapidly makes carry trades or basically the desire for yield far less attractive for the risk. Even though USD/JPY and CAD/JPY are stronger, they have hardly put a dent into Thursday’s losses. Japanese data released overnight was mixed with consumer prices falling, but retail spending increasing on an annualized basis. The Nikkei was also down 418 points or 2.3 percent overnight. This seems to matter little for yen traders because they are solely focused on the market’s aversion for risk. If stocks continue to collapse, carry trades will continue to fall. Meanwhile in the week ahead, there is a lot of data on the Japanese calendar including industrial production, the trade balance, household spending, labor cash earnings, and the jobless rate. The market has gone from pricing in a 64 percent chance of an August rate hike to a 45 percent chance.

Uptrend in Commodity Currencies Come to an End
The trend of multi year highs in the commodity currencies have finally come to an end this week with the New Zealand, Australian and Canadian dollars suffering significant losses. The biggest losers in the currency market today were also the NZD and AUD. As warned by central bank Governor Bollard earlier this week, exporters are definitely beginning to feel the pain of a strong currency. Both imports and exports dropped significantly, turning the NZ trade surplus into a deficit. Meanwhile there have been reports that model and momentum funds are aggressively selling the Aussie which means that they are no longer holding out the hope for a recovery in the high yielders and are instead either getting stopped out or initiating fresh short positions. Australia has retail sales next week which will be worth watching. Canada on the other hand has raw material and industrial product prices along with GDP and IVEY PMI. USD/CAD has bottomed out and we expect the bottom to hold.

EUR/CHF Sees Biggest Weekly Drop in 4 Months, EUR/USD Weakens on Dollar Strength
Over the past 2 days, the Swiss franc has rallied significantly against the Euro as a direct result of the currency’s own safe haven status. The KoF report of leading indicators was stronger than expected which has also helped, but the move in the currency pair began on Thursday. In the week ahead, we have the UBS consumption indicator and PMI from Switzerland. Both are expected to remain strong, illustrating the overall health of the economy. The Euro on the other hand has weakened for no other reason than dollar strength. There are a ton of PMI, unemployment and consumer spending reports due out next week, which could lead to some Euro drive action.

Weak Housing Numbers Weight on British Pound
Like the Euro, the British pound has sold off significantly today on the back of liquidation of high yielding assets as well as a broad dollar recovery. House price growth continues to be soft which could be concerning going into next week’s heavy economic calendar. We are expecting more housing market reports as well as money supply, consumer confidence, distributive trades, manufacturing and service sector PMI. Overall the UK economy still remains healthy and the Bank of England could raise rates to 6 percent by the end of the year. The global markets just need to stabilize before these factors come into play once again.

US Dollar Drops to Fresh Lows on Pronounced Stock Market Tumbles

The Euro rallied to fresh record-highs against the US dollar, with sudden fallout in domestic equity markets sending the Greenback lower across the board. Disappointing earnings reports from internet titan Google Inc. and construction conglomerate Caterpillar Inc. led broader indices significantly lower. Such stock market tumbles were likewise enough to send 10-year Treasury yields crashing below 5.00 percent—adding further selling pressure to USD pairs.



The Euro saw peaks of $1.3842 before settling to trade at $1.3812 through time of writing. British Pound bulls likewise sent Cable to 26-year highs of $2.0568, while a modest pullback saw the Cross-Atlantic currency pair move to $2.0544. Further rallies were limited by a simultaneous advance in the Japanese Yen, which saw the USDJPY lose as many as 130 points off of daily highs.

There was no new economic data out of the US on the day. Yet markets experienced a significant jump in price movements across the board, as the S&P 500 Volatility Index (VIX) added a whopping 2.26 to weekly highs at 17.48 percent. The closely-monitored VIX serves as an accurate measure of overall risk aversion across financial asset classes, which likewise explains the sharp drop-off in the popular forex carry trade. In fact, a simple correlation study shows that the high-yielding Australian Dollar-Japanese Yen currency pair keeps a strong -0.55 correlation with the measure. Though equity performance hardly dictates every movement in the JPY, experience has clearly shown that stock market tumbles have had far-reaching effects on the incredibly oversold Japanese currency. It will subsequently be important to watch the performance of Asian markets through Sunday night’s open; extended declines would only further fuel the JPY short-covering.

The Dow Jones Industrial Average stole headlines for all the wrong reasons, losing a substantial 160 points to 13,840 through time of writing. Broader S&P 500 stocks fared no better, as the index shed 1.2 percent to 1,534.63. Yet declines in the Dow and S&P still fell short of the drop in the tech-heavy NASDAQ Composite, which moved 1.34 percent lower to 2,683.54. Earnings reports and renewed talk of Subprime lending fears were the primary culprits for the significant losses. Disappointment in Google Inc.’s Second Quarter numbers sent the high-flyer 5.0 percent worse to 521.00, while Caterpillar Inc. tumbled 7.75 percent to 80.24 for much the same reason. Likewise significant, an early speech by St. Louis Fed President William Poole reignited market jitters on the lending crisis. The official said that the subprime lending issues were pronounced enough to dampen outlook on the broader housing market. Though the speech was largely a restatement of what was already known, the text teamed up with disappointing earnings reports to send equities lower.

Fixed income markets saw significant rallies on a flight to quality, with the US 10-year Treasury Note up ½ points to 96 and 19/32. Yields took a hit on the day, breaking below the key 5.00 percent mark to trade at 4.94 percent at time of writing. Such rising bond prices and falling yields bode poorly for the potential of a US dollar retracement, with the greenback remaining relatively subdued despite signs of stabilization across markets.

China Central Bank Raises Interest Rates To Cool Overheating Economy

In response to the rapid pace of growth in the world’s fastest growing economy, the People’s Bank of China raised interest rates by 27 basis points. Bringing the benchmark lending rate to an eight year high of 6.84 percent, policy makers additionally increased the deposit rate to 3.33 while cutting the tax on interest income, hoping to promote savings. The tax rate will incidentally drop to 5 percent from 20 percent beginning August 15th. Already expected by the market, the decision will, however, likely do nothing in denting the current pace of economic growth as money continues to pour into China, especially the stock market. For the year, with speculation on the bid side running rampant, the benchmark index has risen 95 percent after more than doubling returns in the previous year. Subsequently, the gains have supported higher consumer and business spending, driving economic growth to the fastest in 12 years. Ultimately, the market should expect further tightening measures (if they are to come) in the near term with the proposal of a more flexible currency regime still on the back burner. With the decision widely digested by the equity markets already, the currency was taken back a bit in the overnight session, falling to 7.5740 against the US dollar as well as the Euro and the British pound. Incidentally, there was some speculation that had surfaced over a potential intervention by the PBoC, helping the Chinese yuan to drop in dramatic fashion.

Sterling gains on rate outlook, yen slips

NEW YORK, June 20 (Reuters) - Sterling rose on Wednesday after Bank of England meeting minutes hinted at a rate hike as soon as July, while the euro and dollar gained for the fifth day in six against the low-yielding yen.

With no U.S. economic data to provide direction, traders focused on the differences in relative interest rates and traders favored currencies tied to higher or rising rates.

Sterling rose to $1.9941 , a two-week high, and hit a fresh 15-year peak against the yen after BoE minutes revealed that officials fell one vote shy of lifting interest rates at a meeting earlier this month, with central bank governor Mervyn King among the outvoted who favored a hike.

In Sweden, the Riksbank lifted rates to 3.5 percent and unexpectedly raised its year-end rate forecast to 4 percent, pushing the crown up 1.5 percent against the dollar and putting it on track for its biggest daily gain against the euro in more than five years .

Earlier this week, the euro hit its best level against the Swedish currency in more than a year.

"It seems clear to me that central banks globally are a little more comfortable with the risk outlook and are taking a bit more liquidity out of the markets," said Firas Askari, head of currency trading at BMO Capital Markets in Toronto.

The BoE minutes "really caught people off guard," Askari said, and 44 of 64 economists polled by Reuters now expect rates to go to 5.75 percent in July rather than August.

The poll also found economists expect rates to hit 6 percent by year end. For more, see [ID:nL20587237]. The BoE's King and UK finance minister Gordon Brown will both speak around 4 p.m. EDT (2000 GMT).

The yen, tethered to Japanese interest rates at just 0.5 percent, continued to suffer as investors borrow it cheaply to finance purchases of higher-yielding currencies and assets.

Late morning, the euro was up 0.2 percent at 165.90 yen , near a record high above 166 yen.

The dollar hovered near a 4-1/2-year peak at 123.65 yen , up 0.25 percent from late Tuesday. The Japanese currency also plumbed multiyear lows against the Australian and New Zealand dollars.

Bank of Japan Governor Toshihiko Fukui said last week officials wanted to be sure capital and consumer spending remained firm before pushing interest rates higher.

"Japan's central bank has shown it's in no hurry to raise rates, and with U.S. equities stable, risk appetite remains pretty good," said Michael Malpede, senior currency strategist at Man Global Research in Chicago.

The euro was little changed at $1.3422 as a backup in U.S. bond yields failed to nudge the greenback higher.

The Fed is seen keeping interest rates on hold at 5.25 percent this year, while markets are bracing for at least two more hikes in euro-zone rates, which now stand at 4 percent.

The kiwi dollar also pushed to US$0.7629 against the greenback as interest rates of 8 percent continued to lure investors who shrugged off intervention by New Zealand's central bank earlier in the month to weaken the currency.

The Swiss franc, which has the second-lowest interest rate in the developed world after the yen, rose against the euro and dollar after producer and import price inflation in May came in much higher than expected.

By Steven C. Johnson © Reuters 2007

Dollar strikes 4-1/2-year high vs yen

The dollar soared to a 4-1/2-year peak against the yen and an 11-week high versus the euro on Wednesday as a sharp rise in U.S. bond yields boosted the dollar's allure while carry trades proved resilient.

The euro fell to one-month lows against the yen earlier in the session on concerns that rising global bond yields and sluggish stock markets would spark an unwinding of carry trades, where investors use the low-yielding currency for financing investment in high-yielding ones like the New Zealand dollar.

The single currency later erased the losses and rose more than 0.5 percent against the yen, as a spill-over from soaring U.S. yields to other assets appeared limited and encouraged risk takers, said a chief dealer at a U.S. securities firm.

"An extremely pessimistic outlook on the U.S. economy has given way to views that U.S. fundamentals are solid and are reflected in the sharp rise in yields," he said.

"If risk-taking ability isn't abating and if U.S. yields are topping 5 percent, why buy kiwi, Aussie or pound? The dollar preference will continue and it's back to carry trade."

The rise in U.S. bond yields pushed the euro to 11-week lows below $1.3300.

The euro fell as low as $1.3286 on Reuters data, the lowest level since late March, but later trimmed its losses and stood at $1.3306 , little changed from late U.S. trading on Tuesday.

Against the yen, the euro was up 0.5 percent at 162.57 yen , having regained ground after dipping to a one-month low of 161.45 yen earlier in the session.

The high-yielding New Zealand dollar was up 0.6 percent against the yen at 91.6 yen while the Australian dollar was also up 0.5 percent at 102.69 yen .

The dollar was trading at 122.23, up 0.5 percent.

Earlier this session, the benchmark U.S. 10-year yield jumped to five-year highs of 5.31 percent after climbing on Tuesday on views that robust global growth could prompt central banks to raise interest rates, and due to relentless selling by mortgage players. Treasuries recovered somewhat in Asia since then with the 10-year yield trading at 5.28 percent.

(Reuters)By Chikako Mogi

U.S. Growth Outlook Improves, Rate Cut Less Likely, Survey Says

June 8 (Bloomberg) -- U.S. economic growth will gradually pick up through the end of this year, making the Federal Reserve unlikely to cut interest rates before 2008, according to economists surveyed by Bloomberg News this month.

Economists now forecast the economy this quarter will expand at an annual rate of 2.6 percent, compared with 2.2 percent projected last month and a 0.6 percent pace in the first quarter. The economy will expand at a 2.9 percent rate by the final three months of 2007, according to the median of 69 estimates in a survey taken from May 30 to June 7.

Increased spending on business equipment will help the economy mend after growth last quarter was the slowest in more than four years. Economists now expect Fed policy makers to delay trimming interest rates until next year, the survey showed.

``We've seen improvement in manufacturing and capital spending data, and that's taken away some of the gloomier scenarios for the economy,'' said Ethan Harris, chief U.S. economist at Lehman Brothers Holdings Inc. in New York. ``Inflation numbers have been better but they may still bounce back again, and that's why the Fed can't cut rates.''

Rising commodity and labor costs, along with the forecasts for faster economic growth, prompted economists to nudge up their inflation forecasts. Consumer prices will rise 3 percent this year, up from 2.9 percent economists expected last month, the survey showed.

Outlook for Rate Cut

The Fed will leave its benchmark overnight lending rate at 5.25 percent until the second quarter of 2008, according to the survey. Economists last month forecast a 25 basis-point cut in the fourth quarter.

Policy makers ``cannot afford to be complacent,'' on inflation, Cleveland Fed President Sandra Pianalto said this week. She identified rising energy and commodity prices as possible threats.

Kansas City Fed President Thomas Hoenig in a speech this week said the current Fed target rate is ``modestly restrictive,'' likely to slow inflation while still allowing the economy to grow.

Last quarter, when growth was the slowest since the final three months of 2002, will probably mark the low point of the expansion, economists said.

Lacker Sees Rebound

Richmond Fed President Jeffrey Lacker this week reiterated his view that the economy will rebound as the effects of the housing slump gradually recede.

``The housing market is likely to find a bottom some time this year and no longer be a drag on top-line growth, business investment will pick up, and consumer spending will remain healthy,'' Lacker said in a speech in Frederick, Maryland.

Signs of improvements in manufacturing and corporate investment have helped allay concerns about the outlook. The Institute for Supply Management's factory index for May rose to the highest level in 13 months, and a government report this week showed orders for business equipment rose for a second straight month in April.

Economists lowered their forecast for unemployment to 4.7 percent in the fourth quarter from the 4.8 percent forecast last month. The rate was at 4.5 percent in May, close to a five-year low.

``The economy is steady, is solid, and many chief executives expect things will improve from here,'' Terry McGraw, chief executive officer of McGraw-Hill Cos., said in an interview June 5. McGraw-Hill is the owner of Business Week magazine and Standard & Poor's.

Threats to Growth

Threats remain that could undermine the economy, including a persistent housing slump, higher energy prices and a weaker dollar that could stoke inflation, McGraw said.

A rise in defaults among subprime borrowers, along with a glut of unsold homes on the market, may prolong the decline in housing. U.S. home sales and price declines this year are going to be steeper than earlier forecast, the National Association of Realtors said this week.

``The slowdown in residential construction now appears likely to remain a drag on economic growth for somewhat longer than previously expected,'' Fed Chairman Ben S. Bernanke said in remarks via satellite to a conference in Cape Town, South Africa on June 5. As subprime mortgage lenders make it tougher to get loans, that will ``restrain housing demand.''

Home construction subtracted about 0.9 percentage point from first-quarter growth. Economists said that even with the outlook for a protracted slump, housing will probably take away less from growth in the second half.

Gasoline Prices

Gasoline prices are also a risk to the outlook. The average price of a gallon of regular gasoline at the pump rose to a record $3.22 on May 23, according to figures from the American Automobile Association.

Declining home values and higher fuel costs pose a challenge to consumer spending that may limit the rebound in economic growth, economists said.

Such spending, which accounts for 70 percent of the economy, grew in the first quarter at an annual rate of 4.4 percent, the biggest gain in a year. It will slow to a 2.3 percent pace this quarter, unchanged from last month's estimate, according to the Bloomberg survey.

Spending will grow at a 2.5 percent rate by the fourth quarter, down a 10th of a percentage point from the prior survey. Growth in such spending has averaged 3.75 percent a quarter the past 10 years.

For the entire year, the economy is forecast to grow 2.1 percent, the slowest in five years.

``The economy is in transition from a growth slowdown to growth that's low to average,'' said Kurt Karl, chief economist at Swiss Re in New York.

By Joe Richter and Kristy Scheuble

To contact the reporters for this story: Joe Richter in Washington at jrichter1@bloomberg.net ; Kristy Scheuble in Washington at atanzi@bloomberg.net

F0REX-Dollar rises to 3-month high vs yen

The dollar touched a three-month peak against the yen. The manufacturing report also included the highest reading of prices paid by factory managers since August 2006, reinforcing the view the Federal Reserve may keep rates steady this year, and it offset revised data released earlier in the day showing weaker U.S. growth in the first quarter.

"The prices paid index is very high and support the Fed's view that inflation remains a top concern, and at these levels it may be enough to keep pushing back expectations for a rate cut this year," said David Watt, senior currency strategist at RBC Capital Markets in Toronto. "But now the focus is shifting to the payrolls report tomorrow. We are not likely to see a sharp move on the dollar before the jobs data."

Against the yen, the dollar climbed as high as 121.99 yen, the highest since mid-February, according to electronic trading platform EBS. It last traded at 121.80, up 0.1 percent from late on Wednesday.

Earlier, the dollar slipped after the government revised down its estimate for first-quarter growth, showing the U.S. economy grew at its slowest pace in more than four years.

Analysts have widely discounted a soft economic growth reading and the lower-than-expected result failed to have a sustained impact on the market.

The dollar has clawed its way back from a record low hit against the euro in April and a 26-year low against the pound as worries about the U.S. economy's health have eased, reducing speculation of lower interest rates that would erode the greenback's yield appeal.

The euro was up 0.12 percent at $1.3444, remaining within well-worn ranges for the last month.

After the data releases, the implied chances of a rate cut this year were down to about 30 percent from about 40 percent late on Wednesday, according to Reuters data. Markets still expect the Fed to hold rates steady at its next monetary policy meetings in June and August.

With Thursday's U.S. data out of the way, traders are focused on the release of the May U.S. non-farm payrolls report on Friday. Economists forecast an increase of 130,000 jobs. A derivatives auction on Thursday showed traders betting on a 121,200 jobs gain.

Other economic indicators slated for Friday include readings on personal consumer expenditures and confidence.

Jitters before the jobs data and month-end "fixes" -- cut-off rates for currencies given at the end of the London trading session -- also helped push the dollar lower against sterling, traders said.

"People are a little concerned about what's going to happen tomorrow when we get the non-farm payrolls number," said Steven Butler, director of foreign exchange trading at Scotia Capital in Toronto. "We're now into the month-end fixes. Markets are just basically working through some positions."

In early afternoon, sterling traded at $1.9791 .

"There was dollar selling going into the 11 a.m. fix and markets were just covering their positions," he added. "The sharp rise in cable happened as we go through the fix, but the euro is still stuck in a range between $1.34-35."

Against the Canadian dollar, the greenback fell to a 29-1/2-year low at C$1.0666 on data showing that Canada's economic growth outpaced that of the United States in the first quarter. After three quarters of sub-trend growth, Canada's real gross domestic product growth bounced back to 3.7 percent from the previous quarter.