Risk Latte - Has The USD Rebounded?

Has The USD Rebounded?

Team Latte
Feb 24, 2004

The last few sessions saw the USD strengthen more than 2.5 pct against the major currencies. The move was a knee-jerk reaction to the short US$ trend, which had been the main theme of the currency markets for some time. The question is whether this is just a mere correction or an early caveat that currency markets are poised for a reversing trend.


Market Dynamics:

US$/JPY went from 107.20 to 109.40, while EUR/US$ crashed from 1.29 to 1.25 levels. Most of the market participant were of course caught short US$, hence triggered lots of stops on this move. Even the Asian currencies reflected the move through US$/KRW and US$/TWD. For US$/KRW, the move was as big as the US$/JPY, starting from 1153 to 1167, and then gapping up to 1183 and finally stopping at 1185, however for US$/TWD the correlated move was much muted. The risk reversals flipped in favor of US$ calls for most of these currencies, in the shorter end of the curve.

Debate:

Coming back to the crux of the matter, is this move a preface of a broad-based US$ recovery or just a short-term correction, for renewed bearish US$ trend. Few things might throw some light on this debate, which are as follows:

  1. The twin deficits still exists, however the inflows in US had been better than expected lately. A healthy 76 Billion USD of portfolio inflow, is not enough to finance the deficits, unless the amounts in the coming months increase drastically.
  2. The US economy is showing some signals of a pick-up, with some economic data proving to be better than expected. Latest comments by the Federal Reserve do support that, but there is no conclusive signal of any hike in interest rates yet. Once the economy gets into a sustainable mode of recovery and the rate hikes are at the doorsteps, we might be in a position to see a sustained USD recovery, albeit with a certain lag factor.
  3. The revaluation of the Chinese Yuan is another issue, which will certainly affect the currency markets in Asia. Market news and data show, its only a matter of time before the Chinese officials allow there currency to trade within a tight band, pegged to a basket of currencies. This revaluation will bear a positive correlation with the Asian currencies like TWD and KRW as both Taiwan and Korea are large trading partners of China. Under such a move, good chance we might see a renewed pressure on USD to go lower against most of the Asian currencies, to be of course followed by the Japanese Yen. Under very conservative calculations market makers expect a 5 pct appreciation in the Chinese Yuan over the medium term, which might translate into few percentage points for the regional currencies. However Hong Kong Dollar which is pegged to the USD, may not get as much affected.
  4. Finally looking at the gold price and the chart, it is testing a strong support at $398/400 per oz. The weak US economy and the weak USD, and buoyant commodity prices had led both investors and speculators to long the gold, with much satisfaction. It had broken long term resistances and was supposedly poised to trade $480/oz; however with the current US$ strength it reverted from 425 to 400 and is hovering around there. If this support proves strong enough, hopefully we might see a renewed effort to break the 425 and shoot to 450 as the next level of resistance.

All the above arguments may be biased in favor of short US$ again, however this correctional move might have a bit longer life in it. With the European Officials getting vocal with Euro/US$ above 1.2900, it might take sometime before we can see 1.3000 trade in the Euro.



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