The Dow has rallied more than 500 points over the past 2 trading days, triggering a sharp rebound in all of the Japanese Yen crosses. Carry trades are back with a vengeance, but the question at the forefront of everyone’s minds is whether this trend will continue.
Without a doubt the move in the Dow is impressive, but USDJPY is struggling to sustain its gains above 110 which suggest that further gains in carry trades may be limited. This is especially true since the move in both the Dow and carry trades have been fueled by nothing other than risk appetite and the latest US releases validate the market’s belief that Federal Reserve needs to continue lowering interest rates. The curve is pricing in a 92 percent chance for a 25bp rate cut next month followed by the possibility of another quarter point cut in the first quarter of 2008. The first test of whether the gains in carry trades can be sustained will be when Tokyo opens for trading tonight. Japanese industrial production and small business confidence are due for release this evening, but it should matter little to a market focused on risk appetite. Instead, keep an eye on China. Last night a Chinese newspaper suggested that the government could widen the trading band or make another one off revaluation. The odds are low, but unexpected events like these are exactly what triggers big moves in the currency market.