The US dollar and Japanese yen were the weakest of the majors as investor confidence surged, driving up FX carry trades and sending the DJIA and S&P 500 up roughly 3 percent. In the near-term, there is potential for carry trades to reverse in favor of Japanese yen bulls as we will soon find out the status of troubled commercial lender CIT Group, JPMorgan Chase will publish Q2 earnings on Thursday morning, and Bank of America, Citigroup, and BB&T will publish theirs on Friday.
There are risks to keep in mind in about a month as well, as Japan’s Prime Minister Taro Aso recently called for an election on August 30. Both the ruling Liberal Democratic Party (LDP), to which Aso belongs, and the opposition Democratic Party of Japan (DPJ) have been calling for an early election since last September. The threat here is that the LDP could be booted from power after more than 50 years of governing Japan, creating political instability. Furthermore, the shadow finance minister of the DPJ, Masaharu Nakagawa, said this week that Japan should diversify its currency reserves in the “medium to long term” in order to “avoid the risk of currency losses or economic turbulence that could result if the dollar were to swing,” and “start considering” investment in International Monetary Fund bonds. Any instability derived from a shift in power to the DPJ could cause trouble for the Japanese yen, but it may also create problems for the US dollar as talk of sweeping changes to central bank reserves is enough to hurt the greenback.