US Dollar Tumbles on Carry Trade Bounce, Likely to Continue Lower

The US dollar continued on its overall downtrend, as continued improvements in risk appetite led the safe-haven currency lower against major counterparts. Strong overnight gains in Asian stock markets likewise boosted the carry trade further off of recent depths, with the Nikkei 225 Index rallying an impressive 2.6 percent through the Tokyo session. The equity rally made the Japanese Yen the biggest loser on the day, declining against all of the world?s major world currencies.

The Euro benefited from the carry trade bounce, adding as many as 50 points off its open to $1.3560. British Pound bulls came out in full force, as the Sterling-US Dollar exchange rate climbed back above the psychologically significant $2.000 mark?trading at $2.0050 through time of writing. Renewed interest in high-yielding forex carry trade pairs made the Japanese Yen the biggest decliner on the day, with the similarly weak US dollar improving ¥0.75 to ¥116.10.
Fresh US economic data was limited to the morning?s Initial Jobless Claims report, which showed that labor market conditions continue to deteriorate in the world?s largest economy. New unemployment insurance claims jumped to 322,000 in the week ending August 18, with the previous data being revised worse to 324k for August 11. This registers as the worst two-week total since April of this year, showing relatively clear signs that firms are shedding jobs through the most recent sampling period. It nonetheless serves to note that much of recent market turmoil and high-profile layoffs will only be seen in later job surveys, as the bulk of troubles will likely occur in the aftermath of recent mayhem. The trend remains towards more jobless and fewer jobs created, leaving doubts as to the strength of the labor market and consumer sector rolling forward.

Despite signs of slowing labor growth, interest rate markets continued to scale back expectations of US Federal Reserve interest rate cuts through year end. In what can only be described as remarkably choppy markets, the September Eurodollar contract showed implied yields at a much-improved 5.29 percent through September 19th. This remains only 18 basis points below the current LIBOR rate of 5.47 percent, and shows that speculators remain hesitant on whether the Federal Reserve will scale back its key Fed Funds rate through the period. Many initially believed that the recent credit crunch would force the central bank to ease its interest rate target, but it seems as though the recent discount rate cut has proved sufficient in calming market skittishness. Whether or not the Fed presses on with monetary policy accommodation remains the critical question across financial markets, with the US dollar likely to fall on a cut in the Fed Funds rate.
The Dow Jones Industrial Average initially saw modest gains following the strong Asia market close, but a later reversal showed the index 37 points off to 13,200. The S&P 500 fell by a similar 0.4 percent to 1,458, while the tech-heavy NASDAQ Composite was the worst performer at -16 points to 2,537.

US Treasury markets regained some of yesterday?s declines, with the 10-year note adding 9/32 points to 101 and 3/32nd. Yields dropped 4 basis points to 4.61 percent.

Written by David Rodriguez, Currency Analyst for DailyFX.com
?