Position fatigue prompting short-term dollar rethink
— Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own —
Dollar bears have been disappointed by the G20.
Talk of re-balancing remained just talk; the bears can discern nothing substantial. Some risk is being taken off and dollars bought back selectively. While the dollar’s general downtrend is intact, there are risks of a temporary reversal, with some seeing the euro temporarily back to $1.4500/50.
Traders can contrast G20 with the Plaza Accord in 1985 which was driven by U.S. Treasury Secretary James Baker’s persistence. But he only had to convince four peers. G20 is and will be a different story. Dealing with the G20 must be like herding cats.
Disappointment over G20 has come at an inauspicious moment. Extensive short dollar foreign exchange positions have been underpinned by the unparalleled provision of dollar liquidity by the world’s central banks.
The market has used that dollar liquidity to fund purchases of other currencies and assets. Currency speculators raised their bets against the dollar in the latest week to the most since March, 2008, data from the Commodity Futures Trading Commission on Friday showed.
But the market is realising that the major central banks are contemplating the initial steps in their exit strategies, which would naturally reverse the dollar-funded carry trade.
The liquidity bonanza that has ignited the asset market rallies is going to be pared back. Last week’s withdrawal of some emergency facilities that are deemed to be no longer needed was the first step.
Federal Reserve Governor Kevin Warsh added fuel to the fire asserting “policy likely will need to begin normalisation before it is obvious that it is necessary, possibly with greater force than is customary”.
Seemingly Warsh is not expecting the “softly softly” approach of former Fed Chairman Alan Greenspan in his post-dot com bust tightening cycle that started in mid-2004 and lasted for two years.
Market players who are using the dollar as a carry currency will note Warsh’s comments and may trim back their short dollar positioning.
The yen’s strengthening to 88.23 yen against the dollar today should be seen in the same context, as a trimming back in carry trades by Japanese retail investors, who by and large remain wedded to the U.S. currency.
The market will ultimately want to target the year’s low of 87.15 yen and ultimately the all-time low of 79.80 yen, seeking to tempt Japan’s Ministry of Finance into a reaction.
In an atmosphere where the new Japanese government seems somewhat indifferent to yen appreciation, the market has delivered general yen strength. The headlines focused on dollar/yen but traders reveal that much of the emphasis was on the liquidation of cross yen trades such as euro/yen.
Risk trades have buoyed equity markets as well as fuelling short dollar positions on the foreign exchanges. Risk trades are predicated on the assumption that government economic stimuli will promote self-sustaining recoveries. If that assumption is faulty, then the positions will need some unwinding.
However, traders are now realising that programmes like “cash for clunkers” are merely cannibalising future purchases. Consumers will respond to incentives, but without those incentives they prefer thrift. Lengthening job queues are keeping purse strings tight.
There is therefore a growing belief that the dollar may find passing strength as positioning is adjusted, which traders would see as an opportunity. Proprietorial traders will welcome the unwind and look to take advantage of any such move. Their longer-term view of further dollar weakness is undimmed.
The U.S. national interest remains focused on re-balancing. The exclusion of Mexican trucks from U.S. roads and the imposition of tariffs on cheap Chinese tyres may be dismissed as sops to President Obama’s union backers.
Yet they betray a wider agenda to revive American industrial activity. A lower dollar, even if that hasn’t worked in the past, will be an integral part of that re-balancing act.
While the dollar may therefore draw some transient strength from position adjustment, dollar bears will see the euro around $1.4500 as opportunities to buy the single currency. Moves above $1.5000 are still envisaged.