By DailyFX - US Dollar: Reversals in the Dow and in Carry Trades. We saw major reversals in the financial markets today.Not only...

... did the US dollar erase all of its losses against every major currency with
the exception of the Japanese Yen, the Dow also reversed nearly all of
its gains. The major volatility in the financial markets has been
triggered by one thing and that is fear. In the first half of the
European trading session, demand for carry trades returned with a
vengeance taking EUR/JPY to a fresh record high and CHF/JPY to an 8 year
high. When US consumer confidence came out much stronger than expected,
the dollar began to take off. The strength was so widespread that for a
brief moment USD/JPY rallied in lockstep with USD/CHF. Unfortunately,
the stock market / carry trade relationship is too dominant to suppress.
When the stock market reversed its gains around noontime, USD/JPY also
reversed, despite the fact that the dollar continued to rally against
the Euro and British pound. The trigger for the reversal was another
attempt by China to cool the rapidly growing stock market. With the
Shanghai stock index hitting another record high last night, the
government tripled its stamp tax on stock trading. Having just
increased interest rates, widened the Yuan trading band and increased
reserve requirements 2 weeks ago, the government is clearly becoming
very anxious with the stock markets unstoppable rise. The hope is
that the stamp tax will reduce the amount of trading, but with a tax of
3 in a thousand, the increase may only have a limited impact on the
Chinese market in the long term. In the short term however with the
Chinese stock market, US stock market and carry trades extremely
overbought, this could be a trigger for some further unwinding. This
will all depend on how the Chinese markets behave tonight. A big
reaction in Asia will trigger a bigger reaction in the US, but at the
same time, we need to see that reaction first because the Chinese
appetite for risk should not be underestimated. Meanwhile, it is
important to point out that the S&P/Case-Schiller house price index
dropped for the first time in 15 years, which is further evidence of the
vulnerability of the housing market. This week is non-farm payrolls
week and tomorrows ADP employment index is one of our first leading
indicators for payrolls. A strong number could extend the dollar’s
rally as well as hawkish FOMC minutes from the March 9th meeting.

Euro: Eurozone Economic Resilience Evident in Current Account Data

Even though the Euro gave back nearly all of its intraday gains, next
to the Japanese Yen, it was the best performing currency against the US
dollar. This resilience was thanks to the much stronger than expected
current account data released this morning. The market was completely
caught off guard when the current account shifted from a deficit of -3.7
billion to a surplus of 5.4 billion in the month of March. This is yet
another piece of evidence that the strength of the Euro has had a
limited impact on the overall economy. Instead, ECB officials continue
to remain very hawkish. According to the Financial Times, ECB member
Weber said that “the current cycle of interest rate increases has not
yet reached its end. This clearly indicates that the central bank is
on track to raise interest rates on June 6. German and French retail
PMI data is due for release tomorrow. With business confidence holding
steady, there is no reason to expect weak consumer confidence.
Meanwhile the Swiss franc has performed extremely well after the UBS
consumption index hit a 5 year high. The trade surplus fell short of
expectations, but the market is less interested in trade ahead of the
GDP and CPI data later this week. We expect the weakness of the Swiss
franc to have boosted both growth and inflation.

British Pound: Losing Ground amidst Lack of Data

With no significant economic data to help boost the British pound, the
currency fell quickly and sharply under the weight of the dollar rally.
The only piece of data that was released was the BBA loan numbers for
the month of April. According to the group, home loans fell 13 percent
in the month of April (from 75098 to 64815). The economic calendar is
comparatively light for the UK this week, with only Tier 2 data due for
release. This includes GfK consumer confidence, mortgage approvals, the
CBI distributive trades survey and PMI manufacturing. None of these
reports should alter the markets expectation of another rate hike by
the Bank of England this year. Last week, the minutes from the most
recent Bank of England meeting revealed that they were debating between
a 25 and 50bp rate hike.

Japanese Yen: Carry Trades Refuse to Die

Japanese Yen carry trades were the focus of the day. Many times in the
past, carry trades have refused to die despite minor hiccups which
explain why we are wary of whether this will happen again. The US stock
markets have already recuperated some of its losses and we have key
Japanese data due for release tonight, namely industrial production and
the Bank of Japan meeting minutes. Overnight, economic data from Japan
was very strong with the jobless rate falling below 4 percent for the
first time in 9 years. Overall household spending was also robust which
suggests that we may finally be seeing some recovery in the Japanese
economy.

Commodity Currencies: Canadian Dollar Surges to Fresh 29 Year High

The Canadian dollar surged to a fresh 29 year high today after the
central bank signaled that an interest rate hike may needed in the near
term. The central bank was widely expected to leave interest rates
unchanged at 4.25 percent, which they did on the fear of derailing the
economy by pushing USD/CAD closer to parity. However growth has become
so substantial that if it does not wane any time soon, the central bank
will need to step in and take action. The futures market is now pricing
in 2 rate hikes by the end of the year. Tomorrow we are expecting more
Canadian data with raw materials and the current account balance due for
release. Australian retail sales are scheduled for release this
evening. The strength of the labor market should keep consumer spending
strong.


DailyFX Research Team
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: research@dailyfx.com


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