At a time when most traders in the currency market are focused on whether the Euro will rise to 1.50, many people may not have noticed that record highs or at least multiyear highs are being made in other currency pairs. For example, the US dollar fell to a record low against the Swiss Franc on Wednesday while EUR/GBP rose to record high on Tuesday. Less headline grabbing but still significant moves were seen in other currency pairs such as GBP/CHF and GBP/AUD which fell to 4 and 10 year lows respectively.
Here is a tally of the recent moves:
As you can see, the most profound weakness was concentrated in the British pound pairs. A closer look reveals that nearly all of the currency pairs that hit significant lows are carry trades tied to the Japanese Yen and Swiss franc. For the two pairs that hit significant highs, both had the Euro as one of its components.
Will the Moves Continue?
Fundamentally, there is no reason to believe that the current moves will end. The UK is expected to deliver their second interest rate cut next month, the Federal Reserve is expected to cut interest rates by at least 50bp on January 30th, and the volatility in the stock markets will make it difficult for carry trades to recover. There are two main factors driving the weakness in carry trades: the 800 point drop in the Dow year to date and the beginning of what may turn out to be a global easing cycle. If US growth continues to slow in 2008, this could be a bear market for stocks. In such an environment, carry trades will have a very difficult time rallying. As for the British pound, surprisingly weak economic data has supported the case for further easing. This is a new cycle of monetary policy for the central bank and the past 2 months of pound selling represents position adjustments in reflection of that. The hawkishness of the European Central Bank should keep the Euro steady.
Judging from a sentiment perspective, the moves should also continue. Our latest Speculative Sentiment report signals further losses for USD/JPY, USD/CHF and the GBP/USD. According to our contrarian indicator, long USD/CHF positioning is reaching an extreme. Pound positioning is significantly above its monthly average and despite the recent volatility in carry trades, speculators are holding onto their long positions.
Do you think Carry Trades are Headed for More Losses? See the results of our DailyFX poll.
Technicals paint a similar outlook for USD/JPY and USD/CHF but not for the GBP/USD. In fact, the wave count strongly suggests an explosive move higher in the British pound:
We wrote in yesterday’s Daily Technicals that “given the shelf of support just below 1.9500, the rally this morning makes it possible that at least a multi-week bottom is in place at 1.9483. As such, a bullish bias is warranted against 1.9524 for a rally to at least the 2.0100 level (former resistance). We do not know yet of course whether or not the decline from 2.1160 will complete 5 waves -- so far the decline is in just 3 waves. Recent COT data argues for a significant GBP low to form.” We stand by this analysis and expect the Pound to continue gaining. For more a detailed analysis on our Technical Outlook for the British Pound, see Pound Explosion.
On USD/JPY, we are bearish against 107.88, targeting below 100. On USD/CHF, we are bearish as long as USD/CHF holds below 1.1190 for a move down to 1.0836. For charts of USD/JPY and USD/CHF, see our Daily Technical Report for the Currency Market.
Discuss Carry Trades with our DailyFX analysts on our Forum.
By Kathy Lien, Chief Strategist of DailyFX.com
Contact Kathy Lien about this article at klien@dailyfx.com
