Wednesday, October 29, 2008

Is the Unwinding US Dollar, Yen Carry Trade Overextended? A Look at USD/CAD, AUD/JPY, FXC, UUP, GLD, Charts and Analyst Quotes

Volatility spilled into the forex market recently. Carry trades have been unwinding as investors began to dump risky assets, funded by cheap Japanese Yen and US Dollars. During the past few years, investors have been borrowing cheap currencies to buy higher yielding currencies, profiting from the spread and exchange conversion, while magnifying gains with leverage. They used the Yen and the USD to fund the investments, which were sold to buy the higher yielding currency, which ultimately pushed down the value of the YEN and USD.

Recently investors have been fleeing from emerging market risk; dumping higher yielding currencies and buying back the borrowed USD and Yen. The US Dollar Index and Japanese Yen Index were up 20% since the summer. As these safe haven currencies were bid up, and volatility infested the forex market, the carry trade started to lose value. Also, overleveraged funds were seeing redemptions and margin calls, exacerbating the situation. The inter-bank lending freeze, and the lack of US Dollar liquidity, also contributed to the USD bid. Commodities linked to these higher yielding currencies have seen a steep fall. Canada and Australia are big commodity exporters and their currencies were directly affected.

Has the unwinding carry trade overextended itself in the near term? Could there be a CAD/USD, AUD/JPY relief rally? I charted these currencies out last night, and it looks like it is already taking place (as of 12:06pm Est on 10/29/2008). The Fed is supposed to lower rates today, which is putting pressure on the US Dollar. It is interesting because global central banks have pumped billions of dollars into the banking system, however banks have not been lending out money. Once risk appetite presents itself again, and liquidity gets released into the system, monetary inflation could make commodities more valuable, especially precious metals if demand destruction continues to affect energy prices (as Ashraf Laidi, chief FX strategist at CMC Markets mentioned in the video below). This would benefit countries producing and exporting the commodities, like Canada and Australia against the US Dollar and Yen.

However, in the near term, it's tough to tell how harsh the slowdowns will be around the world, which could cause central banks to cut rates further and intervene, so the forex market is out of anybody's control. The Japanese Government is thinking about intervening in the forex market to halt the rise of the Yen. Plus, every USD and Yen could find it's way back home if we see a deep global recession, which would delay any type of rally. The fact is, a huge amount of paper money will be infesting the Earth very soon and the U.S could be approaching a trillion dollar deficit!

Here are some predictions by analysts, with links sourced, along with charts of USD/CAD, AUD/JPY, FXC (Canadian Dollar ETF), UUP (US Dollar ETF) and Gold.

"The USD CAD posted a new multiyear high on Tuesday but closed lower for the day. Traders sold the USD CAD on the strength of the commodity markets. News that credit markets were loosening led to speculation that demand would increase for commodities such as wheat and lumber. The weaker Dollar also led to a strong crude oil market. Traders are hoping that this rally lasts long enough to have a positive impact on the Canadian economy which is so reliant on stronger commodity prices. The charts indicate the potential of a huge drop to 1.1636 to 1.1335. A break of this sort.....

The AUD USD rallied on Tuesday as the Reserve Bank of Australia intervened for the third day. Sources at the bank claim that the interventions were not to stop the break to five year lows, but instead to provide liquidity so that the markets could function properly. Along with the interventions came renewed appetite for risk by traders seeking higher yielding assets. The threat of interest rate cuts by the Bank of Japan and the Fed are making the Australian Dollar an attractive investment...." -By James A. Hyerczyk (Source: Click link for more analysis.

"The risk at the moment is that we continue to see more Canadian dollar weakness," Shaun Osborne, the chief currency strategist at TD Securities said.", "There's no indication at the moment that this move is done. We're kind of running out of superlatives to describe this because it seems to go from bad to worse every day." (Source: Financial Post)

"The loonie, as Canada's dollar is known because of the aquatic bird on the one-dollar coin, ``appears cheap'' at current levels, said Sal Guatieri, a senior economist at BMO Capital Markets in Toronto. He predicts the currency will strengthen toward C$1.17. Wright predicts a rebound to C$1.20 by year-end." (Source: Bloomberg)

"The equity markets are moving currencies around with a fair bit of severity this morning," said Jack Spitz, managing director of foreign exchange at National Bank in Toronto. "That's favorable for the Canadian dollar, but it's been offset to some degree by month-end flows and the need for some to re-balance hedges, which will attract some buyers of U.S. dollar-Canada between now and the end of the month." Spitz and others contend that sentiment toward the Canadian dollar remains very fragile and could abruptly reverse on any souring of stock or commodity markets. (Source: Dow Jones News via

"While uncertain about what the short term will bring, Laidi is fairly confident gold -- and other commodities -- are good long-term bets because of the dollar's weak underlying fundamentals; namely, a ballooning federal deficit and increasingly loose Fed." -Ashraf Laidi, chief FX strategist at CMC Markets on Tech Ticker.

"ROBERT RENNIE: I think as long as this period of intense volatility continues to rattle through global financial markets, there certainly has to be a risk that the Australian dollar continues to fall and potentially overshoot significantly in the downside. Look I think if we remain very much locked up and in this period of intense volatility there is a risk that the Australian dollar may break beneath 60 cents, there is a possibility that we continue down into the mid 50s. Beyond that point though I think you would have to argue that we really have moved into overshoot territory." -Robert Rennie is the Chief Currency Strategist at Westpac Bank on ABC Local Radio.

"Australian Dollar Losses May Continue As Very Little Support Remains" ( 10/25/2008

"Yen carry trades unwinding in Austrailia, Brazil, U.S$, New Zealand" (

AUD/JPY (source:

USD/CAD (source:

GLD (Gold ETF)(source:

UUP (Bullish US Dollar ETF)(source:

FXC (Canadian Dollar ETF)(source: