Daily Forex Update - Carry Trade Liquidation

by David Settle

Carry trade liquidation and a spike in volatility were the two major themes for the forex markets during the final trading session for the calendar year. Existing home sales and relative calm in central Asia helped the greenback recover some of last week's losses.

USD
As you can see in Figure 1, the U.S. dollar (purple) was the second-best performing major currency today behind only the Japanese yen. The drop in crude oil prices hurt the Canadian dollar. The loonie (light blue) was the worst performer against the greenback. The British pound (dark blue) started the N.Y. trading session as the big winner but finished in the middle of the pack due to carry trade liquidation.


Figure 1 - The Performance of the JPY Crosses during the Last 24 Hours

The Dow Jones Industrial Average dropped over 100 points reflecting a general bearish sentiment surrounding the outlook for the U.S. economy. The yield on the 10-year Treasury note inched closer to 4 percent - 25 basis points below the current Fed funds target rate. This discrepancy shows that bond traders are expecting the monetary policy setting board to drop the overnight cash loan rates another 25 basis points at the next meeting in January. But, despite these two seemingly bearish events for the greenback, the U.S. dollar had one of its best days of the year with most of its gains coming during the N.Y. trading session. The best news for the embattled currency was that Pakistan was able to avoid more turmoil over the weekend in the wake of the assassination of ones its popular political figures.

Another positive release for the greenback was today's surprisingly strong existing home sales report. The market was looking for a small month-over-month drop but investors were looking for a similar freefall that accompanied the new homes sales figures on Friday. Even though the monthly number was positive, the index still declined over 20 percent during the past twelve months. The annualized number of homes sold remains at its second-lowest number since the index began in 1999. Falling mortgage rates usually help boost the number of homes sold but drop in lending rates during the past few months has not helped sales move significantly higher. The median sale price did climb 1.6 percent for the month. Investors are keying on any positive data as they look for clues for the bottom in the housing market and ultimately the financial markets.

NZD/AUD/CAD
The increase in risk aversion had the biggest negative effect on the commodity currencies. The Canadian and New Zealand dollars felt the effects the most with both currencies dropping 300 and 185 pips respectively to the Japanese yen. The Australian dollar, which had under performed its two peers, bounced back significantly today. There was no news released, so most of today's move could be explained by simply a technical correction to the recent bearish trend for the aussie. Figure 2 shows the USD/CAD currency pair bouncing off a technical support level that used to be a downward sloping resistance trend line for the pair. A break aback above parity and the former high at $1.02 would confirm a fresh series of higher highs and lows that would define the new bullish trend for the currency pair.


Figure 2 - Technical Support Bounce on USD/CAD

JPY
Stocks were mixed in Asian and Europe but a big jump in volatility during the U.S. trading session caused the Japanese yen to gain against all the major currencies today. The calendar is completely empty; so keep an eye on the CBOE Volatility Index ($VIX) for clues about the carry trade for the rest of the holiday week. Figure 3 shows the $VIX close to a technical resistance level. If this level breaks, and the volatility index climbs higher than its previous high at 25, forex investors will continue to push the higher yielding currencies lower while buying back the Japanese yen.


Figure 3 - Symmetrical Triangle on the $VIX

EUR/GBP/CHF
The euro and Swiss franc gave back its gains from late last week, as the turmoil in Pakistan appears to be settling down. Early in the trading session the British pound showed some signs of life. The oversold currency started to bounce of its lows against its European peers. Although the pound sterling finished the day higher, it was well off its highs for the day. The Swiss franc out performed the euro on the basis of risk aversion. The lower yielding currency benefits when stock prices fall, but not to the same extent as the Japanese yen. The economic calendar was empty in the region this morning, but this will change after the holiday.

Weekly Articles
Be sure to check this week's "Economic Calendar" to monitor what indicators are due overnight and tomorrow morning. For additional insights for your FX investing, read this week's "Technical Commentary" article. The "Weekly FX Commentary" article wrap-ups last week's action, along with ideas on how you can position yourself for the upcoming week. Finally, "Institutional Tracking" and "Intermarket Analysis" are additional resources for Investools FX students to analyze a few of the key major currency pairs. These are all updated every Friday.

Come see what Investools training can do for you at www.investoolsfx.com/tradingmarkets


Disclaimer: This report is published solely for information purposes and is not to be construed as advice or a recommendation to buy or sell a security. Trading involves risk, including loss of principal and other losses. Trading results may vary. No representations are being made that utilizing techniques mentioned in this article will result in or guarantee profits in trading. Past performance is no indication of future results.