Why Traders Love to Sell Dollars

09/17/2009 12:01 am EST

Focus: FOREX

Kathy Lien

Managing Director and Co-Founder BKForex LLC, BK Asset Management

The US dollar just can’t win in this type of market environment. Despite good economic data and positive comments from Federal Reserve chairman Ben Bernanke, there is no love for the greenback. The dollar ended the US trading session lower against the euro and commodity currencies and virtually unchanged against the Japanese yen and Swiss franc. The only currency that underperformed the dollar was the British pound, which collapsed after Bank of England governor King said he is considering lowering the deposit rate for reserves. Based upon the price action of the US dollar and the price action of equities, it appears that the primary reason why the dollar has moved lower today is risk appetite, but we have also talked extensively about how traders love to sell dollars because it has become one of the cheapest funding currencies (the dollar carry trade). There is no question that the foreign exchange markets are extremely schizophrenic, shifting from trading on fundamentals to risk appetite, but this is what happens when we are in the twilight zone between easy and tight monetary policy.

Bernanke Says Recession “Likely Over”

However, thanks to hints by Fed chairman Ben Bernanke, there is hope that the US economy will come out of the twilight zone in the coming months. According to Bernanke, there is a good chance that the recession in the US is already over. Given the market-moving potential of his comments, the Fed chairman would not pick these words if he did not believe that brighter times lie ahead for the US economy. We can even postulate that in the Fed’s eyes, the risk of a double-dip recession is low. Of course, Bernanke would not be Bernanke if he did not temper his comments with some type of warning. He said that it will take many months before we see a meaningful improvement in the labor market, and for many people, it is still going to feel like a very weak economy. Nonetheless, equity investors cheered the Fed chairman’s comments and their optimism has also eased safe-haven flows out of the US dollar. Although we also believe that the worst is behind us, it is important to point out that Bernanke said the recession is “very likely over” from a “technical perspective.” All that means is that GDP will turn positive in the third or fourth quarter, but what really matters is how positive.

More Pressure on the Dollar?

Based upon the latest retail sales report, GDP should turn positive for the first time since Q3 of 2008. We are still waiting for the September data, but as long as spending did not fall off materially, the US economy could technically rise out of recession like Bernanke predicts. The National Bureau of Economic Research is the official agency that determines when a recession begins and ends, but they almost always make the declaration months after it has happened. This morning's economic reports were overwhelmingly positive for the US dollar with broad-based improvements seen in retail sales, producer prices, and the Empire State Manufacturing survey. Looking ahead, it will be another busy day in the US with consumer prices, the current account balance, Treasury International Capital (TIC) flow report, and industrial production due for release. Last week, reserve diversification fears returned when a UN panel called for a new global currency to eliminate the world’s dependence on the dollar. The TIC data will give us more information on whether central banks have actually been selling dollars.

By Kathy Lien, Director of Currency Research at GFTForex.com

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