If you except the fact that the two main drivers of currency price are interest rate differentials and equity driven carry trades (or what professionals refer to as equity driven cross-border currency flows), the best trade right now is to short USD/JPY for a longer-term trend trade.
Let's review what happened in the spring when the dollar weakened dramatically vs the high yielders (GBP, EUR, AUD and NZD). During most of that time, the fed was percieved to be holding or possibly lowering the overnight rate while the BoE, ECB, RBA and RBNZ were in tightening modes. Interest rate differentals clearly were against the dollar and the dollar weakened dramatically.
At the same time, equity markets were performing very well and carry trades wound. When carry trades wind, the dollar weakens vs the high yielders and gains vs the Yen. What this means is that in the spring, the two main drivers of currency price, carry trade and interest rate differentials, were working SIMULTANEOUSLY to weaken the dollar vs the high yielders.
Let's look at today's situation. Many in the markets are concerned that the US could be going into a recession. That means equities will not be favored and carry trades will unwind, causing the dollar to gain vs the high yielders and lose vs the Yen. But what is also happening is that because the fed looks to be lowering the overnight rate, the interest rate differentials are still favoring the high yielders, meaning that those forces will be pushing the dollar lower. The two main drivers of currency price are now working AGAINST each other. As far as G/U, E/U, A/U and N/U are concerned, it's likely that a "tug or war" will exist and that price will bounce back and forth.
Now here's how to take advantage of the situation. If equities are not favored because of the perceived threat of recession carry trades will unwind, meaning that the dollar will depreciate vs the Yen. At the same time, because the fed looks to be lowering the overnight rate the interest rate differentials will also be causing the dollar to depreciate vs the Yen. In other words, the two main drivers of currency price, carry trades and yeild differential will be working SIMULTANEOUSLY to weaken the dollar vs the Yen.
Let's review what happened in the spring when the dollar weakened dramatically vs the high yielders (GBP, EUR, AUD and NZD). During most of that time, the fed was percieved to be holding or possibly lowering the overnight rate while the BoE, ECB, RBA and RBNZ were in tightening modes. Interest rate differentals clearly were against the dollar and the dollar weakened dramatically.
At the same time, equity markets were performing very well and carry trades wound. When carry trades wind, the dollar weakens vs the high yielders and gains vs the Yen. What this means is that in the spring, the two main drivers of currency price, carry trade and interest rate differentials, were working SIMULTANEOUSLY to weaken the dollar vs the high yielders.
Let's look at today's situation. Many in the markets are concerned that the US could be going into a recession. That means equities will not be favored and carry trades will unwind, causing the dollar to gain vs the high yielders and lose vs the Yen. But what is also happening is that because the fed looks to be lowering the overnight rate, the interest rate differentials are still favoring the high yielders, meaning that those forces will be pushing the dollar lower. The two main drivers of currency price are now working AGAINST each other. As far as G/U, E/U, A/U and N/U are concerned, it's likely that a "tug or war" will exist and that price will bounce back and forth.
Now here's how to take advantage of the situation. If equities are not favored because of the perceived threat of recession carry trades will unwind, meaning that the dollar will depreciate vs the Yen. At the same time, because the fed looks to be lowering the overnight rate the interest rate differentials will also be causing the dollar to depreciate vs the Yen. In other words, the two main drivers of currency price, carry trades and yeild differential will be working SIMULTANEOUSLY to weaken the dollar vs the Yen.
