The US$ continues to weaken as market participant’s concerns about the threat of a subprime mortgage meltdown in the US housing market has investors aggressively liquidating US$ positions. After the release of weak earning’s reports from two US major companies servicing the US housing industry (Home Depot and Sears), US equity markets tumbled as the fear of contagion seems to be hitting other markets. Also failing to offer the US$ any “lifesavers” yesterday was testimony from Fed Chief Bernanke. Bernnake failed to address market concerns about significant fallout in the housing sector and maintained his anti-inflationary mantra. With the market convinced that inflation pressures remain firmly in check within the US economy, many traders are shaking their heads as to the Fed’s priorities and in turn liquidated their greenback holdings. A further area of concern for the market is the skyrocketing price of energy as predicated by increased geopolitical risk and a record heat wave in the US. The US has recently moved a third aircraft carrier into the Gulf heightening tensions with Iran as the US continues to flex its muscles. With these events as a backdrop, market participants continue to avoid the US$, with further weakness prompting the prospect for global diversification away from the greenback. Look for this trend to continue throughout the remainder of the summer.
The euro continues to gain as the market shuns the greenback and favors the Eurozone currency. While there are concerns that the US economic slowdown will quicken,, highlighted by a meltdown in the subprime mortgage lending market, the Eurozone economy remains vibrant. Comments overnight from ECB Member Stark in Frankfurt stated that the recent euro gains “reflect the strength of the region’s economy.” He also highlighted the inflation risk posed by increases in money supply. These comments strengthen the market’s perception that the ECB will continue to hike rates this year as economic growth accelerates and inflation pressures mount. On July 5th, ECB Chief Trichet stated that he is prepared to continue hiking rates to curb these pressures. Expect euro gains to dominate as the market continues to buy the Eurozone currency as a surrogate to holding the greenback.
The yen gained overnight following declines in US equity markets prompted concerns that global contagion could be spreading, forcing investors to liquidate carry trade positions. With the threat of further global financial risk, traders are abandoning carry positions, typically used to fund riskier, more aggressive, higher yielding trades. Also helping move the yen higher was the prospect that the Bank of Japan will signal it intends to push rates higher later this summer following its meeting tomorrow. Traders are now forecasting with a 75% probability that the BOJ will hike rates at its August meeting. An unwinding of the carry trade coupled with the prospect for higher Japanese rates continues to promote short-term yen strength.
The pound surged to the highest level in over 26 years against the US$ as speculation mounts that the Bank of England will continue to push rates higher as the US Fed keeps rates in check amidst a slowing housing market. Sterling’s gains can be directly tracked to the yield advantage afforded by the pound amidst an environment of robust economic growth and mounting inflation pressures.