DB FX Daily: London Why It's Still A Dollar Weakness Story

[RTFX-Trading]

FX Daily: London

Why It's Still A Dollar Weakness Story
Today's payrolls numbers bring the usual uncertainty of the release. If the recent history of relatively close-to-consensus prints is anything to go by (average forecast error of 30k over last twelve months compared to 80k since 1997), EUR/USD may only manage a 100 pip range on the day (the average payrolls range over the last twelve months). Irrespective of today's price action, our attention is focused on two factors that continue to point to this year's dollar weakness environment being intact: (a) While the US dataflow improved over May, it has over the last few weeks not shown any convincing signs of a solid rebound either, with our US data surprise index again easing into negative territory this week. Though not pointing to a recession, the current dataflow out of both the US and Euroland remains consistent with Fed rates on hold (with downside risks) and an ongoing tightening bias from the ECB (confirmed by president Trichet yesterday) (b) Perhaps more worryingly, recent woes in the credit market may threaten to bring the financing issues of the US current account deficit back to the fore. The first chart at right shows a sharp deceleration in US corporate bond issuance over July, falling to the lowest since 2003. This would point to a more than 60bn slowdown in corporate bond inflows, and with these flows accounting for more than 40% of total US capital inflows over 2007 cannot be brushed aside lightly.

Looking for Value in Risk Reversals
The recent carry unwind has seen large moves in options market risk reversals (the difference in price between a call and a put on a particular currency cross). Market attention has focused on USD/JPY risks reversals, which are currently at levels indicating close to record demand for JPY calls over puts. Looking however at a broader comparison of risk reversals across the G10, investor appetite for holding protection in USD/JPY appears to have been present before this week's carry unwind materialized. In contrast, their have been larger swings in the relative demand for GBP/USD, AUD/USD and SEK/USD options. Risk reversals in these crosses may be the first to reverse recent moves should carry trades show signs of recovery.


George Saravelos
Strategist
(+44) 20 754-59847
[email]george.saravelos@db.com[/email]