Bernanke's call disrupts dollar's prospects

PUBLISHED : Friday, 20 September, 2013, 12:00am
UPDATED : Friday, 20 September, 2013, 3:51am

Federal Reserve chairman Ben Bernanke's surprise decision on Wednesday to refrain from reducing the central bank's unprecedented stimulus threatens one of the surest bets in currency markets this year.

Traders borrowing funds in Japanese yen and using the proceeds to buy dollars earned an annualised 21 per cent this year up to September 17, a record based on data going back to 1990. That so-called carry trade was predicated on rising market interest rates in the US as the Fed bought fewer and fewer bonds.

A strategy that favours dollars over emerging market currencies "is going to get smashed", said Sebastien Galy, a senior foreign-exchange strategist at Societe Generale in New York. Investors will now go "short dollar and long emerging markets", he said, referring to trades that would profit from a drop in the dollar.

Prospects for a reduction in bond purchases by the Fed boosted yields on 10-year treasuries earlier this month to the highest since 2011 and spurred a transfer of capital to the US from emerging markets such as Brazil and India even as a debate in Washington heats up on how to lift the US$16.7 trillion debt ceiling to avert a federal shutdown. Department of the Treasury data showed China raised its US fixed-income holdings in July and Japan lifted its stake to a record.

Treasuries soared yesterday, pushing 10-year note yields down the most since October 2011, to 2.69 per cent from 2.85 per cent on September 17, as Bernanke held back from paring the US$85 billion of bonds it buys each month after rising market borrowing costs showed signs of slowing the four-year expansion.

"Conditions in the job market today are still far from what all of us would like to see," Bernanke said after a two-day meeting of the Federal Open Market Committee. "The committee has concern that rapid tightening of financial conditions in recent months would have the effect of slowing growth."

Carry trades targeting the US dollar have paid off as the yield on the benchmark 10-year treasury rose from 1.63 per cent at the start of May. US yields almost matched those on foreign government debt on September 5 for the first time since May 2010, after falling 1.18 percentage points below in late 2011, Bank of America Merrill Lynch index data shows.

The dollar was expected to strengthen at least 2.6 per cent against each of its Group of 10 peers by the middle of next year, based on forecasts of analysts in a survey before the Fed meeting.

"We're looking for the dollar to be supported by investment inflows into the US rather than coming under pressure from being used as a funding currency," said Ian Stannard, the head of European foreign-exchange strategy at Morgan Stanley in London, on Tuesday. "The US is going to become more of an investment destination."