FX volatility drought clears as US dollar softens

The volatility drought in the forex markets could be over, market participants told RiskNews ' sister publication FX Week , as sustained losses in the US dollar last week brought currency pairs out of the narrow ranges they have traded since the start of the year. The euro hit $0.918 against the dollar - a seven-month high -this morning, having traded in a narrow range between $0.865 and $0.885 for most of the year so far.

The euro hovered above $0.90 last week, after a swift jump higher, while the yen broke out of its range of between 130 and 135 yen per dollar, strengthening to 126.9 per dollar.

"It’s been deadly dull until recently," said one trader at a US bank in New York. "But it’s looking like the dollar may have had its day."

But, he added, there are several key levels the euro must break before the dollar’s bull run can be said to be over. The first key level for the currency is $0.933, September’s high, and then $0.96. "If we break that, we will be into a new trend of dollar weakness," said the New York trader.

Other market participants urged caution. "A lot of the flows out of the dollar have been short-term speculative flows," said Will Rugg, senior currency analyst at Standard & Poor’s MMS in London. "If the real money accounts don’t kick in we’ll probably see some retracement. Euro-long positions are also a bit overcooked."

A possible end to the dollar’s near 10-year bull run comes after the market has digested concerns over corporate earnings, false accounting, and renewed fears over the size of the US current account deficit.

So far the rate of incoming foreign direct investment has been sufficient to finance the ballooning US current account deficit, said analysts. But now, said Mike Rosenberg, global head of currency research at Deutsche Bank in New York: "US yields are too low and the equity market is not performing. We have had a bigger current account deficit before, but this time spreads are too low to support incoming flows."

US Treasury Secretary Paul O’Neill added to pressure on the dollar with a testimony before the Senate Banking Committee last Wednesday alluding to the ineffectiveness of intervention in the foreign exchange markets. Dealers viewed the comments as a 'green light' to sell the dollar.

One trader at a bank in New York described the dollar’s losses as "an O’Neill-inspired dollar meltdown". But the majority of the selling came from short-term speculative accounts and dealers reported little in the way of real-money selling following the testimony.