The U.S. dollar faced significant declines on Tuesday, while the yen struggled after a sharp rise in the previous session. Traders are dealing with the unwinding of popular carry trades and anticipating substantial rate cuts from the Federal Reserve.
Early Tuesday, the yen fell 1% to 145.78 per dollar, following five consecutive sessions of gains and a peak at 141.675 on Monday, a seven-month high. The yen also dropped against the Australian dollar, euro, and sterling.
Recent weaker-than-expected U.S. jobs data, disappointing earnings from major tech companies, and growing concerns over the Chinese economy triggered a global sell-off in stocks, oil, and high-yielding currencies.
On Monday, this exodus from riskier assets intensified dramatically, with equity markets in turmoil as fears of a U.S. recession spooked investors.
Despite these concerns, U.S. central bank officials on Monday dismissed the idea that the weaker July jobs data signaled an economic freefall but acknowledged the need for rate cuts to prevent a recession.
“Sell-offs in currency markets, characterized by wild swings, are sharp and swift but usually short-lived,” said Jamie Cox, managing partner at Harris Financial Group. “Markets are clearly jittery about the divergent paths central banks are taking, leading to significant volatility.”
Traders now expect the Fed to cut rates by 109 basis points (bps) this year, with a 50 bps cut in September priced in at a 75% likelihood, according to the CME FedWatch tool.
The yen’s surge follows the Bank of Japan’s interest rate hike last week and a sharp unwinding of carry trades, where investors borrow from economies with low interest rates, like Japan or Switzerland, to invest in higher-yielding assets.
The yen’s value has risen since Tokyo intervened to support the currency last month, lifting it from the 38-year low of 161.96 per dollar it hit barely a month ago.
“The conditions had been ripe for yen-funded carry trades for some time,” said James Athey, fixed income portfolio manager at Marlborough Investment Management, pointing to wide interest rate differentials between the U.S. and Japan, prohibitive hedging costs for Japanese investors, and low equity volatility. “However, yen undervaluation had become extreme, and as conditions shifted, yen appreciation could be swift and aggressive, much like in 2008.”
The dollar index, which measures the U.S. currency against six rivals, was steady at 102.87 in early trading after hitting a seven-month low of 102.15 on Monday.
The euro remained mostly unchanged at $1.095275, while the sterling edged higher at $1.2789.
The Australian dollar rose 0.45% to $0.6526 in early trading, after plunging to an eight-month low of $0.63485 on Monday.
Investors are now focusing on the Reserve Bank of Australia’s policy decision later today, with the central bank expected to keep interest rates steady, according to a Reuters poll of economists.
