Dollar rises versus euro, pound on European bank concerns

Posted Sep 29th 2008 9:35AM by Joseph Lazzaro
Filed under: International Markets, Forecasts, Financial Crisis

The dollar rose early Monday against the euro, pound and yen, but for all the wrong reasons -- a belief that more banks in the U.K. and Europe will face pressure and Europe's economy will slow further.

The dollar rose almost 2 cents versus the euro to $1.4367 and 3 cents versus the British pound to $1.8035. The dollar also rose about one-quarter yen to 106.25 versus the Japan's yen.

Currency Trader Andrew Resnick said the dollar's merely modest rise against the yen is the telling indicator in this currency market. Typically, a dollar rally would spark a large move up versus the yen as well, not just a minor increase. The fact that it hasn't indicates that institutional investors are paring-back their carry trades on concern the U.S. Congress' $700 bailout / rescue bill may not be enough to check the financial crisis, leading to slower growth in Europe, he said.

In a carry trade, investors, especially institutional investors, borrow funds in a country with a low interest rate (or borrowing cost) such as Japan [the yen], and buy assets in a country where returns are higher. The investment can take many forms including stocks, bonds, funds, or even the higher-interest currency itself, such as the British pound.

Another indicator that institutional investors believe there's more pain to come for regional and global banks, and slower growth: a drop in the British pound versus the yen -- a key carry trade. The pound fell more than 3 yen to 191.28 yen early Monday.

"That's another indication of investors bringing money home, reducing leveraged investing. De-leveraging has been occurring for more than a year, and so long as it's gradual, the financial system can handle it," Resnick said. "But it's definitely a bearish sign regarding GDP growth in Europe and Asia. Resnick added that he's presently flat, or had no open currency trading positions.

Forex / Economic Analysis: The U.S. Congress' $700 billion bailout / rescue package represents the first step in a long process of recovery and reform. The rescue will help stabilize credit markets and restore investor confidence, but investors should not view it as a cure-all. More fiscal stimulus most likely will be needed, particularly if private investment is inadequate to jump-start GDP growth.

Tags: bailout bill, banking sector, bond market, British pound, carry trade, credit markets, dollar, EU, euro, Europe, gdp, inthenews, Paulson, U.S. economy, yen