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Dollar recovery half-year away
Signals emerging from the arcane world of currency options suggest the US dollar may hold this week's big rebound for now, although a more meaningful recovery is at least half a year down the road.
- Reuters
- Published: 00:39 March 24, 2008
New York : Signals emerging from the arcane world of currency options suggest the US dollar may hold this week's big rebound for now, although a more meaningful recovery is at least half a year down the road.
Currency options invest-ors insist the professional trading community on balance remains more inclined to sell than to buy the greenback, and its spiral lower could soon resume.
"Everybody thinks the euro is way overvalued here, but at the same time, we don't think the dollar is that undervalued. There is a pretty good chance the euro will go higher from here," said Paul Lennox, corporate treasurer at Custom House, a non-bank global payments and forex dealer in Victoria, Canada.
A series of factors, both technical and fundamental, stacked up in the dollar's favour as the week progressed, helping pull it back from a record low against a raging euro and a near 13-year low against the yen.
On a technical front, the dollar benefited from a view that it had fallen too far, too fast, prompting many investors to grab quick profits on its drop. Additionally, its inverse relationship with commodity prices, which are priced in dollars, also provided a lift when oil and gold prices plunged Wednesday and Thursday.
In its favour on a fundamental front, the Federal Reserve declined to cut interest rates as much as Wall Street had anticipated. That forced traders to pare back positions based on expectations for an even wider interest rate differential between the United States and other regions.
Further, US regulators' latest efforts to revive the US housing market, by easing mortgage purchase limits on Fannie Mae and Freddie Mac, received generally high grades from investors, stoking demand for some dollar-denominated assets such as US stocks.
Nevertheless, it's too early to rush into long dollar positions, currency options traders warn.
Market signals
Option market signals used to gauge bullish or bearish sentiment on currencies, called risk reversals, do give the appearance of a growing negative bias on the euro, Australian dollar and Swiss franc against the dollar, according to data from Informa Global Markets. But a significant chunk of those positions are just hedges for bigger bets the dollar will resume its slide, investors said.
Tim Graf, vice president for forex derivatives at Credit Suisse, said despite the dollar's sharp weakness, risk reversals in many liquid pairs appear to suggest a near-term dollar turn-around, an opinion not shared in the dealer community. Ironically, it's the overall weakness in the dollar that creates that false perception, Graf said. As the dollar weakened recently to near $1.60 against the euro and 95 cents against the Aussie dollar, currency dealing desks had to initiate more hedges that skewed risk reversal signals to appe-ar as if investors were turning positive on the dollar.
To be fair, Graf said because of the dollar's rebound over the past few days he is starting to see "interest" in dollar calls. "We have seen people take off top-side structures on euro/dollar, which seems to suggest that we may have seen the top above $1.59."
Yet despite the market's bearish sentiment on the dollar, many options market are not ruling out a rebound in the currency over the next six to 12 months and this is being reflected in longer-tenor options.
Longer-term maturities in euro risk reversals have favoured dollar calls and euro puts - three month and one-year risk reversals were at 0.30/0.60 and 0.40/0.70, respectively, which suggests a dollar recovery in the next 12 months. That, analysts say, makes more fundamental sense.
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