The US dollar is soaring once again vs. all the major currencies except the Yen. This has been expected from the few of us in the deflation corner, and unexpected elsewhere. Dollar and Yen strength is synonymous with a continued unwind of the carry trade, and a flight out of leveraged anti-dollar bets.

Treasury Safe Haven

Treasuries Gain as Global Slowdown Outlook Boosts Haven Appeal.

Treasuries rose as a plunge in emerging-market assets and expectations of a worsening global slowdown boosted demand for the safety of government debt.

U.S. bonds headed for a fifth month of gains as Argentina’s planned seizure of $29 billion of private pension funds stoked concern it is headed for its second default in a decade. [See Argentina Default Looms, Pension Fund Seized.]

Bank of England Governor Mervyn King said the U.K.’s worst banking crisis since World War I probably will push the country into recession. The dollar rose to an almost two-year high against the currencies of six trading partners.

Evidence grew that the credit crisis that led to a U.S. economic slowdown is spreading. Hungary’s central bank raised its benchmark interest rate by 3 percentage points today, to 11.5 percent, after a series of earlier measures to prop up its currency failed to halt the flight of investors from local assets. The last time Argentina sought to tap workers’ savings to help finance debt payments was in 2001, just before it defaulted on $95 billion of obligations.

Speculation mounted that Europe’s central banks will have to cut interest rates to spur economic growth, driving European bond prices higher. The yield on the German two-year note fell to the lowest level since January 2006.

The dollar rose 1.8 percent on the dollar index against the currencies of the U.K., euro-region, Japan, Sweden, Switzerland and Canada. It last reached this level on Nov. 6, 2006.

Euro, British Pound Plunge In Fund Repatriation

MarketWatch is reporting Euro, British Pound Plunge

The euro and the British pound plunged against the U.S. dollar and the Japanese yen Wednesday, pressured by further fund repatriation and expectations the European Central Bank and the Bank of England will move to aggressively cut interest rates in coming months.

“Investors continue to flock to the dollar as speculation mounts that central banks elsewhere will continue with aggressive rate cuts in an attempt to stimulate growth in the near term,” said James Hughes, analyst at CMC Markets.

Strategists at UniCredit MIB in Milan said fund repatriation to the United States and Japan were the primary driving force behind the moves, while sterling saw added pressure from Bank of England Gov. Mervyn King’s warning Tuesday night that the British economy had entered a recession.

Fresh Wave of Risk Aversion

The Financial Times is reporting Recession fears fuel fresh wave of risk aversion

Investors scrambled to liquidate positions in equities, emerging market currencies and commodities and head for the relative safety of the dollar, yen and western government bonds.

Not even further signs of improvement in the interbank lending market could boost sentiment. In the money market, three-month dollar Libor fell another 29 basis points to 3.54 per cent, well down from a peak of 4.82 per cent earlier this month.

Steve Barrow, currency strategist at Standard Bank, said: “We had thought that slumping Libor rates would reduce risk perceptions, at least temporarily, and haul back the yen and dollar. It seems we were wrong.”

Currency markets saw some of the day’s sharpest moves, with sterling one of the major casualties.

The pound fell to a five-year low against the dollar as investors interpreted Bank of England governor Mervyn King’s warning that the UK was entering a recession as a clear signal that UK interest rates would be cut again.

That view was given further credence by the minutes of the Bank’s monetary policy committee meeting earlier this month.

“Not only did all members vote for the 50bp [rate] cut, but the tone of the discussion was unambiguously dovish,” said Vicky Redwood at Capital Economics.

The sell-off in emerging market currencies gathered pace, with the South African rand touching a 6½-year low against the dollar and the Turkish lira sliding another 4.3 per cent.

Yen Monthly Chart

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I expect that resistance level on the Yen to be take out in conjunction with the ongoing unwind of the carry trade.

Euro Weekly Chart

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I have been favoring a move towards 120 as noted in Telling Action In Euro, Dollar As ECB Holds Rates on September 4, and then again on October 2 in U.S. Dollar Bulls Still Right, Here’s Why. Here is a snip from the latter post:

Technically, if the 135 area does not hold, and I do not think it will, the Euro is headed to 125, then 115. Fundamentally, there is every reason for the Euro to plunge to that level.

The U.S. Dollar index in the above link was just over 80. Let’s take a look at it today.

US$ Index Monthly Chart

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The US$ has hit my first target of 85. Next significant resistance is at 92 but there is no telling if it can bust through that zone of resistance or not. Much depends on how fast anti-dollar deleveraging occurs and the rate at which the ECB and Bank of England cut.

That said, I will caution commodity bulls that this dollar rally can last a lot longer than anyone thinks. Furthermore, I am quite certain the recession will be much deeper and last longer than most expect. As a result, commodities will likely be under pressure for some time, regardless of what the dollar does.

Mike “Mish” Shedlock
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