U.S. dollar falls vs yen; FX options flag QE worry

By Gertrude Chavez-Dreyfuss

NEW YORK (BestGrowthStock) – Uncertainty over a fresh round of U.S. monetary easing weighed on the dollar on Friday, prompting investors in the options market to hedge against any volatility arising from the Federal Reserve decision.

The dollar fell against the yen and was just shy of a 15-year low hit on Monday, with lackluster U.S. gross domestic product data failing to shake expectations of further stimulus for the economy from the Fed. Quantitative easing is viewed as negative for the greenback as it increases the supply of dollars, diminishing its value.

In late afternoon trading, the dollar was down 0.6 percent at 80.42 yen, on track for its lowest close on record, according to Reuters data.

At the same time, signals emanating from the currency options market on Friday are flagging concern about next week’s events, which also include U.S. elections and a non-farm payrolls report for October.

“There’s a little anxiety in the market, and this may be about quantitative easing,” said Simon Smollett, senior currency options strategist, at Credit Agricole in London.

“This may also be about the fact that most currencies have been overbought against the dollar. There is a whole load of factors here, and the bottom line is that the ‘risk off’ hedging behavior has crept back into the market even if the price action in spot has been relatively modest.”

One important gauge showing increased worry is the euro/dollar risk reversal, a barometer of currency sentiment, which is indicating a decline in the curve or a growing bearish view on the currency pair.

The euro this past year has become a proxy for risk appetite in the developed world, rising when there is increased risk-taking in the market and falling when investors become averse to risk.

The single currency’s “put” bias has deepened. On Friday, puts are being traded at a mid-market of -0.925 vol, according to GFI data, with bids at -1.30. This was a steep drop from bids of -0.55 vol on October 14.

“There is clearly an interest to buy the downside in euro/dollar. The market seems to be warning of a move lower in spot (price of the euro),” Smollet said.

Euro gains so far this month have slowed to around 2 percent from a steep 7.5 percent rise in September. On the week, the euro was down 0.3 percent, its worst weekly performance since mid-September.

This week’s decline in the euro versus the dollar is consistent with the pullback in U.S. dollar shorts to $23 billion in the week ended October 26. The euro, sterling, and yen all saw small declines in the extent of their net long positioning against the dollar, while the Swiss franc saw a small increase. See report (IMM/FX: ).

RISING PUTS, IMPLIED VOLS

The options market has also been increasingly wary of the Australian dollar, the euro versus the yen, and Korean won, currencies that thrive in global expansions and rising equity and commodity markets. Their risk reversals have shown an increasing put bias as well.

Implied volatility, another market sentiment gauge, has also spiked in recent sessions. One-week euro/dollar vols have gained over 4 vols the last couple of days to hit the 17.0 handle on Friday although one-month vols remained confined in the upper-13 range.

Sone analysts suggest nervousness about quantitative easing seemed misplaced since most believe the Federal Reserve will err on the side of caution and announce next week a figure that is more in line with market expectations. According to a Reuters poll, most leading economists expect the Fed to buy between $80-$100 billion worth of assets per month.

“The FOMC might end up with a QE3 and a QE4 if the economy really sours, but it can’t reasonably announce much more than a half-trillion for QE2 at this point,” said Avery Shenfeld, chief economist at CIBC World Markets in Toronto.

“Expectations for more than a trillion in one fell swoop have rightly dwindled, so we don’t see much of a market shock from the coming week’s Fed announcement.”

But congressional elections on Tuesday could have implications for fiscal policy, and Shenfeld thinks the market could well focus on this vote instead of the Fed.

Betting websites suggested that Republicans have a 90 percent chance of taking the House of Representatives. A Republican victory should be positive for the dollar, Westpac senior currency strategist Richard Franulovich said.

The Republicans, he said, have been campaigning on a platform of fiscal prudence and this is a “confidence-building event” for the dollar because it undermines the long-run bearish arguments against the greenback with respect to structural imbalances.

(Additional reporting by Nick Olivari; Editing by Kenneth Barry)

U.S. dollar falls vs yen; FX options flag QE worry