Demand for short-dated yen calls declined last week after the Japanese currency depreciated against the U.S. dollar. The dollar strengthened to JPY108.71 on Wednesday from JPY106.97 the week before while implied volatility dropped to 8% from about 9%.
"We've broken some levels, especially against the yen," said Rob Kelly, a senior foreign exchange options trader at Société Générale in New York, referring to the greenback hitting a five-month high Tuesday at JPY108.89. Yet although there has been a big dollar retracement after a steady decline last year, the market remains skeptical. "A lot of questions remain for the dollar up ahead," he said.
Kelly explained U.S. economic data continues to be mixed, the twin deficit still looms and U.S. interest rates may be going up faster than anticipated. In addition, market buzz about a possible Chinese revaluation is always increasing.
Some market players now think the Federal Reserve will raise interest rates at a faster pace than predicted last year, which Kelly said the Fed indicated in the minutes of its last meeting. Without other governments raising their rates, the differential will become a big factor in currency moves, he said. The Australian government's decision not to raise rates last week, which traders expected, hurt the Aussie dollar causing it to slump to USD0.7644 from USD0.7730 in a week.
Kelly explained a widening interest rate differential coupled with the recent rise in U.S. Treasury yields has caused currencies that traditionally perform well against the dollar, such as sterling, Kiwi dollar and the Mexican peso, to experience a sell-off as investors opt for greenbacks.
