Mortgage firms' seizure to add fuel to dollar rally

By Lucia Mutikani - Analysis

NEW YORK (Reuters) - The U.S. government's takeover of Fannie Mae (FNM.N) and Freddie Mac (FRE.N) is seen reducing risk in the global financial system and enhancing the appeal of U.S. assets, providing further support for the dollar's recovery.

Longer term, the U.S. Treasury's plan to provide further support for the housing market and economy by taking over the two ailing mortgage giants is seen reinforcing the view that the U.S. will emerge from a global economic slowdown before other countries.

"We are likely to see the dollar maintain its medium-term trend up. The fact that U.S. authorities are taking direct action to stabilize the credit market is to be seen as a positive by global asset markets," said Ian Stannard, a currency strategist at BNP Paribas in London.

"That's going to keep U.S. assets relatively attractive to other developed markets and that's going to continue to attract inward capital to the U.S., not just from foreign investors but U.S. investors repatriating capital as well."

RISK APPETITE REVIVED?

The immediate reaction in currency markets was to revive the carry trade in which investors borrow in low-yielding currencies to invest in riskier asset with higher yields.

As a result the Japanese yen fell overnight to lows around 109.08 against the dollar with yen crosses under pressure also, as the U.S. government's move revived an appetite for riskier assets funded in low cost yen.

"There were many investors that missed the dollar rally and therefore basically implemented weak long dollar positions and were forced to unwind those positions. A lot of that was initiated from the yen carry trades," said Paresh Upadhyaya, portfolio manager at Putnam Investments in Boston.

But longer term the carry trade is seen unattractive, as economic growth slows in emerging markets and commodity prices fall, allowing those countries where interest rates were raised to combat inflation to lower them again.

"I would look to fade a sell-off in the dollar or rallies in carry or emerging market currencies," said Upadhyaya.

The high-yielding Australian and New Zealand dollars are likely to come under pressure, after spiking higher in Asian trade, weighed down by the deteriorating domestic fundamentals, analysts said.

FISCAL WORRIES MAY HAUNT DOLLAR

Longer term the U.S. government's move is seen supporting the economics behind the dollar's rally, and the recent sell-off of high-yielding currencies may not be over, analysts said.

The U.S dollar saw its biggest one-month rally in more than a decade in August on perceptions of slower economic growth in Europe and Asia which undermined the euro and other currencies.

The dollar's rally continued on Monday, in the wake of the U.S. Treasury's plan, with the euro falling to new 11-month lows around $1.4090.