June 11, 2009 / 5:08 PM / 10 years ago

Forex markets may be bound for rude awakening

NEW YORK, June 11 (Reuters) - Investors in the global foreign exchange markets are still largely aligned for a prolonged recession in the United States and could have a “rude awakening” in coming months if the economy changes course, Barclays Capital said on Thursday.

“Global forex accounts are still positioned for sluggish U.S. growth and there’s a considerable risk for a sharp reversal in currencies if the economy rebounds faster than anticipated,” Steven Englander, a chief foreign exchange strategist at Barclays, told journalists in New York.

Englander noted that the U.S. economy recovered faster than markets had originally predicted after other recent contraction cycles, including the period following the recession of the early 1980s and in the aftermath of the attacks of September 2001.

“It’s not that markets are underestimating the pace of recovery in the U.S., but a sharp recovery is not really priced in,” he said.

The sharp move in some major currencies following the much better-than-expected reading on U.S. non-farm payrolls earlier this month was one indication of the market’s wide bearish stance on the U.S. economy, Englander said.

The dollar had its biggest one-day jump in more than five months against a basket of currencies on June 5 after Labor Department figures showed that U.S. employers had cut the fewest jobs in May since September and far less than economists had forecast. [ID:nN05274048]

“Look at what happened right after the payrolls report,” he said. “Not that we are there yet, but imagine how hard the boat will get rocked if there’s a sudden improvement in the budget deficit or if the Fed hints it will start raising rates sooner than expected.”

Englander said that euro/dollar at present levels around $1.40 EUR= could no longer be considered "ultra cheap," and the growing popularity of the U.S. dollar as a funding currency for carry trades posed "a certain risk" to investors.

In carry trades, investors borrow in lower-yielding currencies such as the Japanese yen and Swiss franc to invest in higher-yielding units such as the Australian dollar and the Brazilian real.

“In a certain way the dollar has become a risky currency,” Englander said. “You need your funding currency for carry trades to be stable, with very low-interest rates for a long time and it has also to be weak. Think about what’s going on in the U.S. and the conclusion is that the dollar may not qualify.” (Additional reporting by Mary Angela Rowe in New York; Editing by Leslie Adler)

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