Currency Markets React to U.S. Inflation Data and UK Unemployment Rate

The yen fell for a second day as investors awaited U.S. inflation data. Meanwhile, the pound rose following an unexpected drop in British unemployment for June. The yen recently rallied but has since reversed due to changes in interest rates and carry trade dynamics. Key U.S. inflation and labor market data are anticipated to guide further moves.

The yen fell for a second day on Tuesday as calmer trading conditions prevailed before U.S. inflation data, while the pound rose after figures showed the British unemployment rate unexpectedly fell in June.

Currency markets have been rocked by a sharp rally in the yen since July that has prompted—and been driven by—an unwinding of a highly popular investment strategy called the carry trade and contributed to a slide in stocks. Yet the dollar rose 0.33% against the yen on Tuesday at 147.71, a second straight rise, in a sign that markets appear to be over the worst of the recent turbulence.

The general feeling is that there is still life in this carry trade, that perhaps the moves against the backdrop of the deterioration in U.S. data have been excessive, and certainly fears of a U.S. recession are overblown," said Kamal Sharma, senior G10 FX strategist at Bank of America. The yen slid to 38-year lows in July as investors piled into the carry trade, where they borrow yen in Japan where interest rates are low, then sell it for other currencies to buy higher yielding assets elsewhere.

A number of factors, particularly a surprise rate hike by the Bank of Japan and expectations of U.S. rate cuts due to a slowing labor market, have combined to reverse the carry trade stampede, leaving the yen up around 8% since mid-July. Government sources told Reuters that Japan's parliament plans to hold a special session on Aug. 23 to discuss the central bank's decision last month to raise interest rates.

Investors on Tuesday were waiting for U.S. producer price index (PPI) inflation data later in the day, before the more closely watched consumer price inflation numbers on Wednesday. Both will help guide Federal Reserve interest rate policy. The dollar index was up 0.13% at 103.21 as investors waited for the figures, with the euro down 0.1% at $1.0922.

Sharma said investors may not be as focused on the U.S. inflation data, which is expected to show a relatively soft 0.2% rise in prices in July, because concerns about the labor market now seem to be driving markets.

Sterling climbed 0.27% at $1.28 after data showed the UK's jobless rate fell to 4.2% in June from 4.4% in May, defying economists' expectations of a slight rise. Job vacancies declined while wage growth slowed. Low survey response rates have recently caused investors and economists to put less weight on Britain's labor market data.

The overall message from today's report is that the jobs market is still cooling—declining vacancies are the main symptom of this," said Francesco Pesole, currency strategist at ING. "But there is probably enough to keep the Bank of England generally cautious on rate cuts.

In other currencies, the Aussie dollar rose 0.27% to $0.6603. The dollar rose 0.21% against the Swiss franc, another currency that has rallied recently as investors have unwound carry trades.

(With inputs from agencies.)