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Posts Tagged ‘what is positive carry’

Dollar Carry Trade Drives Global Equity Markets

Posted by Larry Doyle on September 16th, 2009 2:18 PM |

All aboard!!

As the U.S. Dollar Index makes new lows, equities make new highs and the momentum continues. Where is the ‘juice’ coming from? Is this cash that had previously exited the market now reentering? Is this people who had gone short now being forced to cover? Is this ‘new’ money finding value? Is this a pickup in short term day trading? The answer to all of these questions is yes, albeit to varying degrees. However, the most widely held belief for the rally in the market is the dollar ‘carry trade.’

I highlighted this trade last week in my September 12: Month to Date Review of the Markets. On that day, I wrote about the U.S. dollar:

Commentary: The decline in the value of the U.S. greenback by approximately 2% reminds me of the overused Wall Street phrase, ‘squeal like a pig…’

The fact is Big Ben Bernanke is not only funding the domestic economy with the Fed Funds rate at 0-.25%, he is also funding the spike in a number of markets around the world. How so? Investors around the world have entered and, given this week’s price action, continue to enter into the ‘positive carry‘ trade in which they borrow U.S. dollars to purchase higher risk assets.

This ‘positive carry’ trade was fed by the Japanese yen throughout the ’90s given the exceptionally low rates in that country.

Make no mistake, though, this ‘positive carry’ trade is nothing more than implementing leverage. Do not confuse leverage with brains when a market is rising because as I said the other day, leverage is death when that bull becomes a bear. As I think of market developments, I am convinced that this ultimate unwind of leverage trades currently being implemented is Jeff Gundlach’s reasoning for being bullish on the dollar. How will this work? Investors will look to exit their risk based investments (emerging market stocks and the like) and buy back the dollars which they have borrowed. In the process, the dollar may rally significantly. The timing of this unwind is the critical question.

This morning, the Financial Times weighs in with Dollar Lays Claim to Being Top Carry Trade Currency:

For years, the yen was the currency of choice to fund international carry trades. But is the dollar starting to take its place?

Analysts say negligible US interest rates, its quantitative easing measures and little sign that the country is set to withdraw from its ultra-loose monetary policy anytime soon leaves it in a similar position to Japan at the start of the decade.

“This puts the dollar in exactly the same position as the yen back in 2001 and makes it naturally attractive as a carry trade funding currency,” says Simon Derrick at Bank of New York Mellon. “The dollar is the new yen.”

The carry trade strategy, in which low-yielding currencies are sold to finance the purchase of riskier, higher-yielding assets, was widely used in the years prior to the eruption of the financial crisis.

The FT further adds,

Speculative positioning data seem to back up the shift against the dollar, revealing the extent of recent deterioration in dollar sentiment.

According to figures from the Chicago Mercantile Exchange, which are often used as a proxy for hedge fund activity, aggregate bets against the dollar versus the euro, yen, Swiss franc, sterling and the Australian, New Zealand and Canadian dollars last week rose to their highest levels since July 2008, when the dollar hit a record low against the euro.

Is utilizing the dollar for funding purposes a harmless risk-free trade? Anything but. A weak dollar impacts all dollar-denominated assets and dollar-denominated transactions.

For those entering into these transactions, a sharp reversal in the dollar or in the assets being purchased can lead to tremendous losses. For now, though, traders, hedge funds, and speculators the world over are selling dollars to put this dollar carry trade on . . . in size!

What do our ‘wizards in Washington’ have to say about the plummeting dollar? You can hear a pin drop.


Bernanke Promises to Keep ‘Punch Bowl’ Filled

Posted by Larry Doyle on July 21st, 2009 1:59 PM |

Everybody back in the pool!!! Turn that music up and let’s rock!!

Why so ebullient and energized to ‘party?’  Well, our host, Ben Bernanke, has promised to keep the ‘punch bowl’ filled. As the Wall Street Journal highlights in writing Bernanke Sheds Light on Exit Strategy:

Mr. Bernanke reiterated that despite recent improvements in the economy and financial markets, the federal-funds rate will likely remain near zero for an extended period of time.

That statement by the ‘grand and wonderful wizard’ Ben Bernanke is the equivalent of turning up the volume to some music by the J. Geils Band. How are the partygoers reacting? Filling up their cups, that being, buying bonds like there is no tomorrow.

On the day, the Treasury market has rallied by 10 to 15 basis points (recall lower rates means higher bond prices) as all the partygoers (market participants) reenter into a variety of ‘positive carry’ trades.  In layman’s terms, positive carry trades very simply are a vehicle to use cheap dollars (i.e Fed Funds borrowed between 0 and .25) to purchase higher yielding assets. Another commonly used term for this form of investing is utilizing increased ‘leverage.’ Yes, we have previously partied with increased leverage. That did not end well…

Why would traders or others utilize this approach in the midst of such economic uncertainty? Very simply, when the host tells you that the ‘punch bowl’ is going to remain filled for an extended period, he is compelling you to get involved. In fact, he is effectively forcing you into the pool. How so? The returns on the safest, shortest, and most liquid assets (T-bills, CDs, money markets) will also be kept low for an extended period.

As an investor, the Fed chair is literally forcing you to take greater risks in your investments. Those funds will be utilized by financial institutions to generate increased earnings and thus write off the loans on their books which are defaulting at an ever increasing rate.

What are the risks of keeping the ‘punch bowl’ filled too long?

> inflation, as too much “liquid”ity enters the system

> asset bubbles, as too many cheap dollars chase returns

> mispricing of risk, as market participants focus on the technical rally rather than fundamental analysis

The challenge for Bernanke is knowing when and how to pull that punch bowl away.

The last wizard, Alan Greenspan, badly miscalculated in his assessment which led to our current economic turmoil.

While it is nice to see positive returns in 401K statements and other monthly investment statements, be mindful of another tried and true piece of Wall Street wisdom . . . ‘the road to hell is paved with positive carry.’

In the meantime, as long as we understand the parameters of this situation, let’s enjoy Ain’t Nothing Like a House Party by the J. Geils Band!!


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