Carry Trade

Attempts by carry traders to redeem some P&L after a month of agony crashed and burned promptly, accelerating into the close as the Yen funding unwind killed not just the carry pairs but broader equities. Of particular note is the hurt experienced by AUD longs funded with either USD or JPY. It is officially time for Goldman to enter the stop losses on its various carry trades. The pain for the (leveraged) BZLJPY trade has now become unbearable.

Ready for a breakup of the Euro, anyone? How long can a sober, conservative German grandfather be expected to indulge the disgraceful habits of its party animal, thrill seeking, drug addicted grandchildren? They’re actually worried about inflation down under. If you want to know how the big boys are coining it, come this way. The trade that George Soros and Paul Tudor Jones glory in.

Revolutions happen when broken parts of existing structures reassemble themselves in novel ways. Today’s Japanese carry trade will become something completely new: currency jettison. This coming Yen carry trade is going to fundamentally change Japan. Next time, Miho Maejima won’t be hungry for yield. She has no yen for it: the carry trade will be driven by exchange rate volatility hedging. She’ll handcuff the government to the bedpost and go for full-on dollarization. When she does, shorting yen is the best trick on the planet. Dollarization to control currency volatility happens a lot. It is not even a radically new event in Japan, but it will go viral and mutate into a radically new species of carry trade. The utter abandonment of the yen to de-risk will end any return crash. And the Japanese semi-democracy (that designation applies to all nations, not just Japan) must allow it to happen. Aging pensioners are both creditors and voters: the only possible adjustment they can make to the coming sovereign crisis is by getting entirely out of yen.

As we highlighted previously, any investors who had gone long the Brazilian Real (BRL) in January, funding this position with either USD or JPY shorts, had their face ripped off after a loss of anywhere between 7 and 9% in one month (don't annualize that). But instead of covering, here is Goldman with advice on why Einstein's definition of idiocy is for chums. The firm has just come out with a trading call (remember all that huddle stuff?) telling investors to go short $/BRL "on better macro data and hawkish BACEN February 1, 2010." Who knows, maybe mean reversion will work this month. Goldman's target: 1.75 and a stop above 1.94.

Bernanke gave us an insight into his thinking this weekend. If you think he is going to get tough this year with monetary policy you can forget it. The Carry Trade is alive and well folks....

If the economy is to recover, the price of Nat Gas will have to move higher. Exxon bet a reasonable portion of the 'ranch' on gas with the XTO deal. I think it is a good bet. Exxon's good news is going to be bad news for everyone else. Same old, same old.

I don’t share the recent stock optimism as the tail is wagging the dog. The higher the stock index goes the greater the number of bulls and the greater the amount of decimated bears. Those burned bears will not be adding to the buy side at lower prices to cover shorts. Good news about this will also turn out to be bad when the party is up.

The carry trade is not dead. Only wounded. The prognosis is for a complete recovery thanks to that lifesaver, Ben B.

I have been bullish on the Japanese currency since March 2007. What I think defines broad movement in currencies is perception along with broad relative monetary actions. The expansion or contraction of monetary aggregates in one currency versus another is in essence its purest denominator. We show today such a timing model in the yen/usd rate of exchange. Notice that timing simply based on monetary aggregates can be not forgiving for quite some time until the new trend establishes itself.

The earlier announcement of a 25 bps rate hike by the RBA was not a big surprise. What was, however, was the knee-jerk reaction by both the USD and the JPY, and specifically the relative sizes of said jerk. As both currencies are funding currencies to AUD longs, the relative reactions provide a good, if crude, way to quantify the relative concentration of shorts in any givencurrencies (USD and JPY). Then again, it may merely indicate that tonight's USD-trading night shift at Goldman had much more Red Bull than the OZ one. In either way, both the initial knee jerk reaction as well as the subsequent follow through, indicate a roughly 50-100% greater concentration of dollar than yen-based shorts: in other words: the carry ratio funded in USD and JPY is between 2:1 and 3:2.

What could possibly connect Best Buy, Paul Krugman and the carry trade? The answer is is that everything is connected.

"While there are Dollar-funded carry trades and certainly other cyclical factors behind the Dollar’s weakness, we do not think we are seeing a speculative ‘carry bubble’ for now. The difference being a 20% strengthening in the Dollar upon a reversal, over say 3 months as opposed to 3 days for the latter." - Goldman Sachs

"The Fed’s policy of maintaining low interest rates together with the weak dollar posed a threat to the global economic recovery. It is boosting speculative investment in stock and property markets and will pose new, real and insurmountable risks to the global recovery and particularly to the recovery in emerging markets. The situation has already encouraged a huge dollar carry trade and had a massive impact on global asset prices." Liu Mingkang, China Chief Banking Regulator

In this interview with CNBC on Nov. 4, 2009, Dr. Nouriel Roubini, professor of economics at the Stern School of Business, New York University and chairman of RGE Monitor, cautions investors of the coming asset bubble and crash caused by the dollar carry trade, and at the same time shared his views on the economy and housing.

This is the second time in many weeks that Dr. Roubini warned of a growing dollar carry trade and threatening to cause a global implosion. The following is a summary of his CNBC interview along with my comments.

If the American people want to get the US financial system under control, then the first areas of investigation, we submit, must be fiscal and monetary policies. And if Americans do not soon get control over the habit of borrow and spend practiced by the Congress and facilitated by the Fed, then end result must be a populist backlash against Washington and incumbents in politics and the corporate world. As Congressman Ron Paul (R-TX) writes in his latest book, End the Fed: "Nothing good can come from the Federal Reserve… It's immoral, unconstitutional, impractical, promotes bad economics, and undermines liberty."