Carry trade question

[secondary]

zz

 

[Pippy5000]

I saw the dollar rose quickly when the whole Dubai debacle emerged - probably as usd being the funding rate now, as people unwinded the carry trade position, sold the target currency to buy the usd to pay back the borrowing.

No, this is because the market has been short USD for a while now and when the Dubai news affected global equity markets the way it did it was a signal that short USD positions could go no further in the short term. Everything corrected 😉

I'm sure there were fresh panic shorts, but the majority of the USD positive movement in pairs like EUR/USD and USD/CHF was from people cashing in their trades knowing that risk trades were very much off.

But contrary to this logic we have seen usd basically sink, which is obviously the result of the widening current account deficit - import>export where usd has to be sold to buy the exports in that country's currency

This contributes but there are many, many factors affecting the USD negatively. Over the past 12 months we have seen the USD strengthen due to safety seekers, but when the coast is clear we'll see that the USD is even weaker than it was before the recession. Our debts have grown and the government is currently seeking to borrow even more rather than pay off our current debts to China, Japan and others. This is sparking increased fear that the only real solution will be to print more money and that weakens the USD.

 

[secondary]

zz

 

[Glenn]

No, this is because the market has been short USD for a while now and when the Dubai news affected global equity markets the way it did it was a signal that short USD positions could go no further in the short term. Everything corrected 😉

I'm sure there were fresh panic shorts, but the majority of the USD positive movement in pairs like EUR/USD and USD/CHF was from people cashing in their trades knowing that risk trades were very much off.



This contributes but there are many, many factors affecting the USD negatively. Over the past 12 months we have seen the USD strengthen due to safety seekers, but when the coast is clear we'll see that the USD is even weaker than it was before the recession. Our debts have grown and the government is currently seeking to borrow even more rather than pay off our current debts to China, Japan and others. This is sparking increased fear that the only real solution will be to print more money and that weakens the USD.

"Over the past 12 months we have seen the USD strengthen due to safety seekers."

Hmm, my chart must be upside-down then. A year ago the Dollar Index was at around 87, and now it's at 75.

Low interest rates, and the Fed policy of maintaining them, has encouraged the carry trade. It's a no brainer in those conditions. But as soon as risk comes back then people will want dollars again, for safety as you suggest.
In my view, if Dubai turns out to be the smoke that indicates the fire, the short covering in the dollar will accelerate it upwards and other markets downwards - equities, gold, oil etc. And such downtrends will increase hunger for the dollar as credit becomes even harder to obtain from beleagered banks.

I am already short equities and long the dollar, and will add to these positions as more confirmation arrives in the charts. Such low levels of bullishness in the dollar, and high levels in things like equities and gold (quite a bubble there), to me means only one thing - directions are about to change. And the Dubai news came out the day before the selloff.
If I have timed this right then my risk is low and the potential reward is high, as in very.
Glenn

 

[Martinghoul]

Fair enough, then does this imply the current account deficit and being a low saver create high interest rate environment, and the effects of carry trade is basically short termed?
Thanks

The carry trade is a just a mkt phenomenon... Ultimately, fundamental reasoning prevails.

 

[jaspertrademaster]

I agree with Martinghoul.

 

[Pippy5000]

Can you explain the mechanics of risk appetite affecting currency rate ?

Sure, whenever there is economic turmoil the world will store their money with Japan and the US for safekeeping in the belief that these countries will survive while other countries or collections of countries might not.. This can be a safety bid by foreigners who don't feel very good about their own country's chances or from something called funds repatriation by citizens and companies of the nation in question. When the coast is clear the world will take their money back out again, or feel the time is right to invest in devalued foreign enterprises and cause demand for "risk" currencies like the Euro and weaken demand for the Yen and USD.

i.e. EUR/USD up

"Over the past 12 months we have seen the USD strengthen due to safety seekers."

Hmm, my chart must be upside-down then. A year ago the Dollar Index was at around 87, and now it's at 75.

Pre-recession-- USD weak --> recession -- USD strengthens considerably due to safety seekers, weakens due to profit taking then strengthens again --> the slow comeback (where we are now) -- USD weakens again.. 12 months, 14.47785 months whatever.. The exact time period is irrelevant to the question. The last year OR SO the reason the USD strengthened was not due to brilliant economic strategy or wise spending on the part of our government, but from safety seekers.

There might be further periods of USD strength in the near-term, but the long-term picture is very bleak.. Our economic situation is worse than it was before the recession. We have incurred additional HUGE debts in the process of saving our financial system from collapse..

 

[lisalin]

thanks for your sharing !!

____________

 

[Glenn]

The exact time period is irrelevant to the question.

See notes and longer term chart below.

There might be further periods of USD strength in the near-term, but the long-term picture is very bleak.. Our economic situation is worse than it was before the recession. We have incurred additional HUGE debts in the process of saving our financial system from collapse..

Attached is a 4 year picture of the Dollar versus the Inverted S&P500, showing the strong Inverse relationship.
I agree that the economic picture is bleak. The bear-market rally (imho) since March results from people taking on risk because they think that the credit crunch is over. To me that means that the stock market will fall once people realise how bad it is. The inverse relationship suggests that the dollar will consequently rise.
The huge debts can only be paid off with dollars, which is why banks and people will want to own them, and sell other assets in order to get the dollars.
Are you saying that the economy is weak and the dollar will fall further ?
In the short term that might be the case because people are still embracing risk. But does there not come a point when that weak economy will cause stock prices to fall ? And if that happens, then the dollar must rise.
I think that the appetite for safety-dollars will be the driver. Where else can people go when their jobs and homes are at risk ? Where else can banks go when they have such huge debts ? Where else can the govrnment go unless it is prepared to take on even more debt ?
You cannot have a falling stock market and a falling dollar unless risk and safety go hand-in-hand together, which makes no sense.

Glenn

 

[anestelen]

Nice post, i found it very informative and really subjective… i hope it will benefit to other users like me…

 

[Tarhini_Trade]

First off this is a nice thread, i read and enjoyed the discussion.

Glenn, I understand your logic behind the inverse relationship between the market and USD which I agree with for the most part, but I think if you look at longer term data you'll see a closer relationship with the market and dollar...meaning a down market/economy leads to a weaker currency. As mentioned earlier, once the world economy is truly safe, the dollar and market can be noted as over valued and we can see a major correction to both. over course this is all hypothetical, just to hear thoughts.