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The great carry trade unwind

Kedrosky has a chart of major currencies showing only the Yen is holding it’s own, indeed rising, against the USD over the past two months.

20081022_Currencies.jpg

Update, an even better chart:

20081031_JPY.jpg

Brad Setser also notes that this dollar strength was not global investors fleeing to a “safe” currency.

Net TIC flows in August (line 30) were essentially zero (-$0.4b). Foreigners (apparently led by official investors, but the data here is deceptive) were net sellers of US long-term assets, selling about $9b… Net long-term flows were essentially zero. And so were net short-term flows… The story is simple, at least in my view. Most foreign demand for US assets over this period came from central banks. And they increasingly only wanted to buy Treasuries.

JPY and USD were the two currencies most involved in the carry trade, in which levered hedge funds borrowed at low rates to invest around the world. Now that funds (hedge, pension, bank, SIV) are forced to permanently reduce their leverage they have to get the borrowed currency back to square their books, just when the liquidity in markets has evaporated.

Anybody who thinks that the USD is strong for fundamental reasons is due for disappointment once this unwind is over.

Comments 5

  1. Paul wrote:

    Another great piece from Setser on the unwind of China/Saudi vendor finance - often called “Bretton Woods II”:

    Bretton Woods 2, as it evolved, hinged both on the willingness of foreign central banks to take the currency risk associated with lending to the US at low rates in dollars despite the United States large current account deficit AND the willingness of private financial intermediaries to take the credit risk associated with lending at low rates to highly-indebted US households… The second leg of the chain collapsed before the first. And its collapse looks set to deliver a nasty shock to everyone – including the countries that supply the US with vendor financing… The US taxpayers are currently getting hit with the tab for much of the credit risk that supported the big increase in US household consumption – as Martin Wolf quipped, what looked to be private lending turned out to be public spending. And China’s taxpayers will eventually have to pick up the bill for the currency risk associated with lending to the US in dollars at low rates…

    Posted 22 Oct 2008 at 6:29 pm
  2. Paul wrote:

    Emerging market corporates who’ve borrowed in dollars are finding things tight. Reserves exist, but which corporates can tap them is essentially a political issue.

    Posted 22 Oct 2008 at 6:41 pm
  3. Paul wrote:

    Setser concurs:

    The dollar is rising against everything except the yen — which just hit a 13 year high against the dollar… This is much more of an unwinding of carry trades than a flight to quality — though there is an aspect of that too… The dollar clearly was a “funding” currency for a lot of bets on the emerging world — the dollar not only had fairly low interest rates, but it was tending to depreciate over time v. many emerging market currencies… If the current trend is sustained, US export growth will slow — perhaps sharply. That cuts into one of the current bright spots in the US economy.

    Posted 28 Oct 2008 at 7:08 pm
  4. Paul wrote:

    Yves at naked capitalism points out that much of the global unwinding is yet another unforeseen consequence of Fed/Treasury action, in this case making Goldmans and Morgan Stanley banks.

    Morgan Stanley and Goldman are - by far - the biggest prime brokers, with Morgan Stanley the number one… But as banks, they’re prevented by regulators from lending as much relative to their capital resources as they had been [able to] as securities firms.

    Posted 28 Oct 2008 at 8:20 pm
  5. Paul wrote:

    Marc Faber thinks the stock market selloff is also an unintended consequence.

    The wave of stock selloffs sweeping world markets may be partially caused by the fact that many governments increased guarantees for bank deposits, making them a much safer investment… The interventions, they actually have increased volatility. It’s impossible to forecast market movements when you have interventions…

    Posted 28 Oct 2008 at 8:27 pm

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