Monday, November 16, 2009

I warn you not to underestimate my power

A warning to all you exposed to the dollar carry trade, either directly or indirectly. A group which includes:

  • Anyone borrowing in USD to buy short-term assets in another currency.
  • Anyone borrowing short-term in USD to buy long-term USD assets, i.e., every U.S. bank.
  • Any U.S.-based company selling their product to non-USD consumers.
  • Anyone invested in a U.S. company who is borrowing short-term in USD and buying long-term assets and/or selling products in non-USD currencies. That is, anyone long U.S. stocks or U.S. corporate bonds.
  • Any U.S.-based investor long any non-USD asset, i.e. any investor in foreign stocks or bonds.

So basically anyone holding anything other than cash.

Below is the intra-day chart on USD/EUR.



What the hell happened at noon? Bernanke made a passing reference to the dollar. That's it. Here's the whole quote:
The foreign exchange value of the dollar has moved over a wide range during the past year or so. When financial stresses were most pronounced, a flight to the deepest and most liquid capital markets resulted in a marked increase in the dollar. More recently, as financial market functioning has improved and global economic activity has stabilized, these safe haven flows have abated, and the dollar has accordingly retraced its gains. The Federal Reserve will continue to monitor these developments closely. We are attentive to the implications of changes in the value of the dollar and will continue to formulate policy to guard against risks to our dual mandate to foster both maximum employment and price stability. Our commitment to our dual objectives, together with the underlying strengths of the U.S. economy, will help ensure that the dollar is strong and a source of global financial stability.
Now really, there is absolutely nothing there that suggests the Fed is going to do anything about the weak dollar. In fact, all he's doing is justifying the recent decline in the dollar. You can think what you want about why the dollar is weak or even whether its desirable or not. Bernanke doesn't care about the dollar.
And yet with this tiny nod to doing something about the dollar, the euro plummets. Just think about what's going to happen when the Fed actually hikes rates. There are so many dollar shorts out there. We will be looking at the mother of all short covering rallies. And the carry trade crowd is going to get absolutely crushed.
Will this happen this month? This quarter? This year? I don't know. How impactful will this event be on financial markets? I think it will be quite large, although whether that means S&P -10% or -20% or -30%, I'm not sure. I'm also not sure that we don't rise 10% between then and now and only correct back to where we are. I actually think 2-5 year bonds, including Treasuries, are the most exposed U.S. assets, not stocks, but we'll see.
Either way, I'd love to see the Fed make some kind of move, even if its hiking from 0% to 0.5%, to stem the tide of constant USD selling. The dollar weak crowd is too confident and all that confidence is what causes bubbles. Alas, I don't think its going to happen.

21 comments:

Advant Guard said...

So, worried about the Fed, are you? http://www.bloomberg.com/apps/news?pid=20601085&sid=ajxzgcA7rtRU Greek spreads over German Bunds up are. Believe you that ECB will allow Greek government to default? Confident that Euro rates will rise?

getyourselfconnected said...

It always amazes me that people sit and trade on some blurb only to be shown they were wrong 15 minutes later.

John (Ad Orientem) said...

Not much of a trader here. I look for long term trends and invest accordingly. But I am conservative by nature and keep my portfolio heavily diversified.

Harry Browne saved me a lot of money last year.

In Debt We Trust said...

Have you looked at money market fund outflows?

MMFA on bloomberg symbol ticker. You can track the outflow of retail money from cash into everything else. . . even crappy CDS/ABS/CMBS products. Spreads are probably narrower again although I haven't looked at them recently.

Meanwhile, the CNY and DXY continue to plunge hand in hand while destroying those savers unable to get involved in the carry trade - people like boomers and the greatest generation who live on Social Security/pension stipends.

That's why I think looking at the vix is so important - heavy call volume will tend to precede a dollar spike.

Isam Laroui said...

If and when the Fed hikes rate, they will have telegraphed their move for so long and in so many different ways that the risk-asset "crash" you're alluding to will mostly have been factored in.

Which is not to say that we won't have many mini-crashes along the way, which should provide some interesting trade set-ups.

(musingsofatrader)

Raphaël Kahan said...

Where's the evidence for the dollar carry trade?

http://raphaelkahan.blogspot.com/2009/11/more-on-us-dollar-carry-trade.html

Doug said...

"You're overconfident. It's your weakness"

"Your faith in your friends is your!"

Flow5 said...

Any upward move in the USD based on the FED "tightening" (interest rate differentials), will later be erased. All such moves will be temporary until the US corrects it's balance of trade.

Our cummulative trade deficit since the US became a debtor country in 85 is now at an astronomical $7.4 trillion and compounding. The current rise in the stock market is the beneficiary, etc. And all such imbalances will contribute to a further decline in the dollar and in the standard of living for the vast majority of Americans.

Flow5 said...

USD corrections are predominately due to economic downswings or banking contractions (precipitated by our FED -- which countered in DEC07 with temporary reciprocal currency arrangements). It seems a safer bet to buy foreign denominated bonds (if you buy & hold).

Flow5 said...

2002-01-28 130.0525 = Trade Weighted Exchange Index = Broad = TOP

2002-02-26 112.5016 = Trade Weighted Exchange Index = Major Currencies = TOP

http://research.stlouisfed.org/fred2/data/BOPBCA.txt

Acceleration in the deficit in the Balance on Current Account = 2002-01-01 -104.166

Accompanied by the acceleration in the rate-of-change in the deficit of Imports of Goods & Services = 2002-04-01 -351.123

The latest exaggerated swing due to this recession/depression (see shaded areas):
2008-07-01 -684.619
2008-10-01 -570.708
2009-01-01 -439.427
2009-04-01 -455.584

Trade against the grain???

Fresbee said...

u got be kidding me when u say that FED can raise rates anytime in 2010. They cant even start talking about it. They need this carry trade more than anyone else.

Carry trade guys are not fools right? They are way smarter than almost anyone else in the market. They got this trade going at the absolute plymounth of financial crisis in march. And they wlll exit even before we get a chance to wink....As carry trade player myself...let me just give u hint on how it works:
At the first sign that unemployment is reducing or even the curve is flattening, we will start exiting or even hedging :)


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