the developments in currency markets as a result of moves by major central banks towards quantitative easing

TO BE NOTED: From the FT:

"Carry trade makes a comeback

By Peter Garnham

Published: March 27 2009 15:50 | Last updated: March 27 2009 15:50

A rebound in global equity markets appears to have prompted the return of a familiar investment theme: the carry trade.

The strategy, which involves selling lower-yielding currencies, such as the yen, to fund the purchase of higher-yielding assets elsewhere, was popular among investors ahead of the financial crisis.

The strategy rests not just on interest differentials, but also on stability in asset markets since a sharp fall in the value of an investor’s target investment can wipe out any yield advantage of funding through a low-yielding currency.

Indeed, the turmoil on financial markets saw investors scramble to unwind carry trades as asset prices plunged. This deleveraging sent the yen sharply higher.

Against the dollar, the yen has risen 8 per cent since the collapse of Lehman Brothers in mid-September last year.

It’s rise against the higher-yielding New Zealand and Australian dollars has been more acute, rising 18 per cent and over 28 per cent respectively. But analysts say the rally in global equities has paved the way for investors to return to the carry trade.

Since hitting a 13-year low on March 6, the benchmark S&P 500 index of US stocks has notched up three straight weeks of gains, helped by the aggressive fiscal and monetary policy stance of the US authorities.

Some investors believe that the equity market sell-off has run its course.

Larry Kantor, head of research at Barclays Capital, says after the rally in markets over the past few weeks, the question foremost in the minds of investors is whether it is sustainable or yet another false start.

“We believe that the latest rally will have stronger legs, and thus marks an inflection point,” he says. “We are now recommending that investors become more aggressive and take risks across a broader range of assets.”

Hans Redeker, at BNP Paribas, says the performance of equities are important for carry trade investors.

First, reduced asset volatility allows investors to increase the size of positioning which is important for the asset side of carry trades. Second, rising asset prices will reduce deleveraging pressure.

“Deleveraging pushed the yen lower in the autumn and winter, but those days are gone,” said Mr Redeker. “Financial markets look brighter.”

Indeed, the New Zealand dollar and the Australian dollar, the two major target currencies for carry trade investors ahead of the financial crisis have performed strongly so far this month.

Buoyed also by a rally in commodity prices, the New Zealand dollar is up 14 per cent against the yen and 14 per cent stronger against the dollar since the start of the month, while the Australian dollar has climbed 8 per cent against the yen and gained 8.4 per cent against the dollar.

Mr Redeker believes there could be more gains in store, especially for the New Zealand dollar, the favourite currency of Japanese margin traders.

Rising Japanese shares are likely to increase the risk appetite of Japanese retail investors, encouraging them to send funds abroad in search of yield. “Japanese margin accounts are heavily long on the yen and when this position is reversed the New Zealand dollar will benefit most,“ says Mr Redeker.

Steve Barrow, at Standard Bank, prefers to see the developments in currency markets as a result of moves by major central banks towards quantitative easing.

He says one thing noticeable from currency movements is that the “periphery” currencies, such as the Australian dollar, New Zealand dollar, Norwegian krone and Swedish krona, have out-performed the core – or G7 – currencies.

Indeed, since the start of the month, the Norwegian krone is up 9 per against the dollar and the Swedish krona has gained 13 per cent.

All four of those countries, unlike other major economies are expected to avoid debasing their currencies by moving towards quantitative easing.

“We could, of course, throw in emerging market currencies as well although we feel they are a little more dependent on a persistence of recent stock market strength, which leaves us a little uncomfortable,” says Mr Barrow.

He says if currency investors can ride through any temporary stock market setbacks, the best returns are to be had in these periphery countries unless, they too, take the quantitative easing bait."

“Our strategy for 2009 is to gradually increase risk"

Some good news from Bloomberg:

"Dollar Rally Fizzling as Fed Triggers Risk Appetite (Update3)
By Bo Nielsen and Ye Xie

Jan. 5 (Bloomberg) -- The dollar, yen and Swiss franc may weaken this year against 2008’s biggest losers in the currency markets as the global economy starts to recover, the largest foreign-exchange strategists and investors say.

The winners will be the Brazilian real, Indonesian rupiah and Polish zloty as investors return to higher-yielding assets, according to Bloomberg News surveys. The dollar may strengthen versus the euro and Japanese yen, while dropping against the British pound.

“Our strategy for 2009 is to gradually increase risk( GOOD ),” said Maxime Tessier, head of foreign exchange in Montreal at Caisse de Depost et Placement du Quebec, which is Canada’s largest pension-fund manager, with C$155 billion ($130 billion) in assets. “A year from now, I definitely want to be on the short side on the dollar. We’ll see capital flows out of the U.S. again( WE'LL BE PAYING TOO LITTLE INTEREST, AND THE FLIGHT TO SAFETY WILL HAVE ABATED. ).”

While the International Monetary Fund cut its 2009 growth forecast for the world economy to 2.2 percent in November from 3.9 percent, investors are growing more confident( TRUE ) as central banks lower interest rates and governments earmark trillions of dollars for fiscal stimulus( AS THE GOVERNMENT INTERVENES. GOT THAT. ). The Dollar Index that tracks the currency against six of the U.S.’s biggest trading partners fell 6 percent last month, the most since July 1985, after rising 18 percent from June to the end of November.

The dollar lost steam as the Federal Reserve cut its target rate for overnight loans between banks to as low as zero and poured $8.5 trillion into the financial system. Treasury yields fell to records last year and rates on bills dropped below zero( ZIRP ) last month for the first time as investors sought the safety( EXPLICIT GUARANTEES ) of government debt.

Survey Results

Faster economic growth will cause the dollar to weaken to 2.30 against the real from 2.3145 at the end of 2008, according to the strategist surveys. The rupiah may follow, gaining 11 percent against the dollar to 9,850 by the end of 2010, while Poland’s zloty strengthens 13 percent to 2.62 in two years, the surveys show.

The pound may strengthen 3.5 percent to $1.51 this year, while the euro will depreciate 8.4 percent to $1.28, the strategists said. The yen, last year’s best-performing major currency, will lose 10 percent to 100 yen, they said.

Lawrence Goodman, head of emerging market currency strategy at Bank of America Corp. in New York, said countries that prove better at withstanding the global slowdown should benefit as the flight to safety slows( YES ). The dollar will decline 18 percent against the real and 19.5 percent versus the zloty, he said.

Dollar Bear

“The U.S. dollar will get weaker versus emerging-market currencies,” said Mark Mobius, who oversees about $26 billion in developing-nation assets as executive chairman of Templeton Asset Management Ltd. in Singapore, in a Dec. 24 Bloomberg Television interview. “The reason why we had this weakness in emerging-market currencies is because of the rush into the U.S. Treasuries, into dollars. I don’t think that’s sustainable( I AGREE ).”

Investors see little need to hold dollar assets( THIS IS BUITER'S WORRY ) as the Fed floods the world with greenbacks, the U.S. budget deficit swells to more than $1 trillion and with the trade gap exceeding $57 billion. China cut the share of dollars in its $1.9 trillion of reserves to about 45 percent last year from more than 70 percent in 2003, Deutsche Bank AG in Frankfurt estimates.

U.S. efforts to fix the financial system and the stimulus package promised by President-elect Barack Obama may still support the dollar by helping the world’s biggest economy recover faster than Europe and Japan.( TRUE )

Japan Outlook

Japan’s economy will probably shrink( AN EXPORT COUNTRY ) at an annual 12.1 percent pace this quarter, the sharpest drop since 1974, after reports showed industrial production and exports posted the biggest declines on record in November, Kyohei Morita, chief Japan economist at Barclays Capital in Tokyo, said last week.

By the end of 2009, the U.S. economy will be growing at a 1.8 percent annual pace, while the euro zone will be shrinking at a 0.4 percent rate and Japan will be expanding 0.4 percent, according to Bloomberg surveys.

Deutsche Bank, the world’s biggest currency trader, is among the most bullish on the dollar( IN THE SHORT RUN ), forecasting a rally to $1.20 versus the euro, and to $1.30 against the pound, as the European Central Bank cuts its target rate to 0.75 percent this year from 2.5 percent, and the Bank of England lowers its benchmark to 0.5 percent from 2 percent.

Bank of England policy makers meet Jan. 8 and are likely to lower their target rate to 1.5 percent, according to the median estimate of 50 economists surveyed by Bloomberg. The ECB meets Jan. 15 to set borrowing costs.

U.S. Outlook

The U.S. economy will grow 1.6 percent in 2010 after contracting 2 percent this year, while the 16-member euro zone shrinks 2.5 percent in 2009 and expands 1 percent the next, according to Deutsche Bank. Treasuries due in 10 years will yield 50 basis points, or 0.5 percentage point, more than comparable German bunds by year-end, instead of about 75 basis points less currently, the bank predicts.

“Like after the Great Depression, the recession in the 1970s and the end of the Cold War, the U.S. will emerge strengthened from this crisis and our competitors won’t,” said Marc Chandler, head of currency strategy at New York-based Brown Brothers Harriman & Co. “Our policies have been very aggressive while the rest of the world has been dragging its feet.”

By year-end, the dollar will trade at $1.30 against the euro and at 100 yen, Chandler said. He predicts it will trade at $1.42 per pound.

The dollar rose to 92.96 yen at 9:16 a.m. in New York, from 91.83 yen on Jan. 2, after earlier reaching 93.57 yen, the highest level since Dec. 8. Against the euro, the dollar climbed 2.3 percent to $1.3611 from $1.3921.

Losing Bet

Selling the dollar in 2008 was a losing bet, as the Dollar Index gained 6 percent to 81.308, its first annual increase since rising 13 percent in 2005. The yen and franc also benefited from investors getting out of risky assets, with Japan’s currency appreciating 19 percent and Switzerland’s strengthening 5.7 percent versus the dollar.

The greenback’s share of foreign reserves rose in the third quarter to 64.6 percent from 63 percent at the end of June, the Washington-based IMF said Dec. 31, the biggest increase since the first three months of 2004.

Investors bought the dollar to purchase Treasuries and shield their money from credit-related losses and stock declines( EXPLICIT GUARANTEES IN A CALLING RUN ) that wiped out more than $28 trillion from equity markets. Writedowns and losses at the world’s largest financial institutions since the start of 2007 total $1 trillion, according to data compiled by Bloomberg.

‘Turning the Economy’

The biggest beneficiary was the yen, as the retreat from risk caused investors to unwind carry trades and buy back the Japanese currency that financed purchases of higher-yielding assets. The search for higher yields may trigger demand for the Australian and New Zealand dollars as money managers take advantage of central bank rates more than 4 percentage points higher than in Japan( TRUE ).

The Australian dollar, which weakened 20 percent against the U.S. dollar last year, depreciated 35 percent in 2008 to 63.67 yen. New Zealand’s dollar fell 39 percent to 52.53 yen.

Emerging markets were among the biggest losers last year as the MSCI EM Index fell 54.5 percent.

“If the governments are successful turning the economy, ironically, that will come along with a very weaker dollar,” said Chirag Gandhi, a money manager of a $2.5 billion global fixed-income fund at the Investment Board of State of Wisconsin in Madison, Wisconsin.

‘Signs of Bottoming’

Developing economies will grow 3.1 percent in 2009, following a 5.9 percent gain last year, while developed countries, including the U.S., the euro area and Japan, will contract 1.4 percent after expanding 0.9 percent in 2008, the Institute of International Finance said in its forecast released Dec. 18 in Washington. The group represents the world’s largest commercial and investment banks.

The currencies of Poland, Brazil and Indonesia will be among the best performers, Bank of America’s Goodman said. The zloty will strengthen to 2.39 per dollar by the end of June after dropping 21 percent. The real will surge to 1.90 after plummeting 30 percent and the rupiah will trade at 10,000 by the end of September, Goodman wrote.

Emerging-market bonds are starting to draw investors( GOOD NEWS ). The extra yield they demand to own the debt instead of Treasuries fell to 6.94 percentage points from 8.62 percentage points in October, according to JPMorgan’s EMBI+ Index.

“If we see some signs of bottoming, then the extreme risk aversion will start to mitigate( I AGREE ),” said Robert Kowit, who manages $3 billion of global bonds at Federated Investors Inc. in Pittsburgh. “At that point, we’ll be left with a huge amount of the dollars that have been printed and a huge amount of debt to be issued and bought.”( VERY TRUE )

We are seeing signs of a diminution in the fear and aversion to risk. How fast will this diminution occur?

The Risk Averse Are Coming To America

One consequence of deleveraging:

``We expect risk aversion and ongoing deleveraging to be positive for the dollar, particularly against currencies where the central bank has more room to cut, such as the euro,'' wrote currency strategists led by Zurich-based Mansoor Mohi-uddin at UBS AG, in a research note yesterday. "

Okay.

"Nov. 18 (Bloomberg) -- The dollar rose against the euro and the yen on speculation overseas investors are buying more of the safest U.S. assets as the global economy enters a recession.

The greenback approached a two-year high versus a basket of currencies of six trading partners before the Treasury releases data today that will probably show increased investment in the nation's securities. The Australian dollar declined after the country's central bank said it favored lower borrowing costs.

``We've got this pervasive risk aversion, and we are seeing dollar assets as attractive in a world permeated by fear,'' said Adam Carr, senior economist at ICAP Australia Ltd. in Sydney. ``I'm bullish on the U.S. dollar.''

They're coming to America:

"Overseas investors bought a net $27.2 billion of U.S. assets in September, from $14 billion in August, according to a Bloomberg News survey of economists. The Treasury will release the report at 9 a.m. today in Washington.

Dollar Index

The Treasury received investor bids for four-week bills totaling more than triple the $34 billion that were sold at its Nov. 12 auction. The four-week bills were sold at the lowest rate since they were first auctioned in 2001."

So will exports go down? And will our debt continue to be funded?

Here's an older post making a similar point:

"Saturday, October 25, 2008

" Investors around the world fled stocks and rushed to the relative safety of the U.S. dollar"

The effects of the crisis are spreading. See this post in the Washington Post:

"Gloom about economic growth translated to low expectations for oil consumption. The Organization of the Petroleum Exporting Countries yesterday announced a cut of 1.5 million barrels a day in output -- a move that still failed to arrest the slide in crude prices. Meanwhile, copper prices fell to a three-year low.

Investors around the world fled stocks and rushed to the relative safety of the U.S. dollar by pouring money into 30-year Treasury bonds, a refuge in times of uncertainty. That drove down the value of foreign currencies, from the ruble to the rupee and the zloty to the peso, forcing central banks to spend billions of dollars to prevent even further deterioration. The turmoil in currency markets threatened to reorder trade relations and complicate recovery efforts."

Here's my comment:

DonthelibertarianDemocrat wrote:

"Investors around the world fled stocks and rushed to the relative safety of the U.S. dollar by pouring money into 30-year Treasury bonds, a refuge in times of uncertainty. That drove down the value of foreign currencies, from the ruble to the rupee and the zloty to the peso, forcing central banks to spend billions of dollars to prevent even further deterioration. The turmoil in currency markets threatened to reorder trade relations and complicate recovery efforts."

Doesn't this point out that the U.S. is still the key to worldwide investment?

"Tobias Levkovich, a Citigroup equity strategist, said lower gasoline prices would act like a more than $150 billion stimulus for U.S. consumers."

This would seem to favor a government stimulus directed at infrastructure, say, since the drop in the price of oil has, in effect, given a tax break or stimulus to the consumer.

10/25/2008 11:06:42 AM