The weakness in the Euro is causing a short-squeeze in the U.S. dollar funded carry trade. The short dollar trades used to fund so many speculative investment activities in 2009, are being covered, newest to oldest. Europe's woes are forcing a more rapid-fire unwinding than was previously foreseen, and as a result we are seeing a rapid risk aversion imbalance in all of last year's profitable trades, in commodities, commodity complex economies, such as Canada and Australia, crude, emerging markets, and financials.
"Pi Economics estimated recently that the size of the dollar carry trade may have swelled to between $250 billion and $550 billion (U.S.) in the first half of 2009. Analysts say the yen carry trade grew as large as $1 trillion between 2004 to 2007," according to a Thomson Reuters report.
Here are a selection of clippings from various media outlets shedding light on the effects of the unwinding of dollar carry trades, unwinding debt and the reaction to sovereign debt concerns arising in the PIIGS, or all of the above.
WSJ: "The concerns are global, with sovereign debt issues in Greece, Spain and Portugal affecting investor sentiment," said Macquarie Private Wealth associate director Marcus Droga. "That's putting some pressure on U.S. dollar carry trades. Any deterioration in the U.S. jobs data would not be taken well tonight."
Reuters India: "What we are seeing is dollar-carry-trade unwinding by foreign investors," said Neeraj Dewan, director, Quantum Securities. "They borrowed when the dollar was cheap and now that the dollar is recovering, they are unwinding."
Barron's: "it’s all just part of the debt deflation that’s to be expected in a balance sheet recession. The carry trade unwind continues, driven by the type of mini-flight-to-quality I wrote about in our quarterly commentary. The main beneficiary has been the U.S. dollar as many of the favored assets of the reflation trade, which was funded by borrowing in dollars, are sold and repatriated back into the greenback. Sentiment in the dollar has gotten very bullish, very quickly… not what you typically see at major turning points. While trends in broad stock and commodity indexes remain largely in place from early-2009 lows, many leading indicators have broken down… like a couple of the emerging markets and the Baltic Dry Index (below)."
BusinessSpectator: "The really risky plays would have been to fund the trades in US dollars and then short the greenback to exaggerate the gains – a relatively low-risk play while the US economy remained weak, official US real interest rates were effectively negative, and Asian economies were growing.
The Australian dollar was a significant beneficiary of the carry trades, because of the relatively strong state of the economy and the rebound in Asian demand for resources. The Reserve Bank’s rapid-fire rate increases last year supported the dollar and, indeed, offered (until this week’s unexpected pause) the probability of an additional layer of gain from a strengthening currency.
The problem with momentum trades – carry trades that become so popular that the weight of money creates self-fuelling trends in asset prices – is that they create bubbles and are ultimately self-reversing. When they do reverse it can be ugly, because everyone tries to exit through the same gates at the same time, exacerbating the volatility and damage."
Barron's: "By all indications, that rush was to unwind so-called carry trades, which consist of borrowing dollars to fund purchases of other, presumably higher-returning assets. And with U.S. interest rates near zero, the allure of the carry trade is well nigh irresistible.
That means carry traders effectively are short the dollars they borrowed to buy commodities, emerging-market stocks, junk bonds, which beckoned with higher-potential returns. When those positions start to go against the carry traders, the leverage turns painful."
WSJ: "Investors are anxious that more negative factors may emerge. European debt concerns have strengthened the U.S. dollar and this has stoked concerns that the dollar carry trade may end soon and risk aversion may heighten further," said Min Sang-il at E*Trade Securities in Seoul.
