Thursday, May 28, 2009

Long Term Carry Trade Fundamentals

While reading a recent CNBC article about current events something clicked for me.

Here is the passage:
The dollar rose broadly on Thursday as yields on 10-year U.S. government bonds jumped more than 50 basis points in the last two weeks, drawing Japanese investors into overseas assets like global semi-conductor stocks, banks and U.S. junk bonds, according to Reuters.
Do you remember the massive unwinds that occurred during the past year? Do you remember all the talk about money heading towards Japan due to risk aversion?

Pay attention, this is significant. It's also backs up my much touted long term notion that carry trade currency pairs are in for a recovery.

Given the quote above what do you think will happen once the jobs numbers start to turn around in the US economy? I'll tell you what I think. I think interest rates and yields will start to rise. What do you think all that money sitting in Japan will do if there is a hot US economy paying good yields? I suspect that it will leave Japan in order to earn good returns.

Guess what that will do to the Yen? That's right, it will drop like a stone. When that happens you'll see carry trading pairs rise massively.

Okay, I realize this may be a year to two away, but as long as we do eventually get a worldwide economic stabilization this is what is in store for us. Anyway, if you are a rookie, be careful, as you can't simply make long term bets willy-nilly. The market can always move against future expectations long enough to blow up your account and it often does so as soon as you throw caution to the wind.

What this means for me is that I may be more willing to accumulate carry trade positions at moments of opportunity. Keep an eye out for fundamentals and watch leading economic indicators such as the Baltic Dry Index or the price of copper.

As you can see these indexes are rising. However, they are still at historically low levels. Are we just in a bounce with respect to worldwide economic activity or are we simply coming up from a recent bottom? You decide.

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