2008 … will the carry trade unwind now???

After reflecting this weekend over the current global situation and zapping through the long term charts, I think, the days of the carry trade are numbered.
Some long term trends are about to reverse soon, helped by a sentiment which calls contrarians to act.

Everybody is bearish on the US Dollar, everybody is bullish on the Euro. European, especially German equities are favoured against their US counterparts. REALLY smart?

I doubt it

A look into the charts reveals, that the Yen started its downtrend against the Euro in 2000 at around 90 and reached last year a low of around 170.
The Euro startet its rallye against the US Dollar in 2002, at below 90 and reached around 1,50 in late 2007.

The Yen is now fighting with its downtrend against the Euro and should be able to take it out “soon”. As we talk monthly charts here, soon for me is within the next 3 months.
On the other hand, charts suggest a FINAL rallye of the Euro against the US Dollar, but without major gains. Pain could be triggered if we turned down without this expected “last high”.

Levels to watch closely: 153.5/154.5 in EuroYen and 1,4350 in EuroDollar!!!

Most endangered species … the DAX …

The Dax was one of the most favoured markets through this currency moves. BUT now, the relative strength shows first cracks. Not only against the US markets, no … as well within Europe!!! So we should watch very closely, how the Dax performs against its brothers and sisters

If you want a fundamental explanation for it, here we go …

What did many investors do?

1. Recognize, that Japanese interest rates are low and will stay low.
2. Recognize, that Yen will go down as interest rates can not go lower … so bond prices can not rise further … money looks for other opportunities.
3. Being a European investor, you take on loans in Yen and look, where to invest.
4. First you invest in Europe, than a bit later you look elsewhere, where the yield is higher …
5. The investor detects SUBPRIME … COOL AAA valuation and higher yield.
6. Now I have still a currency problem … as I owe Yen, which is against Euro in a downtrend, I am fine and don’t have to to anything.
7. But as I have to invest in US Dollars, which against Euro is as well in a downtrend, I hedge the US Dollar … I sell it forward.

NOW COMES THE WHAMMY!!!

8. Investor detects, that subprime is WORTHLESS. So he does not get the Dollars back, he needs to fill his forward Dollar sales. RESULT: HE BUYS US DOLLARS!!!
And competes with Arab and Asian SWFs which are buying Dollars (not all as they have most of their money in US Dollars) as well to support Financials there! And they love to prop up the Dollar as they are heavily invested in it
9. Investor must still honor the loans in Yen and BUYS YEN AS WELL RESULT: EURO FALLS against BOTH
10. Currency trends reverse and accelerate investors’ pain!!!

AUTSCH!!!

Tags: carry trades, Dollar, outlook, subprime, SWF, Yen

This entry was posted on Sonntag, Januar 27th, 2008 at 22:22 and is filed under FDAX. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.