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The US Dollar Carry Trade: Caution Ahead


The US Dollar Carry Trade: Caution Ahead

Pacifica Partners’ Financial Post Weekly Column – Nov 5th 2009


Preview:


If one were to ask most any investor to choose the single most disliked asset class in the world it would be safe to assume that the reply would be “The US Dollar!”. The announcement yesterday by the Fed that they would continue to maintain their low interest rate policy for some time, along with a seemingly apathetic attitude by the US Treasury Department, has allowed investors to continue to take on risk using something called the $US Carry Trade.


US Carry Trade

Click to enlarge image: Data Source: Stockcharts.com

In a basic sense, the carry trade is a process by which investors borrow US dollars at low interest rates, sell those dollars and then invest those proceeds in a country of their choice where interest rates might be higher or perhaps that nation’s currency is expected to rise relative to the $US. This puts downward pressure on the US dollar because of this additional selling pressure. Given that there are no clear signals from the authorities in the US that they want to put a stop to this activity or that they are even too concerned with the dollar’s weakness, investors have been having a field day.

In addition, the markets are able to use the longstanding relationship of the $US to commodities. That is, commodities tend to move inversely to the US currency. Thus, if they feel it is open season on the US dollar, they move into commodities with conviction. The only time they seem to stumble is when they are met with economic data that does not live up to expectations.

If markets are hit by a dose of fear in response to the release of a particular economic data point, they reverse their carry trade and we see capital come running back to the $US and commodities stumble. If the data is positive, investors send the dollar down and they ratchet up the carry trade. As the above noted factors weigh on the $US, commodity investors have been pouring money into this sector and into the currencies of the commodity producing countries such as Brazil, Canada and Australia.

We just have to look at the oil markets to see the impact of the carry trade. It is increasingly hard to justify crude at $80/barrel based on the usual arguments of expected demand from China and India. It is probably quite true that the various studies that suggest that any significant reserves of oil to be exploited in future are going to be found in some of the most inhospitable political and geological environments in the world. Therefore, they will be costly to get to and this should put some sort of floor on the price of oil.


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Pacifica Partners are weekly columnists for the Financial Post



Legal Disclaimer

This report is for information purposes only and is neither a solicitation for the purchase of securities nor an offer of securities. The information contained in this report has been compiled from sources we believe to be reliable, however, we make no guarantee, representation or warranty, expressed or implied, as to such information’s accuracy or completeness. All opinions and estimates contained in this report, whether or not our own, are based on assumptions we believe to be reasonable as of the date of the report and are subject to change without notice. Past performance is not indicative of future performance. Please note that, as at the date of this report, our firm may hold positions in some of the companies mentioned.

Copyright (C) 2009 Pacifica Partners Inc. All rights reserved.




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