Excellent article calling for what is highly likely imo. Carry meltdown!!!
Expect a lower EUR-USD if USD-JPY stays at the current rate or lower USD-JPY if EUR-USD stays the same. Basically EUR melting against JPY. This phenomena is very very negative equity globally!!!
Fwiw....EUR is example for all anti dollars like CHF/GBP/AUD/NZD etc....so the meltdown could be on xxx/JPY.
Please do your own research before doing anything and dont blame anyone. The author nor the poster takes any responsibility on possiable profits/losses. Read the poster's disclaimer.
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"Crash and Carry" March 17th 2008
Lena Komileva, head of G-7 market economics at Tullett Prebon, predicts a sharp reversal of the global carry trade.
The most startling aspect of the USD's decline over the past year has been its occurrence against a backdrop of fairly limited re-pricing of risk across other G-10 currencies, and extreme correction in risk premiums in other financial asset classes. Swap spreads indicate that the subprime-driven credit crunch is a global phenomenon - the longer it lasts, the greater the impact will be on global asset valuations, including previously sheltered markets such as Asia and the emerging markets.
Yet, in the early days of this credit crunch, one of the most popular FX carry pairs, AUD/JPY, did not peak until the last week of July 2007, despite deteriorating investor risk sentiment dating back to the beginning of the month. These early warning signals included increased contagion from US subprime across all mortgage securities, including AA and AAA tranches, and wider European asset swap spreads, as a sign of cross-border financial stress.
This month, liquidity tensions in core term-funding markets forced the Fed to intervene twice with liquidity-providing measures and to co-ordinate actions with other G-10 central banks, as it did in December, to avoid a Northern Rock-type problem in the US. Signs of stress were visible well outside US markets as a reflection of the hole in banks' balance sheets left by paralysed sub-investment securitisation markets: spreads between term-deposit rates and overnight index swaps in the euro and sterling markets widened to the highest levels since the year-end liquidity crunch levels in December; Japanese asset swaps saw their sharpest widening on record; and German Bund option volatilities spiked to new highs. Yet EUR/JPY has held above 155, well clear of the low of 149.3 reached last August.
Indeed, despite elevated and shock-prone equity risk premiums, bond yield differentials retain the strongest explanatory power for any major currency, particularly for the US dollar. With the US yield curve steepening on expectations of more aggressive Fed easing, US yield pessimism and wider spreads between carry and funding currencies continue to unite investors. The market has moved to favour yen calls and euro puts in recent weeks and is prepared to pay almost double the volatility premium to hold long yen positions against the Australian dollar. But valuations have stayed short of levels at earlier periods of peak stress, in January or last August, despite signs of fatigue in 'euro bull' FX sentiment gauges.
The de-coupling between FX and other financial asset classes is particularly striking considering the driving factors behind bond yield differentials. At the start of this year, Tullett Prebon's US Leading Indicator gave a strong signal of an imminent recession in the US, at 85%, compared with a market consensus of 45%. This, along with expectations of aggressive Fed easing, has since been fully priced and overpriced in financial valuations. From here on, the case for independent dollar weakness requires evidence that the US economic weakness is an isolated event.
This does not appear to be the case. Official growth projections for other industrialised economies are still being revised down, as communications this month from the ECB, the OECD and the UK Treasury indicated, tracking the market and the economist consensus cycle. With no end to financial credit problems or the US-led G-10 slowdown in sight, concerns about the resilience of export-dependent emerging markets have joined the global re-pricing of fundamental risks.
Expectations about medium-term growth fundamentals back the argument against isolated dollar weakness. Index-linked bonds are showing lower, but still resilient, growth expectations for Japan by the standards of the past decade. In contrast, projections for medium-term European GDP have fallen by more than a percentage point over the past nine months, tracking projections for UK and US growth. The market's rationale on relative domestic demand fundamentals is supported by developments in financial risk premiums. The dislocation across money markets, as a proxy for the magnitude of a negative money supply shock from financial volatility onto the real economy, is greatest in the US dollar market, but it is also much wider in the euro market than in the yen market.
Overall, the de-coupling between the FX and other markets implies a high risk of a quick and sharp capitulation of the global carry trade. To the extent prolonged dollar weakness has been the main axis for the current status quo in G-10 and emerging market carry, there appears to be a vast pent-up potential for a broader re-pricing of risk. In the absence of a top-down, yet market-based, structural solution to the credit crunch, we do not expect the Fed to be in a position to declare the bottom of this rate cycle in 2008. The origins of both the financial crisis and the US slowdown are more structural than cyclical, so a cyclical recovery is some way off.
Instead, a broader shake-up of market risk is likely to arrive from the realisation that the aggressive US policy stimulus is a reflection of the unique group of cyclical and structural risks facing the US economy and global financial markets rather than an antidote to these risks for the rest of the world. This is consistent with faster 're-coupling' between G-10 growth and policy rates versus the US over the next two years and slower liquidity growth in emerging markets, including and possibly led by China. The bulk of de-leveraging in the FX market has yet to come."
Edited by BubbleVision - 16/Mar/2008 at 7:40am