Carry Trade? What Carry Trade

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Global Trade, Macroeconomics

A Reuter’s article this week reported that Liu Mingkang, a senior Chinese regulator, warned on Sunday that ultra-low interest rates in the United States are fueling speculation in overseas asset markets and threatening the global economic recovery. Before the housing bust, the Fed (Alan Greenspan in particular) and other major central banks advocated a hands-off approach to asset prices, arguing it is easier to clean up the mess after a bubble burst than to spot and stop it preemptively. Now it looks as if that attitude is changing as a result of the pain inflicted by the last twelve months.

San Francisco Federal Reserve Bank President Janet Yellen, is quoted as saying “We should be monitoring asset prices for signs of bubbles. My views on that have changed because of the crisis.”

European Central Bank Governing Council member Axel Weber said earlier this month that the financial crisis taught central bankers they cannot afford to ignore wild asset price developments.

Yet even though global stocks have risen some 70% this year, officials in the west are saying they do not see asset bubbles brewing yet. That position seems to be in contrast to the Asian view that largely puts the blame for rising asset prices in the region at the door of low dollar interest rates fueling speculative investment the so called dollar carry trade.

Singapore in September acted to cool the property market by releasing more land and making it harder for home buyers to defer payments. Hong Kong’s central bank has said it would cap the mortgage limit for luxury property at 60% and limit loan values. But China with its currency pegged to the dollar and its economy awash with bank loans is already some way down the road of building its own asset bubbles, blaming the US is not going to solve them.

Whether low dollar interest rates have played a part or not is difficult to say but the FT’s Short View this week illustrated that if there is a carry trade going on, it must be in niche areas because there is little or no evidence of major leveraged speculation. Bank lending is way down and still falling, while the re-purchase or repo market where assets such as Treasuries, Stocks or Mortgage backed securities are used as collateral to borrow against. That market reached a peak in 2008 at some $4.5trillion but fell sharply with the financial crisis, although it has picked up a little lately at $2.5trillion. It is still at 2003 levels, so clearly not a source for major carry trade leveraged speculation.

The reality is China is probably ticked off with the US because the yield on 10yr Treasuries is only 3.35%, whereas as last year it was 5%+. Holding as they are some $800bn it’s reasonable to assume the Chinese are worried about their poor return and gradually depreciating assets as the dollar continues to slide. Still it hasn’t stopped them buying more, up nearly 30% in the last year according to CNN.

–Stuart Burns

Comments (4)

  1. a says:

    “China is probably ticked off with the US because the yield on 10yr Treasuries is only 3.35%, whereas as last year it was 5%”

    why would they be ticked off? that means they have mtm gains on those treasuries they bought at 5% — and it’s not like the fed isn’t trying to move heaven and earth in order to create inflation

  2. marcus says:

    Well, clearly if they MTM to USD then they would be making a gain on the bonds, but they’d be lying themselves ’cause vs. a basket of currency, their mtm is probably down 20%-30%.

    I live in Hong Kong and goes up to China quite often. I can tell you the propertyh market is definitely in a bubble. everybody is leveraged up to buy new apartments since borrow cost is so low.

    I don’t know where your get your stats from Stuart..

  3. Stuart says:

    Marcus, thank you for your comments on the property markets. I state my stat sources in the article, and indeed those same sources do say parts of HK are forthy and the authorities are getting concerned. The more general point of the article is that the low dollar rates are not creating inflation in the west, in parts of China it could be a different matter but then we come back to the RMB peg, if China set interest rates at a level appropriate for their own country and allowed the currency to float they would not be at the mercy of the dollar’s slide.

  4. Jamie says:

    First, MetalMiner is terrific! Second, I really enjoyed the fresh perspective on the so-called USD carry trade and tend to be a contrarian as well (i.e. leverage made available by low rates, pales in comparison to the structured leverage manufactured by Wall Street over the last 8 years – just look at the number of hedge funds who aren’t around anymore). I would also argue that the reason why we will continue seeing lower volatility is due to the dismantling of market structures that were entirely focused on exacerbating volatility (e.g. naked options writing, off balance sheet CDS, over zealous securitization & general financial engineering). I tend to disagree with the “all commodities are in a bubble” statements, but do think there are areas of commodities that have gotten way too far ahead of themselves (namely collectibles like gold and maybe silver). China is clearly in a bubble but of a very different kind and I think the surprise may be how overly dependent China is on the export model. China’s bubble is in fact its failure to spend its reserves and my conclusion is China’s demand for industrial materials, especially copper, oil and iron ore, will persist for sometime because spending those reserves is the best way to cool growth.

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