Roubini Not Alone in Fearing Dollar Carry Trade
The last two years have taught investors that so-called once in a generation events can happen far more often.
If you had predicted in late 2006 and early 2007 that the wholesale markets where about to dry up and titans of the financial services industry like Lehman , AIG and Bear Stearns would have been gone by the end of 2008 you would have been laughed out of the room.
At the 2007 World Economic Forum meeting in Davos, something similar happened to a then low-profile economist called Nouriel Roubini. He was berated by a number of big name CEOs who believed his Dr. Doom predictions where simply wrong.
Nearly 3 years later and some of those CEOs are out of work while Roubini is coveted as one of the world’s leading economists for calling the credit crisis when so many others had been found wanting.
Mention the name Roubini now though and many in the market will groan. He missed the recent rally and even a broken clock is correct twice a day is the type of criticism you hear.
It is true that being a bear has been an expensive game since March, but Roubini has not been advising to stay out of stocks, instead warning that when the current rally comes to an end there will be a far bigger, more aggressive crash than we saw in the wake of the Lehman crisis.
He did though call the credit crisis and if you had traded on his advice in 2007 and 2008, you could have made once-in-a-lifetime profits if you got your timing right.
So when Dr Doom says the dollar carry trade is about to come to an end and the greenback will soar as equities crash you have to, at the very least, take his predictions seriously. His view is based on the assumption that there is a so-called ‘Wall of Money’ driving recent equity gains and other assets like gold and oil.
What is a ‘Wall of Money’?
This term refers to the belief that low borrowing costs around the world are allowing traders to borrow at low rates, gear up and then buy higher yielding assets. Recent earnings from the likes of Goldman Sachs and Barclays indicate the ‘Wall of Money’ theory is more than just a theory.
As George Soros put it last week, the banks are being gifted huge profits by central banks pumping billions into the system, which the banks simply put to work in stocks, emerging market debt, gold etc.
This trend has been very good for stocks since the March lows but it is not just Roubini who is worrying what will happen when the dollar carry trade unwinds.
Fredrik Nerbrand, the Head of Global Strategy at HSBC Private Bank in London told Europe Tonight that he is warning clients that we have been seeing asset price inflation for months.
Fredrik says we are seeing collective amnesia from investors buying into all sorts of assets that just 6 months ago people would have said they would never buy again, like mortgage backed securities.
Buy Dollars, Sell Everything Else?
Selling up and hiding dollars under the mattress was a wonderful trade between September 08 and March 09. As long as no one stole your hard-won money, you would have made big gains doing nothing as the world as we knew it fell apart.
That trade would have been terrible since the market turned in March and if you believe the likes of Nouriel Roubini, then you have to ask yourself: will his prediction come true and if so what time frame will the correction play out over.
At some point the Fed, ECB and other central banks are going to have to put their foot on the brake and start working on an exit strategy. Whether this means the end of quantitative easing or higher rates in 2010 or maybe even 2011, at some point the dollar carry trade will end.
It may just need an indication from Bernanke that he is considering such a change to push bond yields significantly higher, at which point the dollar carry trade could begin to unwind. This is the point at which HSBC would become bearish, but they do not see this happening in the short term.
The question then is the speed of any correction. Will it be a short, sharp shock that will see big moves over weeks or will it be a longer shake-out, taking months, like the recent rally? If it is the latter then you will have time to position your portfolio to play the trend, if is a short sharp shock, you could miss the party and find yourself nursing big losses.
Then again Roubini could be wrong and solid fundamentals will continue to drive the equity market higher for many happy months to come.