Kaydee, carry traders, not bond vigilantes, are running
the show in the currency markets today; 400 Trillion
dollars notional in interest rates derivatives is 30 times
the size of US GDP. Mostly these derivatives are currency
swaps and interest rates swaps. The mechanics is to short
the bonds of a country with low interest rates and invest
the proceeds in bonds in a country with high interest rates, pocketing the
interest rate differential. The big theory behind that is
that rates in different countries must converge over time.
(and as if monetarization and printing does not matter, huh?)
That's the theory that famous LTCM fund that blew up used.
Thus, when you short 10-year bonds in a country with
low rates and invest the proceeds in 10-year bonds in
a country with high rates, you expect to make a profit.
The Yen rate is currently 0.5%,
US rates are 4.75%, so these huge trades are borrowing
Yen to pile in the US bonds. US rates stay low despite
the dollar crisis we have just entered.
As US raised rates in 2004-2006, the dollar moved higher
despite the negative trade balance. Now both the negative
trade balance and the carry trade are working against the
dollar.
The Euro rates are a lot higher, they were raised a lot
more recently. As the Euro rates were raised, the dollar
fell against the Euro. Also note that the Euro has
emerged as the second reserve currency, which has put a fire
under it. By looking at the size of
Euro currency and dollar currency derivative markets, my
guess would be that that second major source of Euro
appreciation has been pretty much exhausted. Interest
rates differentials do matter, however, for now. Hence,
everyone and their mother continue to borrow from Japan
and invest in Euro and the dollar.
The carry trade is the most enormous bubble, and once it blows
up, I would expect trade surplus currencies, such as Yen,
will skyrocket, as Yen-denominated debt must be paid,
eventually. So will gold (0% lease rates). Wait, it's
skyrocketing already. -g- Well, as Fed lowered rates, carry
traders actually
made a profit, cause... US bonds went up. They are long those.
Once the Yen carry trade blows up, we'll have a real dollar
crisis: long term rates will move sharply up and the Yen will
skyrocket. |
