Traders Await a Coordinated G-20 Exit Strategy, but are Officials Already Reining in Stimulus?
dailyfx.com
Risk appetite has advanced for yet another week and in the process we have seen new highs set by EURUSD and the Dow Jones Industrial Average. However, with the G-20 meeting underway, we are in the midst of a very important transition. Though we are still a long way from a complete withdrawal, the world’s governments are already removing their financial support from the market. This is a critical and risky step in returning to the conditions that were ‘normal’ prior to the worst onset of the worst financial crisis since the Great Depression. Now, we will see whether risk appetite is in fact recovering or if the temporary guarantees and liquidity buffers provided a false sense of security that will come crashing down. Taking a snap shot of current market levels, optimism is still firmly planted. For the currency market, carry interest has risen to highs not seen the capital markets were in the middle of the sharpest free fall in modern history (October 10th). The building interest in carry is finding consistent support from rising yields and tempered risk. While there is a considerable possibility of a temporary market correction (or trend change), the fear of another systemic seizure has vanished. Naturally, corporate default premiums are less than a third of what they were during the height of last year’s panic and the demands for return on speculative assets over risk free is at its lowest since before the Lehman Brothers’ collapse. At the same time, diminished risk means little without the potential for income. Benchmark rates are still extraordinarily low; and yields on speculative assets will be tempered until the foundation is lifted. Yet, in the meantime, there are sources for income – like funding carry positions with dollars.
The US dollar has quickly become one of the most popular currencies in carry trade circles – though not for its positive attributes. In recent weeks, the benchmark market rate (the three-month Libor) for the US has consistently edged to new record lows. This is not unusual as yields on similar products in other financial centers around the world has done the same. What is notable though is the fact that the US rate is now at a discount to nearly every one of them – including its Swiss and Japanese counterparts. This positions the dollar as the world’s most attractive funding currency all while carry interest is building momentum. For now, this provides unique opportunities for stable pairs like EURUSD and AUDUSD; but can these conditions last? Certainly, the dollar’s role as a funding currency will not likely last for long. While rates are low now and Fed Chairman Bernanke has vowed to keep them that way well-into 2010; the draw of American assets and its deep markets will eventually draw lending rates higher and fortify the currency. But, the more important consideration is how will risk appetite as a whole perform going forward. In the next few months, there will be a major test in the conviction of investors’ optimism as governments start to implement exit strategies for the trillions of dollars of support that is still propping up the markets. Many of the industrialized powers have already started the process. Just today, the Fed announced it was further reducing some of its emergency lending programs (TAF and TSLF); and the German Federal Finance Agency cuts its proposed debt lending through the end of the year. These changes are generally ignored; but they represent serious progress towards a true withdrawal. Should the G-20 offer a coordinated time frame, it would make the transition more of a reality for the all involved. |
