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Carry Trades In Dangerous and Final Stage
Carry trades have continued to exert a powerful influence on the markets over the past week with most currency pairs showing the impact. The carry-trade party could continue for marginally longer, but the overall dangers are now running at extreme levels. <?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" /><o:p> </o:p> The Japanese yen has remained under pressure following the dovish Bank of Japan comments which has fuelled further high-yield currency buying. The New Zealand dollar has recovered from the sharp decline following Reserve Bank intervention to push back towards record highs above 0.76 against the US dollar. The Australian dollar has also continued to test 18-year highs against the US currency while the Swiss franc has remained under downward pressure. <o:p> </o:p> The signs of excess confidence can be seen in most major asset classes. <o:p> </o:p> Global stock markets have survived the scare surrounding rising bond yields to push higher with US and European stock markets challenging 6-year highs. The confidence in markets can be seen in the UK FTSE reaction today. The MPC minutes were tougher than expected and suggested a July interest rate increase, but the FTSE has strengthened over the day. <o:p> </o:p> Emerging market currencies have remained strong with the Brazilian Real, for example, trading at a 7-year high against the dollar. Credit spreads remain low and there is intense private-equity finance activity which is supporting global stock markets. <o:p> </o:p> Overall liquidity conditions are tightening, however, as central banks raise interest rates which will gradually slow global liquidity growth. It is also the case that global lending standards are gradually being tightened which will have an important impact. This is particularly evident in the US mortgage sector, but there will also be a tightening throughout the Euro-zone and even the UK property sector will not be immune to these pressures. A slowdown in credit growth will also curb the potential for rising asset prices. Any unwinding of global leverage will be especially dangerous as it would result in a rapid contraction of credit. <o:p> </o:p> There are now very clear warning signs that carry trades are being caught up in the mania for wider asset-price inflation. It is a particularly important sign that markets are ignoring ‘bad news’ and gaining ground simply because they have been rising. <o:p> </o:p> As credit conditions tighten, there will be an outflow of longer-term capital which will leave asset prices increasingly dependent on more unstable flows to maintain current levels. High-yield currencies and carry trades will also be even more reliant on unstable flows to make further progress. <o:p> </o:p> Given these conditions, there is now an increasing threat that only a small shock will trigger a huge adjustment in global markets and a rapid reversal in carry trades. One possible trigger remains the collapse of a prominent hedge fund.
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- Comment #1
- Jun 20, 2007 10:47am Jun 20, 2007 10:47am
- 4x_Trader
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- StockKJay
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- Investica
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- sf2000
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- NewstraderFX
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