“There has,” says Goldman Sachs strategist Mark Tan, “been a lot of focus recently on the extent of Dollar-funded carry trades contributing to the decline in the USD”.
The IMF in a report prepared for the recently concluded G-20 Finance minister’s meeting cited ‘In addition to foreign funds moving into emerging market equities, led by expectations of higher growth, there are indications that the U.S. dollar is now serving as the funding currency for carry trades.
All well and good, but Tan reckons the IMF should be looking more closely at stronger flows into emerging markets, rather than jumping to the conclusion that the behaviour of the dollar is driven by carry-trading speculators.
While there has been a pick-up in investment in higher yielding currencies and assets, there is a distinction to be made between speculative carry trades and investments made on the basis of stronger EM fundamentals. It is hard to draw the line where investment activity becomes a speculative bubble but we do not think that we are in the midst of a ‘carry bubble’ at the moment.
Yes, inflows into EM assets have accelerated rapidly over the last several months but this has also arguably been led by improving fundamentals in these countries in general.
Another factor to consider is what Tan refers to as dollar “hedging asymmetries”. Simply put, this refers to the idea that overseas investors who are long US assets currently appear to be FX hedged more than US investors in foreign assets. This means that when risky assets rally, the dollar comes under selling pressure as people realign their hedging ratios.
And last on Tan’s list of counter bubble arguments is the idea that it is actually other peoples’ bubbles that are feeding into the behaviour of the dollar. There is, he says, a “difference between a dollar-funded carry bubble, and asset price bubbles from importing loose US monetary policy”.
Rapid asset price inflation in places such as Hong Kong and Singapore can, to a certain extent, be attributed to the actions of the Fed. This pushes up the value of these country’s currencies against the dollar, thus giving the impression of a significant carry activity when it isn’t actually there.
So, no currency bubble here boys. Now move along please.
Debunking the size of the carry trade – FT Alphaville
Roubini: Mother of all carry trades faces an inevitable bust – FT