Judging by comments on some of our correlation-related posts, people seem a bit touchy about the idea that the dollar is stoking a cross-asset bubble.
Nevertheless, those saying it is so are standing firm. Among them is Olivier Jakob at Petromatrix, making the case for the oil market specifically. As he wrote on Monday (our emphasis):
We had raised our systemic risk assessment because of the increasing correlations across markets. Equity analysts are saying that their markets are driven by the oil markets, oil analysts are saying that their markets are driven by the equity markets; everybody agrees on the Dollar correlation. The growing problem is that across asset classes everyone jumps on trading the correlation since it is a winning trade but the underlying distortions that it is creating in the real economy is making the correlation trade a time bomb in the making the same way that the sub-prime sandwiches were a time bomb.
He concluded that:
In our opinion, WTI has traded nothing but the Dollar/Equity correlation last week and given that this week will be particulariy heavy in terms of global economic inputs we would not want to adventure for the next five days outside of those correlations. Trading the DOE weekly statistics will be difficult as they will be followed a few hours later by the statement of the FOMC and in the current environement a change of words from the Fed should have a much greater impact on the price of oil than a stockchange in the DOE report. Given the importance of the Dollar in this trading environment, the second half of the week should remain volatile as well as we will have to digest as well the comments from Trichet on Thursday and the non-farm payroll on Friday. The level of speculative length in the oil commodities is extreme and these positions will require a further weakening of the Dollar Index to be sustained.
But Jakob is not alone on making the point. On Monday, none other than Nouriel Roubini, aka Dr. Doom, was making much the same argument in an FT opinion piece. Roubini, though, had dubbed it ‘the mother of all carry trades’ saying:
Let us sum up: traders are borrowing at negative 20 per cent rates to invest on a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade. Every investor who plays this risky game looks like a genius — even if they are just riding a huge bubble financed by a large negative cost of borrowing — as the total returns have been in the 50-70 per cent range since March.
People’s sense of the value at risk (VAR) of their aggregate portfolios ought, instead, to have been increasing due to a rising correlation of the risks between different asset classes, all of which are driven by this common monetary policy and the carry trade. In effect, it has become one big common trade — you short the dollar to buy any global risky assets.
So the combined effect of the Fed policy of a zero Fed funds rate, quantitative easing and massive purchase of long-term debt instruments is seemingly making the world safe — for now — for the mother of all carry trades and mother of all highly leveraged global asset bubbles.
So will it all end in tears?
Inevitably, according to Roubini, it will — because the dollar simply cannot continue falling to zero. And when the proverbial buck does stop, the effects will lead to nothing less than the biggest coordinated asset bust ever.
Now that does sounds scary.
Related links:
RIP oil fundamentals? - FT Alphaville
Oil, the great inflation hedge - FT Alphaville
So who says there’s no oil/dollar correlation? - FT Alphaville
