Notes From Underground: Is the Euro the New Funding Currency For the Carry Trade?

For many years the carry trade has been the mainstay of the RISK-ON profile. For some periods the ZERO INTEREST RATE POLICY of Japan forced money out of its system and in search of high-yield currencies in Australia, New Zealand, Brazil and other attractive venues. One of the best carry trades ever was LONG BRAZILIAN REAL/SHORT YEN as investors could fund the trade by borrowing YEN at very low rates and placing it in high yielding Brazilian bank accounts. As the Brazilian currency attained status as a commodity currency and, thus, a proxy for the China growth story, the BRAZILIAN REAL soared and the carry trade was a major win/win. When the U.S. FED went to an extreme low interest rate, the U.S. DOLLAR became a funding currency as the U.S. became a much less attractive place for global capital flows.

It seems that as the EURO is labeled vulnerable because of its banking and sovereign debt crisis, investors are using EUROs to fund investments around the globe. If you use EUROS and the currency depreciates, the borrower is paying back the lenders at a much lower price and if the trade is left unhedged the difference goes to the investor. With EURO rates at 1% and the LTRO operation in December  locking in borrowers for three years, the effect is a comfort to borrowers seeking alternative investments to Europe. The lower EURO will power Germany’s export engine even as the peripherals enter into an ADVERSE FEEDBACK LOOP RECESSION. Will German growth be able to provide for the rest of a very stressed European economy? If this thinking is correct, it will help to explain the DECOUPLING of the EURO with the S&Ps and other risk assets.

During the huge GOLD sell off, I suggested that the GOLD/EURO would be a much more important indicator regarding the role of GOLD as a haven from credit turmoil and also the massive increase of liquidity that would flood the world from the ECB‘s actions. The theory is being tested as the U.S. economic data improve and it appears as if China will be more responsive to preventing a slowdown. Good investing advances “ONE FUNERAL AT A TIME.” Let’s see if this idea dies under the weight of a total credit debacle in Europe.

***First Friday of the month and it is time for the jobs report from both the U.S. and Canada. The Canadians report first at 6:00 a.m. CST and the consensus is looking for a job growth of around 17,000. Last month, the market was disappointed by a loss of 18,000. The unemployment rate is expected to remain at 7.4%. My readers are well aware that Canada can be an important prelude to the U.S. report because of the synergy between the two NAFTA partners. Canada has been far healthier than the U.S. but because of the strong LOONIE the Canadian manufacturing sector has remained moribund. Ontario is home to many auto parts producers so it important to look at manufacturing jobs to measure if the automobile sector is finally beginning to add jobs. The recent data out of Canada has been positive, including today’s PMI, which was much stronger than projected.

At 7:30 a.m. CST, the U.S. number will be released. Expectations are for a NONFARM PAYROLL OF 175,000 with state and local governments shedding another 20,000. The UNEMPLOYMENT RATE IS PROJECTED TO RISE TO 8.8% as SOME PREVIOUSLY UNEMPLOYED RETURN TO THE JOB MARKET. Average hourly earnings are expected to rise 0.01%. This is a very important piece of data for if wages do not begin to rise then consumer demand will be challenged as the Christmas has forced down people’s savings. If the consumer is to aid the recovery WAGES WILL HAVE TO BEGIN TO INCREASE. If the STATE GOVERNMENTS ACTUALLY INCREASE JOBS,THIS NFP NUMBER MAY ACTUALLY BE MORE THAN 200,000, which would make today’s ADP upside surprise a comfort to the ADP analysts who have badly missed on several previous employment reports.

THE ADP DATA SHOWED A NET GAIN OF 325,000 PRIVATE SECTOR JOBS, ALMOST DOUBLE THE GUESSTIMATE. If the data is strong, the S&Ps should get a rally as the EQUITIES have been able to absorb all the negative news from Europe and gain a respectable 1.5%. The U.S. TREASURIES are much more difficult to assess because of the FED’S involvement and the need for high quality collateral to replace UNDESIRED EUROPEAN SOVEREIGNS FOR THE REPO MARKET.

***QUICK HITTER: In tomorrow’s Financial Times there is a story about Japan and South Korea seeking to diversify away from Iranian oil for fear of a shutdown of the Straits of Hormuz. This is of interest because the CAD/YEN cross is on my radar screen as a trade: long the CAD, short the YEN. Technically the trade has been a nonentity for a while but with the YEN so strong and Canada so resource rich and an attractive investment environment, it is worth doing the technical prep and being aware of a possible trade. A strong Canadian jobs report will help provide a test to the possibility of this trade. Just something to watch in the same way attention was drawn to the CAD/SWISS TRADE.

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3 Responses to “Notes From Underground: Is the Euro the New Funding Currency For the Carry Trade?”

  1. Misha Says:

    Morgan Stanley’s reading Notes from Underground?

  2. yra Says:

    Misha –thanks for the update.Glad to see the readership is widening and it is a compliment.

  3. tom quayle Says:

    a must read for me. thanks

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