Sunday, September 20, 2009, Source: Shocked Investor
The US Dollar Carry-Trade is Financing Dangerous Global Currency Speculation
As readers here know, we are gravely concerned with the current chaos on world currencies and the collapse of the US Dollar. French newspaper Le Monde says the USD is now the "vedette" of speculators. With interest rates so low in the US, it is the chose mechanism, just like Japan's Yen was.The situation is scary for those invested in money markets are other such instruments considered "safe", as we have also mentioned many times.The USD was the currency that was used as the world's refuge and safehaven during the financial crisis, but is now used by carry-trade speculators. This consists of borrowing money in currencies where rates are lowest then investing this money into currencies that pay more. This raises a huge red flag with certain currencies. The emphasis is mine.Since late August, the U.S. interest rates fell below the rates of Japan and Switzerland. They are referring to the practical rates for banks. Speculators who, since the spring, had borrowed money in Yen and Swiss francs to invest it place in markets where rates were higher (such as the Australian dollar or the New Zealand dollar or, and this is my concern, the Brazilian Real - see my post on Brazilian inflows), are now using the USD dollar. The also invested in raw materials and commodities. To implement these "carry trade" strategies, they need to sell the borrowed dollars, thus the USD was under great pressure, and the currencies in which they were reinvested exploded. Le Monde adds: "Since March, the New Zealand dollar has risen 43% against the dollar." The central bank said that if the appreciation of its currency continues, it could jeopardize the country's economic recovery. "A warning should not be taken lightly, say economists at BNP Paribas. ( ...) It would not be surprising to see the central bank intervening in the event of further increases in the New Zealand dollar against the USD. The United States is a major trading partner of New Zealand, unlike Australia, which deals mainly with Japan and other Asian economies. Rates still low, and too lowSo far, the speculators have been unable to make the dollar fall sharply against the euro. While gold has now crossed the threshold of 1,000 dollars an ounce, the dollar has suddenly stalled, sending the Euro to its highest level since September 2008. Le Monde says that economists do not rule out seeing the Euro soon exceed $ 1.50. In fact, "a very big investor blocked for several days the market so that the dollar did not fall below the level of 1.4450 USD for 1 Euro. But this position did not resist, Tuesday, at the power of the dollar selling wave that followed the summit of G20 finance this weekend of September 4 and 5 September, and this has caused a panic, "said Sebastien Galy, currency strategist at BNP Paribas. The bankers have realized that the cost of borrrowing money will stay low for a long time and they could continue to speculate. Dissapointing econimic data might even encourage investors to take risks and make aggressive moves in emerging markets to the extent that there will be no quick exit from the fiscal and monetary policy expansionary in industrial countries, says the BNP Paribas. Thus the prudence of central banks could turn against them. If they leave rates low for too long, they may create bubbles.Following a monetary policy ultra-flexible conducted since 2001, the Bank of Japan long hesitated in 2006 before starting to normalize its monetary policy. They feared causing imbalances in light of the considerable sums that speculators had the time to borrow yen at very low rates in operations of Japanse carry trade. In March 2006, however, it decided to reduce the facilities it gave to banks. A year later, in February 2007, they began to raise interest rates.This is a very risky and unstable situation. Straddles are a favoured way to take advantage of this explosive and volatile conditions. We will be updating our post on USD straddles this week.
Monday, September 28, 2009
Friday, September 18, 2009
Level 4-Should a Shrinking Dollar Worry You?, WSJ, by Jason ZweigSep 12, 2009
The dollar is falling. Is the sky falling, too?
As of this week, a dollar would buy only 0.68 euro, down from 0.80 in March and a peak of 1.21 in 2000. The greenback slid against other major currencies as well.
That may be a problem for investors. If most of your assets are in dollars but much of the goods and services you consume are priced in other currencies -- say you like imported cars or regularly vacation abroad -- your future spending needs have just gotten harder to fund.
Fortunately, it's not that hard to protect against further erosion in the dollar. And not all investors need to take action. Hedging would be vital, quips Campbell Harvey, an economist at Duke University who edits the Journal of Finance, "if your mortgage is denominated in euros." But if you make your money in the U.S. and spend it in the U.S., a falling dollar isn't the end of the world. Thus, the slide in the greenback need not prompt every investor into urgent action, but it is an ideal pretext for asking whether you are globally diversified.
Three cures are most commonly prescribed for investors worried about a weakening dollar: foreign currency, gold or a diversified basket of commodities.
Trading foreign currencies like Australian or Canadian dollars, both tied closely to commodity prices, sounds appealing. But foreign-exchange trading usually relies on high margin, or leverage, which is risky, and gains are taxed at hefty rates. So an individual investor has to be really right to rationalize doing it, says Mark Kritzman, who helps oversee more than $25 billion at Windham Capital Management in Cambridge, Mass.
As for gold and other commodities, they have provided an average return of around 20% in the four quarters following the worst drops in the value of the dollar, according to Michele Gambera, chief economist at Ibbotson Associates.
Surprisingly, these glittering returns look tarnished next to those of stocks and foreign bonds. On average, based on more than 20 years of returns, Mr. Gambera found that in the four quarters following the steepest declines in the dollar, U.S. stocks go up 25%, various baskets of international bonds gain between 21% and 28%, and non-U.S. stocks go up more than 56%.
So, with many commodities near record highs, there may be no need to join the stampede into gold or most other hard assets.
If the dollar keeps dropping, stocks and bonds priced in euros, yen, rubles or shekels will tend to become more valuable; anything denominated in foreign currency will then buy more dollars. That's why, for U.S.-based investors, international stocks and bonds tend to outperform commodities when the buck falls. Global diversification thus provides an automatic buffer against a dollar drop, unless the fund managers have hedged the holdings back into U.S. currency.
By the same token, big American companies that earn much of their revenues outside the U.S. may do better as the dollar drops; kronor and rupees will then convert into a greater number of greenbacks, putting more profit in U.S. shareholders' pockets.
But raising your overseas holdings can make sense even if the dollar stops falling. U.S. stocks represent less than half of the total value of equities world-wide, and yet American investors keep more than 70% of their stockholdings here at home. Although roughly two-thirds of the world's debt is outside the U.S., American investors have less than 4% of their fixed-income portfolios in foreign bonds.
For many years, I've kept half of my stockholdings outside the U.S. The more convinced you are that the dollar will fall, the more you should hold in international stocks, ideally through a low-cost index fund that doesn't hedge currencies. Even if your view on the dollar turns out to be wrong, you will end up with a better diversified portfolio.
I don't have any foreign bond funds myself; I was turned off long ago by their risk and illiquidity. But choices are better today. If you are especially worried about Uncle Sam, consider T. Rowe Price International Bond or, if you can avoid the sales charge by going through a discount broker, the Class D shares of Pimco Foreign Bond (Unhedged). SPDR Barclays Capital International Treasury Bond, an exchange-traded fund, is another good choice, but only if you can find a discount broker that won't charge commissions to reinvest your interest income.
Over the course of time, currency fluctuations tend to wash out. And even a long-term decline in the dollar might not be disastrous; since 1950, South Africa has had one of the world's weakest currencies, but one of the best-performing stock markets. The dollar is falling, but the sky isn't.
QUESTIONS: 1. (Introductory) By how much percentage did the U.S. dollar fall against the euro since its peak in 2000?2. (Advanced) What options are available to investors to protect them against a weakening dollar?3. (Advanced) How do big American companies with overseas earnings benefit from a falling U.S. dollar?4. (Introductory) Does a weak U.S. necessarily imply it is a bad for U.S. stock markets over the long period of time? Why?
The dollar is falling. Is the sky falling, too?
As of this week, a dollar would buy only 0.68 euro, down from 0.80 in March and a peak of 1.21 in 2000. The greenback slid against other major currencies as well.
That may be a problem for investors. If most of your assets are in dollars but much of the goods and services you consume are priced in other currencies -- say you like imported cars or regularly vacation abroad -- your future spending needs have just gotten harder to fund.
Fortunately, it's not that hard to protect against further erosion in the dollar. And not all investors need to take action. Hedging would be vital, quips Campbell Harvey, an economist at Duke University who edits the Journal of Finance, "if your mortgage is denominated in euros." But if you make your money in the U.S. and spend it in the U.S., a falling dollar isn't the end of the world. Thus, the slide in the greenback need not prompt every investor into urgent action, but it is an ideal pretext for asking whether you are globally diversified.
Three cures are most commonly prescribed for investors worried about a weakening dollar: foreign currency, gold or a diversified basket of commodities.
Trading foreign currencies like Australian or Canadian dollars, both tied closely to commodity prices, sounds appealing. But foreign-exchange trading usually relies on high margin, or leverage, which is risky, and gains are taxed at hefty rates. So an individual investor has to be really right to rationalize doing it, says Mark Kritzman, who helps oversee more than $25 billion at Windham Capital Management in Cambridge, Mass.
As for gold and other commodities, they have provided an average return of around 20% in the four quarters following the worst drops in the value of the dollar, according to Michele Gambera, chief economist at Ibbotson Associates.
Surprisingly, these glittering returns look tarnished next to those of stocks and foreign bonds. On average, based on more than 20 years of returns, Mr. Gambera found that in the four quarters following the steepest declines in the dollar, U.S. stocks go up 25%, various baskets of international bonds gain between 21% and 28%, and non-U.S. stocks go up more than 56%.
So, with many commodities near record highs, there may be no need to join the stampede into gold or most other hard assets.
If the dollar keeps dropping, stocks and bonds priced in euros, yen, rubles or shekels will tend to become more valuable; anything denominated in foreign currency will then buy more dollars. That's why, for U.S.-based investors, international stocks and bonds tend to outperform commodities when the buck falls. Global diversification thus provides an automatic buffer against a dollar drop, unless the fund managers have hedged the holdings back into U.S. currency.
By the same token, big American companies that earn much of their revenues outside the U.S. may do better as the dollar drops; kronor and rupees will then convert into a greater number of greenbacks, putting more profit in U.S. shareholders' pockets.
But raising your overseas holdings can make sense even if the dollar stops falling. U.S. stocks represent less than half of the total value of equities world-wide, and yet American investors keep more than 70% of their stockholdings here at home. Although roughly two-thirds of the world's debt is outside the U.S., American investors have less than 4% of their fixed-income portfolios in foreign bonds.
For many years, I've kept half of my stockholdings outside the U.S. The more convinced you are that the dollar will fall, the more you should hold in international stocks, ideally through a low-cost index fund that doesn't hedge currencies. Even if your view on the dollar turns out to be wrong, you will end up with a better diversified portfolio.
I don't have any foreign bond funds myself; I was turned off long ago by their risk and illiquidity. But choices are better today. If you are especially worried about Uncle Sam, consider T. Rowe Price International Bond or, if you can avoid the sales charge by going through a discount broker, the Class D shares of Pimco Foreign Bond (Unhedged). SPDR Barclays Capital International Treasury Bond, an exchange-traded fund, is another good choice, but only if you can find a discount broker that won't charge commissions to reinvest your interest income.
Over the course of time, currency fluctuations tend to wash out. And even a long-term decline in the dollar might not be disastrous; since 1950, South Africa has had one of the world's weakest currencies, but one of the best-performing stock markets. The dollar is falling, but the sky isn't.
QUESTIONS: 1. (Introductory) By how much percentage did the U.S. dollar fall against the euro since its peak in 2000?2. (Advanced) What options are available to investors to protect them against a weakening dollar?3. (Advanced) How do big American companies with overseas earnings benefit from a falling U.S. dollar?4. (Introductory) Does a weak U.S. necessarily imply it is a bad for U.S. stock markets over the long period of time? Why?
Thursday, September 10, 2009
Movement versus Shift
Why is it important to understand the difference between movement along the curve and a shift of the curve?
Decision makers want to know whether there is a structural versus an ephemeral change in their market. For example, an investor would not sell their entire portfolio if the price of their stock fell or rose during any random day. Now they might sell or buy if something structural was changing such as legislation that would tax profits.
Decision makers want to know whether there is a structural versus an ephemeral change in their market. For example, an investor would not sell their entire portfolio if the price of their stock fell or rose during any random day. Now they might sell or buy if something structural was changing such as legislation that would tax profits.
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