Will someone please explain "carry trade" to me?

[Chuck Bao]

I'm probably stupidier than stupid, but I am not getting this, at all.

US banks are using near zero interest rates from the open window of the Fed to bet against the dollar and still not lending to Americans? Is that right?

This is my daily today and you have to ignore all except the last paragraph. I really, really want someone to correct me.


The Thai stock market has been given a reprieve this week with the Red Shirt rally originally scheduled for this weekend being called off until after HM, the King’s birthday on December 5. Following yesterday’s big gain of 19.47 points to 695.69 on this news, we may not see that much further upside this week as the Thai market’s focus will again turn back overseas in the near term. Coincidentally, US markets will be closed for the Thanksgiving holidays tonight and trading will only be for a half of a day on Friday. More likely Thai investors are going to be less active. We are still thinking that the Thai stock market offers very good value and investors should use this period to accumulate stocks. Our favourite plays include XXX, XXX and XXX.

• Just more cat and mouse political games: We reiterate what we mentioned yesterday that the Thai stock market should not over-react to domestic politics. We do not see any real threat to the current government or short-term end-game or do-or-die scenarios that were mentioned in the popular press earlier this week. On the other hand, it is pretty hard to ignore the sad state of affairs when the Thai Prime Minister needs added security to visit Chiang Mai scheduled for this Sunday. We assume that local investors will be relatively quiet for the remainder of this week, while foreigners were net sellers of Bt1,614mn yesterday and may continue looking for better short-term gains elsewhere.

• US markets break for Thanksgiving at new 13-month highs: US markets have given good reason for giving thanks with the DJIA and the S&P 500 rising to new 13-month highs. The DJIA rose 30.69 points, or 0.29%, to 10,464.40 last night. The broader-based S&P 500 gained 0.45% and the tech-rich Nasdaq 0.32%. Buyers were attracted back by to equity markets with some favourable economic numbers: new claims for unemployment fell by 35,000 from the previous week to 466,000, new home sales rose by 6.2% and consumer spending rose by 0.7%. Mostly, US investors are keen on an indication of “Black Friday” consumer sales which is the Friday after Thanksgiving and the start of US holiday spending season.

• Borrow in dollars and bet against the dollar: Another reason for US markets to hit new highs is the fact that the US dollar is hitting new 14-month lows. The big US banks can basically borrow dollars near zero interest rates and essentially bet on equity or commodities as a hedge against further dollar weakening. This “carry trade” is working out very well for them and their privileged clients. The US dollar index fell 1.06% overnight. Meanwhile, gold futures with February ‘10 delivery jumped $20.60 to $1,188.00/ounce and light crude futures with January delivery rose $1.88 to $77.90.

[Frozen Sooner]

Sure. Carry trade is the practice of taking out loans denominated in currencies that are depreciating rapidly relative to other currencies, then purchasing either hard assets with the funds or investing in slow-depreciating or appreciating currencies.

[tommieharris91]

http://en.wikipedia.org/wiki/Carry_trade#Currency


The carry of an asset is the return obtained from holding it (if positive), or the cost of holding it (if negative) (see also Cost of carry).

For instance, commodities are usually negative carry assets, as they incur storage costs or may suffer from depreciation, but in some circumstances, commodities can be positive carry assets if the market is willing to pay a premium for its demand.

This can also refer to a trade with more than one leg, where you earn the spread between borrowing a low carry asset and lending a high carry one.

Carry trades are not arbitrages: pure arbitrages make money no matter what; carry trades make money only if nothing changes against the carry's favor.

[Chuck Bao]

Okay, I can see that US banks can't be hamstrung by federal intervention in conducting normal business.

I am just curious as to how abnormally low Fed Funds rate is financing their betting against the dollar or encouraging mutual funds and hedge funds to bet against the dollar.

I mean a lot of these banks needed to be bailed out at taxpayer expense. They are not lending to Americans but instead using the money to bet against the dollar?

Is this perverse or am I getting the wrong end of the stick?

[OUHOMER]

sound like you got it right Chuck, greed at its finest. it not about the tax payers who bailed them out. It all about them, again

[tommieharris91]

Asset bubble being formed, getting ready to pop when the Fed raises rates?

[Chuck Bao]

Asset bubble being formed, getting ready to pop when the Fed raises rates?

Geez, it just seems like that is all the free market and US financial institutions are good at - creating new asset bubbles, even as the old ones are still deflating. That is just sick.

[JohnnyMack]

Geez, it just seems like that is all the free market and US financial institutions are good at - creating new asset bubbles, even as the old ones are still deflating. That is just sick.

http://www.rollingstone.com/politics/story/29127316/the_great_american_bubble_machine

[Frozen Sooner]

Okay, I can see that US banks can't be hamstrung by federal intervention in conducting normal business.

I am just curious as to how abnormally low Fed Funds rate is financing their betting against the dollar or encouraging mutual funds and hedge funds to bet against the dollar.

I mean a lot of these banks needed to be bailed out at taxpayer expense. They are not lending to Americans but instead using the money to bet against the dollar?

Is this perverse or am I getting the wrong end of the stick?

There's a lot of excess savings out there. The "market" rate isn't appreciably higher than the Fed Funds rate as a result of all the Chinese money floating around out there.

[Chuck Bao]

There's a lot of excess savings out there. The "market" rate isn't appreciably higher than the Fed Funds rate as a result of all the Chinese money floating around out there.

The Chinese have their own asset bubbles to deal with. Why they want to be starting **** and new asset bubbles. Oh wait, their money has no where else to go. Maybe if we didn't buy so much Chinese crap.

That is getting off topic, though. I thought this was about bailed out US financial institutions borrowing in dollars and betting against the dollar. The Chinese are not borrowing, they're lending.

[Frozen Sooner]

The Chinese have their own asset bubbles to deal with. Why they want to be starting **** and new asset bubbles. Oh wait, their money has no where else to go. Maybe if we didn't buy so much Chinese crap.

That is getting off topic, though. I thought this was about bailed out US financial institutions borrowing in dollars and betting against the dollar. The Chinese are not borrowing, they're lending.

All I'm saying is that the Fed Funds rate, while certainly lower than the market rate, isn't incredibly out of line. The effect of the Chinese current account surplus and incredible savings rate is tremendous. Wolf's Fixing Global Finance has some pretty good arguments for how the current low interest rates aren't causing "crowding in", rather they've been necessary to maintain borrower of last resort status. Unfortunately, the merry-go-round stops at some point.

But yeah, digression.

Any time your country is the hedge in the carry trade, that's a bad deal.

[Chuck Bao]

All I'm saying is that the Fed Funds rate, while certainly lower than the market rate, isn't incredibly out of line. The effect of the Chinese current account surplus and incredible savings rate is tremendous. Wolf's Fixing Global Finance has some pretty good arguments for how the current low interest rates aren't causing "crowding in", rather they've been necessary to maintain borrower of last resort status. Unfortunately, the merry-go-round stops at some point.

But yeah, digression.

Any time your country is the hedge in the carry trade, that's a bad deal.

Zero interest rate isn't incredibly out of line? Let's see what Citibank is charging me what for my outstanding balance on my credit card that I didn't manage to pay off last month. Okay forget that, I don't even want to know.

I don't personally know any of the fund managers managing China's foreign reserves but I get the very distinct impression that they don't really care too much if their vast holdings in US dollar depreciates against other currencies. They have like more than a trillion dollars worth of reserves, what is a few hundreds of billions? I get the idea that they think that reserves can be sacrificed for the sake of keeping the domestic manufacturing engine going.

So yeah, China is the enabler.

And, it would be odd if US financial institutions are working the other way in borrowing money from the Fed to bet against the dollar. Just as the US government borrows money from Chinese to finance the deficits. It all seems a bit self defeating to me.

I think you summed it up well, Froze, with your last statement: "Any time your country is the hedge in the carry trade, that's a bad deal."

[Frozen Sooner]

Zero interest rate isn't incredibly out of line? Let's see what Citibank is charging me what for my outstanding balance on my credit card that I didn't manage to pay off last month. Okay forget that, I don't even want to know.

C'mon man. I know I don't have to explain to you the difference between interbank and discount window rates and unsecured personal debt rates.

No link, but I remember hearing that the current estimate for what a floating market rate would be is only like ten basis points or so above the fed funds rate.

[Chuck Bao]

C'mon man. I know I don't have to explain to you the difference between interbank and discount window rates and unsecured personal debt rates.

No link, but I remember hearing that the current estimate for what a floating market rate would be is only like ten basis points or so above the fed funds rate.

Yeah, I know. Still the open window from the Fed and the large excess funds in the system are keeping deposit rates abnormally low. People living on fixed income accounts are suffering. Okay, that's not my point, for now anyway, as inflation is very low or currently negative.

My point is that commercial banks are being allowed to profiteer. Their interest rate margins are unusually wide. And, some of that excess funds are being channeled to bet against the dollar instead of lending to the real sector, and that in my opinion is obscene.

Several years ago, I interviewed a senior officer of the Bank of Thailand (Thailand's central bank) and a member of Thailand's Monetary Policy Committee (which sets Thailand's equivalent of the Fed Funds rate). I tried my best to start an argument about how the central bank is keeping interest rates artifically low and that has allowed the private commercial banks to profiteer as they're keeping lending rates high or not lending at all. The Bank of Thailand guy just smiled and refused to argue. Apparently, the central bank was quite happy to sit back and let the commercial banks recapitalize by achieving large profits. The net effect on the economy was negative, but the central bank had to ensure that the financial system was secure first.

Maybe that is the case of the US Fed now. They are giving the US banks a chance to recapitalize through earnings growth. I don't disagree except when these same banks pay out huge bonuses to executives. Now, that's obscene.

[Chuck Bao]

Dubai is destroying confidnence in the global financial system. DU ****ing BAI.

Damn. You'd think that they would be doing okay with crude prices at $60-70and a war or two in the region. I was all prepared for a strong argument on the rebound potential of Thai stocks today and these people mess it all up.

[StoopTroup]

That King in Dubai is on record that he's not going to base the future of his Country on oil. By the way they do things there....the word "Ruthless" comes to mind when I think of how he's playing the game. They hire people to do **** for them. We still have people in our Country that want to work.

No way I'd ever be a slave to them.

[Chuck Bao]

That King in Dubai is on record that he's not going to base the future of his Country on oil. By the way they do things there....the word "Ruthless" comes to mind when I think of how he's playing the game. They hire people to do **** for them. We still have people in our Country that want to work.

No way I'd ever be a slave to them.

Yeah, ain't that the truth. They pay a lot of money but there is no way that I could ever work in a muslim country. For those of you all regiliousy, it must feel the some on the other side. And, the weird thing is that people are the same whereever you go in the world. I have yet to get a perception that some people, somewhere in the world has caught the automatic line to God. Well, their actions do not indicate that.

Going back to point is that fund flows are crazy. Money is seeking the best return and bubbles form.

I once told my best friend wanting to put his life savings in the stock market that it is better to get in and get out. Trade the market on short-term gains and don't worry so much about the peak. Take the profit and be happy that it is a profit.

[BermudaSooner]

Okay, I can see that US banks can't be hamstrung by federal intervention in conducting normal business.

I am just curious as to how abnormally low Fed Funds rate is financing their betting against the dollar or encouraging mutual funds and hedge funds to bet against the dollar.

I mean a lot of these banks needed to be bailed out at taxpayer expense. They are not lending to Americans but instead using the money to bet against the dollar?

Is this perverse or am I getting the wrong end of the stick?

Another reason why gubment should stay out of business.

But let me get this straight, are you saying that since we bailed out these companies, you don't want them to try and do their best to make money (and therefore pay us back) but rather do "social good?"

Isn't that what the gubment is supposed (in some people's minds) to do?

Think through what you are saying. It sounds to me like you are saying bailing a company out means the gubment should then control it--dictating what it should do. I think the Russians and Chinese have a term for that...

[BermudaSooner]

My point is that commercial banks are being allowed to profiteer.

Oh no!!! The horror!!!

[tommieharris91]

But let me get this straight, are you saying that since we bailed out these companies, you don't want them to try and do their best to make money (and therefore pay us back) but rather do "social good?"

It's not in those companies' best interest to pay back the US taxpayer. Why should they?

[Chuck Bao]

...Think through what you are saying. It sounds to me like you are saying bailing a company out means the gubment should then control it--dictating what it should do. I think the Russians and Chinese have a term for that...

I have thought through what I am saying, but that is no guarantee that my ideas are good. You may be right BermudaSooner.

You have to remember that a central bank's monetary policy is largely effected through private commercial banks in a capitalist system. This is not the Russian system, nor the Chinese system. A central bank’s interest rates are just symbolic unless private commercial banks follow suit with similar interest rate adjustments and THEY ARE ACTUALLY LENDING.

My key point in the previous post may not have been so clear. It seems to be a very conscious and deliberate decision to allow banks to profiteer and rebuild capital so the financial system starts working again. Central bankers know that the financial system has to function before the economy recovers. It has nothing to do with repayment of the bailout money.

Treasury Secretary Tim Geithner mentioned last week that US banks are still not lending to small and medium-sized businesses. That is why I think the US should have nationalized the banks instead of bailing them out. Bailing those out deemed too big to fail just creates a moral hazard and I think we are seeing that now.

Banking shares could have been easily privatized later and the US government could earn a very nice profit on the sale. I would love to see shares offered to bank depositors first for suffering through low interest rates.

Instead, now we have the bailed out banks not lending and instead betting against the US dollar, diverting capital into trading commodities and awarding their own executives huge bonuses.

Are you okay with that because I am not.

[BermudaSooner]

I'm not for bailing out the banks to begin with. They must know there are consequences when they make the big bets that they do. So far there are no real consequences. An oil trader at Citibank got a $100 million bonus in July for making $700 million in oil trades. It worked out well, and he has no reason to be cautious on the trades he makes--the US gov't has his back.

[JohnnyMack]

I'm not for bailing out the banks to begin with. They must know there are consequences when they make the big bets that they do. So far there are no real consequences. An oil trader at Citibank got a $100 million bonus in July for making $700 million in oil trades. It worked out well, and he has no reason to be cautious on the trades he makes--the US gov't has his back.

While that sounds good in theory, history has shown that when the
populace doesn't have faith that their money is safe, they do things like make runs on banks. I say an ounce of prevention is worth a pound of cure.

[jkjsooner]

I'm not for bailing out the banks to begin with. They must know there are consequences when they make the big bets that they do. So far there are no real consequences. An oil trader at Citibank got a $100 million bonus in July for making $700 million in oil trades. It worked out well, and he has no reason to be cautious on the trades he makes--the US gov't has his back.

The trader got a $100 million bonus for trading other people's money?

Seems to me there's no need to be cautious with or without the US backing. Our bonus structure is a head I win tails you lose proposition either way.

Do you think this guy cares if next year he loses his job because his risky bets didn't pay off? Do you think next time he would be more conservative just because he once lost a job due to risky bets (and also made a hundred million)?

I agree the govt has encouraged a moral hazard but we've long since institutionalized our own moral hazards.