'Carry' On!: All In The Search For Yield
A: I realize this is not a direct discussion of Manhattan real estate, but then again, when the ABX's started to plunge in the fall of 2007 that was also a topic I felt worth discussing as a sign that maybe a problem could be brewing in the secondary mortgage markets that could possibly signal a credit event and a stress to the banking system; a ripple effect that could and did ultimately hit out our markets. We have to continue to think outside the box and talk about the stuff that is not in the rear view mirror, but that may lie ahead of us and impact our markets. This is not a fear tactic, its a discussion of one possibly big unintended consequence of policy actions that were taken to stem the debt-deflationary episode we just went through to avoid a second depression. The latest warning comes from China's chief banking regulator. Meanwhile, Money Market Mutual Fund Assets continued their decline to almost $500Bln YTD.
I discussed the extreme positive carry that trade that is on a few weeks ago:
"With the fed guaranteeing everything and engineering such a low interest rate environment (basically to recapitalize our banks), almost all assets got a strong bid; yes, the crappy ones too. AN EXTREME POSITIVE CARRY TRADE IS ON!!Two days later, doom & gloomer Professor Nouriel Roubini released a statement on how 'the mother of all carry trades faces bust'. Now, China's chief banking regulator comments on the massive speculation built on the foundation of a dollar carry trade that is powering asset prices across the world. The WSJ reports "China: Loose US Policy, Weak USD Creating Speculation":
China's chief banking regulator on Sunday sharply criticized loose U.S. monetary policy, including the weak U.S. dollar, saying the situation is creating massive speculation in global asset markets.At some point this will end! For now, wall street is too focused on maximizing profits while the game is still on.The U.S. Federal Reserve's promise to keep U.S. interest rates at extraordinarily low levels for an extended period "has already led to a massive U.S. dollar carry trade and massive speculation," Liu Mingkang said at the International Finance Forum in Beijing, which began just hours before U.S. President Barack Obama was scheduled to land in China on his first ever visit.
Liu said that the weak U.S. dollar and low U.S. interest rates are creating "unavoidable risks for the recovery of the global economy, especially emerging economies" and that the situation is "seriously impacting global asset prices and encouraging speculation in stock and property markets." In such a trade, investors sell currencies with low interest rates to buy higher-yielding units - a common theme in the foreign exchange markets that has already put the dollar under pressure in recent months.
The only reason credit is flowing in the short end, in libor, in agencies, in everything for that matter is because of the gov't guarantee that nothing will fail. Liquidity started with the fed and was multiplied by the street and global investors. Fed policy, post Lehman, is clearly that no large firm will be allowed to fail and as a result, excessive risk is being taken as investors are being forced to the outside of the curve to get return. It is no different than the last time. Money market fund assets are dropping like a stone as investors take on risk such as high yield junk bonds, stocks...basically everything all in the search for yield!
Here is a chart courtesy of my old trading buddy Anthony over at Momentum Trading Partners, showing us the YTD decline in money market fund assets as dollars chase yield:
Now that is money looking for return! Another clear of example of this is the disconnect between plunging commercial real estate prices and rising defaults in the commercial sector all while bids for CMBS surge. All asset classes have been affected.
Hard to time the end of this game or to predict the spark that may light the fire. Maybe its China? Maybe something else. Who knows - for now its ride the carry gravy train for as long as possible. One thing I learned about speculative episodes is that it they usually last far longer than people think and well after the alarm bells first start to go off. The unwind then occurs when the story is too dated to make headlines.
Comments (16)
Noah, sorry - totally unrelated - what's the deal with inventory going down...any thoughts?
Posted by Random? | November 16, 2009 3:07 PM
I think the market is experiencing:
1) good activity
2) good amount of listings being removed from market; for numerous reasons
3) fewer new listings hitting market; likely waiting for late JAN
Posted by Noah | November 16, 2009 3:50 PM
Noah, what are some of the initial signs that may indicate the positive carry trade unwind is upon us?
Posted by Danny Abajian | November 16, 2009 4:00 PM
Noah, what are some of the initial signs that may indicate the positive carry trade unwind is upon us?
Posted by Danny Abajian | November 16, 2009 4:00 PM
the main sign will be a sharp, fierce rally in the US dollar and likely a similar fall in commodities/stocks. I wonder how metals will react as they may disconnect a bit given the nature of the crisis and actions taken across the world to stem it.
we should be able to spot it when it starts. Then its a matter of whether trading dynamics kick in and we see a crowded trade rush for the exits - this has been building for 7-8 months now so an orderly unwind is of course possible, but usually unlikely. time will tell. my eyes are open
Posted by Noah | November 16, 2009 4:13 PM
The warning sign will be a jump in options volume for vix call futures.
Posted by In Debt We Trust | November 16, 2009 11:14 PM
Noah,
I think this is a great article indicating a problem ahead. However, I am not sure I fully understand the consequences for US real estate (and in New York in particular) (or the sequence of events that should/could be occurring)
Could you maybe add a bit more explanation?
thanks!
Posted by Consequences? | November 17, 2009 9:27 AM
can you elaborate more - why likely waiting for late Jan? Is that a cycle thing - get through holidays and list for spring? Thanks...
Posted by Random? | November 17, 2009 3:45 PM
Noah, what are your thoughts on volume?
http://www.zerohedge.com/article/no-volume-whatsoever
Posted by Anonymous | November 17, 2009 4:55 PM
Noah, how do these tax increases compare to expectations? (i.e. built into pricing already?)
http://wcbstv.com/politics/nyc.property.tax.2.1318668.html
Posted by Realist | November 17, 2009 8:30 PM
sorry guys, on small trip in Maine and limited access to web...wife birthday, so will answer these when I get back and me and my dogs are out of our orange "dont shoot me" gear for hunting season here.
Posted by Noah in Maine | November 18, 2009 9:02 AM
consequences - well if the carry trade unwound in a fierce way you will see a rush for the exits by a very overcrowded trade. the dollar will fly, stocks will plunge, who knows how much maybe 10-20%, in a short period of time (imagine the Dow falling 2100 points in 3 or 4 weeks - just like china did after a HUGE rally and the govt talked about curbing bank lending), and how it may affect wall street trading profits in a time of fragility.
It ripples. Im not saying it happens this exact way, but if it happens the markets usually do overreact before finding equilibrium. Amazing to me how with this rally short term bond yields are still so low as money is parked in safety. Look at Bill Gross and what he is doing with his money!
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aN78quNzqd5Y
"Gross boosted his $192.6 billion Total Return Fund’s investment in Treasuries, so-called agency debt and other U.S. government-linked bonds from 48 percent of assets in September while reducing his position in mortgages to the smallest since May 2004, according to data on Pimco’s Web site yesterday.
Gross said in his December investment outlook last week that the “systemic risk” of new asset bubbles is rising with the Federal Reserve keeping interest rates at record lows. Under what Pimco has termed the “new normal,” investors should be prepared for lower-than-average historical returns with heightened government regulation, lower consumption, slower growth and a shrinking global role for the U.S. economy. "
The man does know a few things!
Posted by Noah | November 24, 2009 9:58 AM
Realist - i saw that, just getting back to my groove here. I will tell you I just LOST A DEAL because a coop unit, 800 sft 1BR, found out the re taxes have been reassessed higher and the monthly hit on the unit my client had a deal for was just under $400/mth, starting Jan 1st. Im told coop is fighting this assessment and it could take a year or so to get results. It affected the deal because of when it came out, after offer was accepted and right before attys got started
Posted by Noah | November 24, 2009 10:03 AM
Dude, did you get lost in the snow?
Posted by OT | November 24, 2009 10:11 AM
ha, nope Im here...just busy!
Posted by Noah | November 24, 2009 10:55 AM
I should probably be able to figure this out myself, but explain why the dollar would rally in this scenario? I am guessing due to "flight to quality" amongst those who hold U.S. financial assets (stocks, etc.), but wouldn't that be canceled by a covering on short term borrowing (used to fund those asset purchases in the first place)? Or are we talking about long-only participants who would just move into dollars, cash (as opposed to short US gov)? But that makes no sense either. I've got an MBA from Stern, I really ought to be able to figure this out, but it eludes me.
Posted by Mike | December 3, 2009 6:12 PM