'Carry' On!: All In The Search For Yield

Posted by urbandigs

Mon Nov 16th, 2009 01:13 PM

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.

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.
At some point this will end! For now, wall street is too focused on maximizing profits while the game is still on.

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:

money-fund-outflows.gif
*Click For Larger Image

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.

Add a comment

16 comments

CAPTCHA Image