USD Yield Curves, LIBOR, Quant Easing and the new carry trade...

[MichaelW]

Guys,

This is a topic near and dear to my heart which I don't think has been getting enough attention here and warrants some discussion. I'm not an expert so I hope the likes of Token Funder and others with more knowledge of this space can help shed some light on likely implications of the current state of play.

To kick things off, here's a nice article which talks to some of the issues:

http://www.ibtimes.com/articles/20090923/yield-curves-fx-libor-trends.htm

While FX trading seems to become increasingly bifurcated (broad USD weakness & broad JPY strength or vice versa), the unfolding trend remains a concerted move away from the QE currencies (USD, GBP) and into the commodity/high yielders as well as the EUR. Emerging talk on whether the US dollar has become the new low-yielding vehicle for carry trades financing equities, commodities and currencies vehicle highlights the difference between the USD and JPY carry trades.

Yield Curve Steepening and Dollar Flattening

The chart below shows the US yield curve (as measured by the 10-2 spread) has peaked out at 2.60-2.70% in each of the last easing cycles (1991 & 2001 recessions). Thus, each time the 10-2 spread neared 2.70%, the FOMC was at the end of its easing cycle. This time, the two main forces that could help the current steeping exceed the highs of 1992 and 2003 are soaring US govt debt and secular decline in the US dollar.

Here's another nice article covering LIBOR's trajectory:

Key lending rate sinks to record low

NEW YORK (CNNMoney.com) -- A key bank-to-bank lending rate fell to its lowest point on record Wednesday, signaling continued easing of the once-frozen credit markets.

Three-month Libor fell below 0.30% (0.269869%) for the first time since the British Bankers' Association started keeping records in 1986. That's a far cry from where rates sat just one year ago, when the 3-month rate peaked above 4.8% on Oct. 10.

So we have a 3 month LIBOR at almost zero, yet long dated rates much higher due to all the quant easing going on. My initial question is how long is this sustainable for? History suggests the 10-2 spread tops out at 2.7% so we might be near a tipping point, but the author goes on to suggest there's more QE coming and we might see the 10 rate edge higher still. Even a mention of $1200 gold by year end as an obvious inflation hedge.

My second question is around the implications of the new USD carry trade that has been mentioned by a few commentators. If traders are borrowing USD and investing in the AUD, then what will be the implication of all that money flowing onto our shores. And what is the risk to the AUD FX Rate if the RBA does start rising our cash rate even further and creating an even better carry trade option for those inclined. I see a lot of cash already flowing our way with more to come if our economy remains robust and the RBA starts hiking.

So, more cash in our banks? More lending? Asset bubbles? AUD at USD parity or beyond?

I'll bow out and defer to the Forex experts to help enlighten us ill informed masses...

Thanks in advance,
Michael

 

[toony]

So, more cash in our banks? More lending? Asset bubbles? AUD at USD parity or beyond?

I'll bow out and defer to the Forex experts to help enlighten us ill informed masses...

Please enlighten us/me. I have a Bachelor of Commerce, and I find this bloody heavy and makes my head hurt trying to get my teeth around this one.

 

[boz]

Guys,

This is a topic near and dear to my heart which I don't think has been getting enough attention here and warrants some discussion. I'm not an expert so I hope the likes of Token Funder and others with more knowledge of this space can help shed some light on likely implications of the current state of play.

To kick things off, here's a nice article which talks to some of the issues:

http://www.ibtimes.com/articles/20090923/yield-curves-fx-libor-trends.htm





Here's another nice article covering LIBOR's trajectory:

Key lending rate sinks to record low



So we have a 3 month LIBOR at almost zero, yet long dated rates much higher due to all the quant easing going on. My initial question is how long is this sustainable for? History suggests the 10-2 spread tops out at 2.7% so we might be near a tipping point, but the author goes on to suggest there's more QE coming and we might see the 10 rate edge higher still. Even a mention of $1200 gold by year end as an obvious inflation hedge.

My second question is around the implications of the new USD carry trade that has been mentioned by a few commentators. If traders are borrowing USD and investing in the AUD, then what will be the implication of all that money flowing onto our shores. And what is the risk to the AUD FX Rate if the RBA does start rising our cash rate even further and creating an even better carry trade option for those inclined. I see a lot of cash already flowing our way with more to come if our economy remains robust and the RBA starts hiking.

So, more cash in our banks? More lending? Asset bubbles? AUD at USD parity or beyond?

I'll bow out and defer to the Forex experts to help enlighten us ill informed masses...

Thanks in advance,
Michael

There is nothing new coming up on this, it has been very cheap to borrow in US$ for months and you get over 3% in buying AU$. It is difficoult to quantify how much speculation has already been priced in the current exchange rate, in my opinion it has not much more to go as country like Canada and EU will not allow other currencies to get too weak, Australia trade deficit is also ballooning because of exchange rate, and of course it is not sustainable for long time.
The 3 months US libor rate is even below the one of Japan and only Switzerland is below USA, to get yield so low there is not as much money running out of the US$, even at 0.27% the 3 months bonds in US have plenty of buyers. Banks and people are just saving more and keeping money away from spending, it is not that the FED is that much in control of rates

 

[chilliaa]

http://www.ibtimes.com/articles/20090923/yield-curves-fx-libor-trends.htm

By the time you read this in the retail press, trust me its well in execution stage amount institutional investors and hedge funds. If you join the party now just remember you are significantly behind the 8 ball.

So we have a 3 month LIBOR at almost zero, yet long dated rates much higher due to all the quant easing going on. My initial question is how long is this sustainable for? History suggests the 10-2 spread tops out at 2.7% so we might be near a tipping point, but the author goes on to suggest there's more QE coming and we might see the 10 rate edge higher still.

Guess who is the biggest holder of US treasuries?
No not China, the US federal reserve by a factor of 6. How long can this continue? how long will the market continue to trust the feds buy back of government securities?

Even a mention of $1200 gold by year end as an obvious inflation hedge.

Yeah sure it could do, but let me say one thing gold is currently the hottest speculative asset in town. What is the potential risk when everyone is long on the same speculative asset? This is not to say gold can't go higher, just be very aware that 'everyone' is on this play.


My second question is around the implications of the new USD carry trade that has been mentioned by a few commentators. If traders are borrowing USD and investing in the AUD, then what will be the implication of all that money flowing onto our shores.


This has been in play since around April/May of this year and its getting stronger. I dont have time to go into big details, but basically there was disbelief amongst overseas hedge funds and institutional investors about Australia being able to weather the GFC. Once they saw Australia did pull through, the fast money is flowing fast and furious towards australia.
You get a double bonus: currency appreciation and asset class appreciation.

Australia is not the only one, canada as well.

 

[boz]

Guess who is the biggest holder of US treasuries?
No not China, the US federal reserve by a factor of 6. How long can this continue? how long will the market continue to trust the feds buy back of government securities?

well china doesn't have much holding in US treasury, last time I looked was only few hundred bil$, they invested more in other US bonds I presume like fannie and freddie, but still the FED is by far a small player in US treasury that is worth several times M1


Yeah sure it could do, but let me say one thing gold is currently the hottest speculative asset in town. What is the potential risk when everyone is long on the same speculative asset? This is not to say gold can't go higher, just be very aware that 'everyone' is on this play.

no its not, do you see many taxi driver talking gold lately? I can mention much more people talking about home prices going up, and if it is not home prices share market is the hottest subject, speculation on gold can go much higher.
EDIT: by the way, gold is at 14.5 times oil which is very much close to long term average

 

[chilliaa]

no its not, do you see many taxi driver talking gold lately? I can mention much more people talking about home prices going up, and if it is not home prices share market is the hottest subject, speculation on gold can go much higher

mate im not getting into an argument about this.
Let me just say i get access to information thats not available to the 'retail' public, and trust me this trade is on big time.

 

[boz]

mate im not getting into an argument about this.
Let me just say i get access to information thats not available to the 'retail' public, and trust me this trade is on big time.

good for you,
anyway, here you can get free information about speculation on gold, by the way, have a look at the increasing speculation on AU$ (that is just for future contract not forex)

 

[chilliaa]

Here we go the stuff i was talking about is now hitting the retail news wires:

US Fed holdings of US Securities: Flip through to see who is number 1 and by what factor
http://www.cnbc.com/id/29880401/

Now relate this to the interest rate term spread and the risks:
http://www.cnbc.com/id/33004753

 

[boz]

Here we go the stuff i was talking about is now hitting the retail news wires:

US Fed holdings of US Securities: Flip through to see who is number 1 and by what factor
http://www.cnbc.com/id/29880401/
OK, why don't you look at the FED website if you want to know how much treasury they hold? wednesday the count number was 762 bil$ similar amount then china
Now relate this to the interest rate term spread and the risks:
http://www.cnbc.com/id/33004753

I don't agree with Julian robertson, would be a problem if foreign holder of US treasury will offload it very quickly causing the USD to collapse (but I believe they'll offload other US bonds first). USA foreign debt is not high at all (at least comparing it to Australia or NZ).As I previously point out The point is not about foreign holder of US debt is about debt within US. US is at point of Japan 20 years ago and they had a public debt to gdp similar to USA (around 50% GDP prebubble bursting) and it took 20+ years to get at today point of 200% public debt agaist gdp for Japan, but the overall debt in the country has gone down. So like Japanese start saving and pooring it into public debt the same thing will probably happen to US with a shift from private debt (like mortgages) into treasury and public debt. But of course USA is of a much different size of Japan and a lot of other things can happen and turn the world economy around.

 

[Aaron Sice]

AUD at parity? gotta be kidding - it'll go to $1.12 - $1.15 - well beyond.

the USD is in for some short selling and devaluing. you can't print trillions of dollars and not lose dollar value. you can hold it off, but the inevitable happens.

buy gold and buy lots - coz it's up, up and away, in my beautiful balloon, my beautiful ballooooooon.....

 

[Aaron Sice]

good for you,
anyway, here you can get free information about speculation on gold, by the way, have a look at the increasing speculation on AU$ (that is just for future contract not forex)

*gasp* you mean currency markets and forex trading ISN'T specualtion?!?!?!?

 

[Aaron Sice]

no its not, do you see many taxi driver talking gold lately? I can mention much more people talking about home prices going up, and if it is not home prices share market is the hottest subject, speculation on gold can go much higher.
EDIT: by the way, gold is at 14.5 times oil which is very much close to long term average

ah the old "taxi drivers economy gauge" © (patent pending).

al the more reason to buy gold - by the time taxi drivers have heard about people making money, it's too late.