L’action des banques centrales (Fed, BCE) pour réduire le stress sur les marchés souverains et reflater le prix des actifs (physiques et financiers) a un impact négatif sur le dollar et crée un environnement compliqué pour les opérations de carry-trade, selon les analystes de JPMorgan.
« For the second time this year, the Fed and ECB have triggered a dollar collapse through near-simultaneous commitments to ultra-easy money. The first episode occurred in late January, when the FOMC pushed its rate guidance from mid-2013 to late-2014 after the ECB promised two long-term repo operations. The current selloff is unfolding as the Fed commits to open-ended asset purchases just a week after the ECB pledged unlimited buying of peripheral debt if and when countries enter an EFSF/ESM program.
There is something in this pattern for the conspiracy theorists and currency warriors alike, since Bernanke and Draghi were practically classmates and since several central banks seem to be pursuing currency debasement in tit-fortat fashion. Leaving aside the conjecture and the hyperbole, their policies create a tricky environment for the carry trade which we, like most investors are moving further into this week. The current liquidity environment is dollar-negative and carry-positive given rare central bank promises to anchor funding rates, buy assets and contain tail risks, all at a time when investors are close to neutral in dollars. The complications are that inflation expectations are so much higher now than at any previous QE launch, which politicizes the easing; the odds of growth lift are low given ongoing fiscal tightening in the G4 and rebalancing in China; and valuations on most high-yield currencies are poor. But those concerns won’t be relevant until later this fall. For now, widen the set of trades benefitting from a weaker USD and less tail risk in Europe.
Although the world’s three biggest central banks – plus the Bank of England and Swiss National Bank – have been engaging in various forms of QE all year, the dollar has been the biggest casualty so far. It is down 3% tradeweighted, outdone only by the declines in IDR, BRL, ARS and GHS (chart 1). This momentum surprises some who think of all balance sheet expansions as equal and therefore offsetting as far as their currency influence. Not true: as we have outlined before, balance sheet expansion entails positive and negative effects on currencies, so the central bank’s decision on how and when to deploy liquidity is critical. The currency-positive effect is lower default risk if the central bank targets distressed assets (ECB). The negative effect is lower real yields if asset purchases push nominal rates down and inflation expectations up, as all central banks are doing to varying degrees. If default rates decline, this impact is positive where investors are underweight the currency as a credit hedge (euro), since QE drives short-covering. If real rates fall, QE is more negative if the country is a capital importer (US) or if investors had been long the currency (USD in 2009) or close to neutral (September 2012), since investors will fund carry trades in the lowest-yield market.
From this perspective it should be clear why the Fed will have much more luck weakening the dollar with its balance sheet than will the ECB or the Bank of Japan. Fed QE is driving up inflation expectations more quickly and from a higher level than is the ECB of BoJ (chart 2); the US is the current account debtor amongst the G-3; and investors are roughly neutral between funding in dollars and euros after six weeks of short-covering in the euro crosses. To offset the Fed’s move, the ECB would need to cut rates again.
The beneficiaries will be those currencies offering the highest yield (measured in absolute or risk-adjusted terms), the lowest fundamental vulnerability (measured by the current account), the best valuation (measured by real exchange rate levels or value models) and the least central bank intervention (a country-specific policy call). Chart 4 shows the first two criteria: risk-adjusted 1-mo carry on a range of currencies versus the most-recent reading on the current account balance. The oil exporters (NOK, RUB), EM Asia and HUF come out on top and Latin America in the middle, while commodity exporters running deficits are at the bottom (NZD, AUD, ZAR). The arguments for wning an oil currency are obvious. The merits of NZD and AUD are less clear until one caveats EM Asia and sometimes Latam’s attractiveness for the inevitable central bank intervention and recycling into G-10 currencies, including the euro.
Our reservations about the carry trade are the usual ones: (1) with the exception of CAD, the commodity currencies most want to own are not cheap, as shown in chart 5; (2) asset purchases won’t generate growth given incomplete fiscal tightening in the G-4 and rebalancing in China; (3) easing is coming at a high level of expected inflation, which undermines central banks’ claim that the risks to this policy are minor; and (4) as a consequence, asset purchases are highly politicised forms of easing, so may not be as openended as they appear now. But those are all issues for later this year once it is clearer who will be running Washington and how large the ECB’s balance sheet becomes. The more data-driven stumbling blocks could be Q3 US earnings season which begins October 11; the round of activity data to be released next month as the fiscal cliff nears; the usual China releases; and the unnerving spike in inflation breakevens. It looks like more a dirtylocks than goldilocks, but good enough to motivate adding to our basket of trades which benefit from a weaker USD and less tail risk in Europe. »