Carry trades fuelling ‘huge' asset bubble.

JOHANNESBURG - Investors worldwide are borrowing dollars to buy assets including equities and commodities, fuelling "huge" bubbles that may spark another financial crisis, said New York University professor Nouriel Roubini.

"We have the mother of all carry trades," Roubini, who predicted the banking crisis that spurred more than $1,6trn of asset write downs, said. "Everybody's playing the same game and this game is becoming dangerous."

Roubini explains that investors who're "shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates - as low as negative 10 or 20% cent annualised - as the fall in the US dollar leads to massive capital gains on short dollar positions".

"Let us sum up: traders are borrowing at negative 20% rates to invest on a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade. Every investor who plays this risky game looks like a genius - even if they are just riding a huge bubble financed by a large negative cost of borrowing - as the total returns have been in the 50-70% range since March," he writes in the FT.

In effect, say Roubini, this has become "one big common trade - you short the dollar to buy any global risky assets".

The dollar has dropped 12% in the past year against a basket of six major currencies as the Federal Reserve, led by Chairman Ben Bernanke, cut interest rates to near zero in an effort to lift the US economy out of its worst recession since the 1930s. Roubini said the dollar will eventually "bottom out" as the Fed raises borrowing costs and withdraws stimulus measures including purchases of government debt. That may force investors to reverse carry trades and "rush to the exit", he said.

He supposes that the "combined effect of the Fed policy of a zero Fed funds rate, quantitative easing and massive purchase of long-term debt instruments is seemingly making the world safe - for now - for the mother of all carry trades and mother of all highly leveraged global asset bubbles".

This carry trade bubble will get worse, believes Roubini: "if there is no forex intervention and foreign currencies appreciate, the negative borrowing cost of the carry trade becomes more negative. If intervention or open market operations control currency appreciation, the ensuing domestic monetary easing feeds an asset bubble in these economies. So the perfectly correlated bubble across all global asset classes gets bigger by the day".

Why could this all unravel? Roubini says that once the dollar stabilises (since it cannot fall to zero), the cost of borrowing in dollars will become zero, as opposed to highly negative. Secondly, the Fed's trillion-dollar purchase plan will end next year. Also, if US growth continues to surprise on the upside, "markets may start to expect a Fed tightening to come sooner, not later". Lastly, there could be a "flight from risk prompted by fear of a double dip recession or geopolitical risks" which would trigger a dollar rally.

"The risk is that we are planting the seeds of the next financial crisis," said Roubini. "This asset bubble is totally inconsistent with a weaker recovery of economic and financial fundamentals."

Roubini concludes in his FT opinion piece, stating that "The Fed and other policymakers seem unaware of the monster bubble they are creating. The longer they remain blind, the harder the markets will fall."

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thats a big understatement the next leg down will make the feb/march lows look like a picnic, fundamentals and techinal charts point to a rise in the dollar and a fall in assets in general, even gold by francois on November 02 2009, 17:09 Find this comment inappropriate? Report it

Useful article..... MNYWB providing financial analysis (even 2nd hand?). Thought that was reserved for FW and FM??? Encouraging by Clueless on November 02 2009, 17:48 Find this comment inappropriate? Report it

Interesting Very interesting. Hmm by cwf on November 02 2009, 18:32 Find this comment inappropriate? Report it

@clueless Makes a nice change from their vacuous ideology pushing agenda. by Cluedup on November 02 2009, 18:38 Find this comment inappropriate? Report it

probably will happen sooner or later - get set, ready, GO! da by not bad on November 02 2009, 21:51 Find this comment inappropriate? Report it

THEN WHEN DOES ONE HIDE If this is the case then, where does Joe Soap put his money? by newbie on November 03 2009, 07:27 Find this comment inappropriate? Report it

my two cents I believe that the financial calamity that will hit the US, Japan and Europe (the recent 'crash' was just foreplay) will power the further rise of India and China and will substantially benefit the next tier of Aus, NZ, Singapore, S Korea, Abu . .more Dhabi, Brazil, Argentina, RSA & Canada - I also believe that Africa will benefit hugely - the next 20 years are going to be one hell of a ride ..... . .less by pamplona on November 03 2009, 08:35 Find this comment inappropriate? Report it

@Clueless Irrespective the article does give a reader food for thought. You are sure starting to sound like a belligerent old f@rt who presently seems to be shortchanged by his wife!!!! by Ohpis on November 03 2009, 09:34 Find this comment inappropriate? Report it

He got it right and warned last year... worth paying attention to Roubini... again... and to MNY... this is the type of news worthy info we need to consider... by Guessing on November 03 2009, 10:19 Find this comment inappropriate? Report it

@Koos Sounds like Piet runs an escort agency! by Joker on November 03 2009, 11:03 Find this comment inappropriate? Report it

Alternative classes of investments... hedge funds... FI funds (which were the best performing asset class last year)... commodity funds... SRI funds... The question to ask is the severity of the bear market to come... 2 years, 3 years, 5 years, 7 years, 15 years? What asset . .more class would benefit your risk appetite then? . .less by where to hide... on November 03 2009, 12:36 Find this comment inappropriate? Report it

@pamplona africa, argentina? by sonja on November 04 2009, 08:50 Find this comment inappropriate? Report it

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