Monday, August 9, 2010

Farchy: Dollar faces gathering headwinds

...In July, net inflows from foreign institutional investors into the Indian equity market totalled $3.8bn. The Korean and Taiwanese equity markets each received net inflows of more than $2bn last month. These flows have boosted the region’s currencies. The Singapore dollar is flirting with a record high, while the Indonesian rupiah and the Malaysian ringgit have risen to their highest in more than a year.

The conditions are building, too, for a return of the dollar “carry trade”, in which investors take advantage of low US borrowing costs to invest in higher-yielding assets elsewhere. Given the weaker outlook for the country’s economy, US interest rates are expected to stay on hold at least until late 2011. Hans Redeker, head of currency strategy at BNP Paribas, says his bank’s measure of “carry risk” has peaked, an auspicious signal for for carry traders.

In addition, Volatility has also fallen in the past two months, providing the stable conditions needed for a successful carry trade.

One dollar carry trade has involved buying Indonesian bonds. Foreign ownership of Indonesian bonds has risen to a record, while bond yields – which move inversely to prices – have fallen to record lows. Estimating the size of the dollar carry trade is an inexact science. Tim Lee at Pi Economics, a consultancy, says the dollar carry trade may now be worth more than $750bn, approaching the size of the yen carry trade at its peak in 2004-07. A revival of the carry trade would put further downward pressure on the US currency. In the short term, though, the currency’s direction is likely to be determined by the Fed’s action on Tuesday, with traders saying anything short of a move to ease policy further is likely to disappoint the market...

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