Nouriel Roubini, aka Dr. Doom, has written a damning op-ed in the Financial Times, Mother of all carry trades faces an inevitable bust.
Firstly a carry trade is:
investors borrow low-yielding currencies and lend (invest in) high-yielding currencies.
Firstly, Roubini notes risky asset prices have risen too much, too soon and too fast compared with macroeconomic fundamentals.
Roubini then asks why is this happening?
The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time. Investors who are 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 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions.
and notes the herd think trade behavior going on currently:
it has become one big common trade – you short the dollar to buy any global risky assets
Roubini also notes that the Fed's "buy everything" program has artificially reduced asset risk:
the perceived riskiness of individual asset classes is declining as volatility is diminished due to the Fed’s policy of buying everything in sight – witness its proposed $1,800bn (£1,000bn, €1,200bn) purchase of Treasuries, mortgage-backed securities (bonds guaranteed by a government-sponsored enterprise such as Fannie Mae) and agency debt. By effectively reducing the volatility of individual asset classes, making them behave the same way, there is now little diversification across markets – the VAR again looks low.
All of this is creating a massive carry trade and a global asset bubble.
Roubini continues to outline when this asset bubble may burst and says the Fed. is asleep at the wheel:
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.
ZeroHedge not only agrees with Roubini, but predicts a bubble burst will be harder and faster:
we think Roubini is only half way there, implying that the swift reversal will be even uglier (and swifter) than even Nouriel thinks possible. By that, we refer to our analysis of BIS estimates of dollar-denominated duration funding mismatches.
Pop goes the Weasel.