We’re becoming used to banker-bashing, but in Davos last week Financial Services Authority chairman Adair Turner indulged in a little FX-bashing. He said: “If I could wave a magic wand here and greatly reduce the carry trade, I’m pretty certain the world would be a better place.”
There’s many bankers I know who, if they had a magic wand, would wave it to make his Lordship disappear right now. But let’s not dwell on wishes.
Adair went on to say: “It’s a form of speculative activity where you can’t work out what the value is to the real economy.”
The ‘real economy’ – there was a lot of talk of it at theWorld Economic Forum – is a figure of speech used to separate the world of finance from the ‘real world’ of Joe Public, the voter. Or, as the politicians and regulators will have it, respectively the perpetrators and the victims of the global economic mess.
Zhu Min of the People’s Bank of China was also concerned about the carry trade build-up. “To me, the big risk this year is the dollar carry trade. It is a massive issue – estimates are that it is $1,500 billion – which is much bigger than Japan’s carry trade.”
Carry trade strategies will inevitably exist when currencies are floating and freely convertible. And for investors looking at near-zero yields, they seem a possible means of positive returns. The carry trade can’t be magicked away. It can be made less viable however, at least for institutional players, by regulatory change.
Unilateral change will not be the way forward, despite Obama’s rhetoric (by the way, has anybody pointed out the size of US taxpayer losses that are due to the Fannie Mae and Freddie Mac bailouts?). Any new, sustainable, regulatory regime will proceed from the recommendations of the G20’s Financial Stability Board, on which Turner sits. However, the FSB looks unlikely to report before the end of the year. By which time the Fed will probably have started to hike rates and dollar carry positions will have begun to be unwound.
Hopefully the unwind will not be as savage as the PBoC fears. Whether or not peak exposure got anywhere near Zhu Min’s extraordinary estimate is hard to say, but there are grounds for thinking that it has come and gone. Since the beginning of December the USD index is up 6% and the dollar is 3% stronger against AUD. And this week’s unexpected rate pause by the Reserve Bank of Australia has been a reminder that the carry trade, like any trade, is not a dead cert.
Currency pairs: Turner, Potter