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Foreign Exchange

Living in a deleveraging world

Was leverage responsible for driving some FX rates to extreme levels? And is its withdrawal causing those same rates to move back to their longer-term equilibrium rates in some cases and below them in others?

Many years ago, FX legend Andy Krieger explained part of his trading style to me over a nice lunch in New York. Krieger was clearly an early exponent of leveraged trading and he said that in his view, there was no point in being right in 10 if you could be right in 100.


I was never able to trade that way; I was not able to detach myself from my P&L, which may explain why the attraction soon wore off for me. But the subsequent emergence of a huge leveraged trading community suggests that others were.


The world is changing now though and it looks like we are going back to basics. And this got me thinking: was leverage responsible for driving some FX rates to extreme levels? And is its withdrawal causing those same rates to move back to their longer-term equilibrium rates in some cases and below them in others?


For instance, depending on who you ask, the long-term equilibrium rate for cable is somewhere around 1.60 to 1.65, for EUR/USD it’s around 1.20 to 1.25. Has the sudden reversal been caused because the highs were exaggerated by the flood of leveraged carry trades being put on? Talking around, it seems this is a plausible theory.




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