Carry Trade Beginning To Unwind

Nearly two months ago, China’s stock market declined 15% in one session, leading capital markets around the world to drop off precipitously. This collapse quickly spread to forex markets, where spooked traders began to unwind their Japanese yen carry trades, fearful that the volatility would trigger a short squeeze, causing the Yen to rapidly appreciate. While the yen has returned to its former low levels, it seems foreign investors have prudently unwound up to 60% of their short positions in the Yen, anyway.

A quandary has plagued analysts, who are attributing the failure of the Yen to appreciate to a surge of carry trade interest by Japanese retail investors. Long term Japanese interest rates remain pathetically low, and Japanese investors have taken to buying securities in American and Australia, where yields are significantly higher. However, if Japan's Central Bank begins to raise rates- as analysts expect will take place as soon as May- investors could be persuaded to repatriate their capital to Japan. The Economist reports:

Retail investors’ direct share of Japan's foreign-currency market may be 20-30%, whereas individuals’ holdings of foreign currency exceed foreigners' holdings of Japanese securities. The clue to the yen's future, in other words, lies with the little man.

Dollar Hinges On Economic Data

This week witnessed a flurry of economic data, capped by tomorrow’s scheduled release of employment and GDP statistics. At the beginning of the week, the perennially pointless monthly durable goods statistics indicated a rise in durable goods orders, which Dollar bulls interpreted as a good sign. However, real estate data indicated a lower-than-expected rise in new home sales as well as a dramatic decline in the sale of existing homes. Polled economists are predicting that tomorrow’s news will likely fall into the dovish category, painting a picture of an economy that has already peaked and making the case for the Fed to hold interest rates at current levels. However, the bond markets are still pricing in 1-2 rate hikes over the near-term, which currency markets may use to prop up the Dollar. The Daily Reckoning reports:

Money supply growth has a negative impact on the dollar. Inflation is a currency killer, and looking at the broadest measure (M3), money supply growth is out of control.

New Forex Products To Meet Rising Demand

Anecdotal evidence that forex trading is expanding rapidly can be found everywhere these days, from the decline in volatility wrought by a surplus of liquidity, to the proliferation of websites and companies that offer guidance to retail currency investors. Lured by the most liquid market in the world and 100:1 leverage, hedge funds have also piled in currencies. As a result, in its not-yet-released annual report, the Bank of International Settlements is expected to confirm that daily forex volume now exceeds $3 Trillion, up from $2 Trillion in 2004! Wall Street investment banks are springing into action to meet this growing demand for forex products and services. This week, Citigroup launched an ETF based on “common FX strategies. Credit Suisse, meanwhile, launched an index that lets investors mimic the carry trade.