Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.
Dear Professor Succo,
I agree that the carry trade is the dominating structural force at work right now - one just needs to look at the correlation between various asset classes (and U.S. dollar) to determine as much. However, isn't it too simplistic to lump all asset classes into a single cause/effect relationship and timeframe? For instance, isn't it probable that different asset classes have been impacted by varying degrees by the carry trade? And assuming that premise is correct, couldn't some unwind faster than others? I sense from your writings that the process is/will be binary for all asset classes. Thanks.
This question is spot on: a rise in rates will affect the value of all assets, but affect them at different rates.
As I have described, the carry trade in my mind is simply borrowing money and buying assets with it. In a more traditional sense it is borrowing money short to lend it long (buying an interest bearing security) to earn a spread in rates. In a less traditional sense it is borrowing money short to buy a non-interest bearing security, like a car, for value that can be measured in service.
A rise in rates curtails both, but at different rates. To know these different rates it would require an exact knowledge of the shape of the propensity for demand curve for each asset. I don't know this, but I can guess.
I think the more traditional carry trade would be curtailed first, but not by much. As the spread between short and long rates narrows, traders who are highly levered would unwind this quickly.
For the less traditional carry trade, which has less to do with the financial system and more to do with the real economy, I view the demand curve normally flatter: it would take a larger increase in rates to quell the demand for cars and houses.
But because the consumer is so levered this may not be the case and demand for hard assets could falter very quickly along with financial assets.
The key variable is leverage: the more levered the consumer, the more they will be negatively impacted by a marginal increase in rates.
No one knows for sure what this demand curve looks like. The Fed is definitely trying to determine this, feeling out the markets as they tip-toe around higher rates.
My guess is that consumers are very sensitive to higher rates and lower demand from higher rates for financial assets will be quickly followed by lower demand for hard assets.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Daily Recap Newsletter