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Thursday, April 28, 2011

Cheap Dollars keep flowing outside United States: reason for weakening dollar !!

US Dollars
US government continue its easy monetary policy to stimulate weak US economy, It has maintained an interest rate at historically low. This means investors borrow dollars without paying any interest on them and keep buying higher yielding assets,currencies, metals, oil and other high yielding investment assets. The situation make the dollar more weak as investors demand higher yielding currencies and precious metals to exchange US dollars as there is no good returns in US investments.

For Example popular yen carry trade, which involves borrowing yen at Japan's near-zero interest rates to purchase other higher-yielding securities such as Treasuries. In a similar manner dollar is being used to fund higher yielding investments.

The Barclays' G10 carry excess return index shows that borrowing in low-yielding currencies such as the greenback and buying those with high interest rates like the Australian dollar has generated returns of about 37 percent so far since the end of the financial crisis in early 2009.

If we see the numbers dollar index has dropped 10 % since its peak in january and crude oil futures up 23 % so far in the year 2011. The Thomson Reuters-Jefferies CRB index, a global index of commodities, is up 10 percent.

It is a preferable choice for investors to borrow dollar and invest them in other currencies.

The risk involved with the current monetary policy of US is easy money driven asset bubbles formation and eventually confidence lost in economy. For Example developing countries like China and India are struggling with very high inflations and tightened up their monetary easing policy to control inflation and food prices and easy money from United states kept pouring in these economies to inflate them. When this easy money policy ends, liquidity sucked out of developing countries and bubble busts.

Feasible Alternative

For some investors, using the dollar in carry trades remains the only feasible alternative to other low-yielding currencies such as the yen and Swiss franc.While the yen yields an interest rate of zero, like the dollar, the Japanese currency could strengthen if the economy goes into recession. Since Japan has huge overseas investments, a recession would prompt a repatriation of domestic investors' funds to bolster savings, boosting the yen.

The Swiss economy is in much better shape than the United States and a rise in inflation there could well prompt the Swiss National Bank to raise interest rates, much like the European Central Bank did early this month.

Although dollar is a big short among hedge funds, fund managers become more cautious and reduced their short positions in dollar due to the risk of crowded trade.

In a crowded trade, there is a risk of huge losses. For example, if global stocks drops or risk factor rises investors close out their short positions of carry trades and start buying the shorted currency for example dollar here. So investors and fund managers have to be cautious and minimize risk positions as such condition swirl up.

This happened in 2008 during the global financial crisis see below links and could well happen again.

( Source  Thomson Reuters )


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