Forex Investment and Currency Trading

Deleveraging

Global markets are deleveraging. In the process there is distress selling. There is also a lack of differentiation. Currency positions are being unwound across the board. The main beneficiaries of this are the USD, the JPY, and, at least on the crosses, the CHF. The tables have turned, and the once funding currencies of carry trades are staging a comeback. The biggest victims are the so-called high-yielding currencies. The Australian dollar (AUD), Turkish lira (TRY), Brazilian real (BRL), and South African rand (ZAR) are under immense pressure, and are down by 22.22%, 23.53%, 16.41%, and 29.85%, respectively, year-to-date through 11 November. It was not that long ago that the Icelandic krona was one of the favourite carry trades in FX markets, and it is currently down by 50.38% year-to-date.
Deleveraging is already taking place at a breathtaking rate. Carry trades are under pressure. Foreigners are no longer so eager to borrow in JPY. Despite the rate of change, years of leveraging cannot be reversed in two months. The process of deleveraging is nowhere near completion. It is therefore difficult for one to expect carry trades to gain in popularity anytime soon.

Flight to liquidity

The most liquid market right now is the market for US treasury bills. Flows into US Treasury bills are on the rise, with the yield on 3-month T-bills dropping from 3.32% at the beginning of the year to 0.48% currently. This is supporting the US dollar. It has been described as a flight to quality. We beg to differ. The US economy is running twin deficits (still), the financial sector is a mess, debt levels for both consumers and the government are high, and the economy is heading at full speed into a recession that will probably be deeper and longer than once anticipated. This can hardly be described as quality. Fundamentals have been thrown out of the window. Liquidity is at a premium. As long as this continues, and it should continue at least until halfway through 2009, the USD should remain supported. Only once sentiment calms down will the market start refocusing on fundamentals.