The Financial Times carried a long article yesterday by Peter Garnham on the fears for the future of the dollar carry trade. The key takeaway from the article is that China estimates the dollar carry trade to be $1.5 trillion compared to an $1 trillion that was put into the Yen carry trade (the Yen estimate is not from China but from an independent economics firm).
If this is true, then when the U.S. economy improves and the Fed is forced to raised interest rates, a reversal of the short dollar carry trade could send the dollar sharply higher. A stronger dollar will have significant consequences for commodities and equities (think lower gold and oil prices and weaker earnings).
This of course is still a long ways off since the Fed is normalizing monetary policy at a snails pace, which will leave the dollar a cheap funding currency for the time being. Here are some snippets from the article. You can read the full article on the FT site (subscription may be needed).
Fears rise for dollar carry trade future
At the World Economic Forum in Davos last month, Zhu Min, deputy governor of the People’s Bank of China, spoke openly about his biggest fear for global financial markets in 2010.
“To me, the big risk this year is the dollar carry trade,” he said “It is a massive issue. Estimates are that the dollar carry trade is $1,500bn – which is much bigger than Japan’s carry trade was.”
His fear was that the carry trade might start to unwind, pushing the dollar higher and derailing the rally in asset markets that has accompanied the global economy’s emergence from the financial crisis.
It is a sentiment shared by other investors, particularly now that the dollar is strengthening after a prolonged period of weakness last year. Just as the Japanese yen jumped higher following the collapse of Lehman Brothers in 2008, so the dollar could appreciate sharply in the next few months, and assets such as commodities, equities and other higher yielding currencies sell off.