New York: The US Federal Reserve left the benchmark federal funds rate unchanged in the 0-0.25% range on Wednesday. The Fed also stuck to its commitment to keep borrowing costs near zero for “an extended period”. Commenting on this, Nouriel Roubini, chairman of New York-based economic and financial analysis firm RGE Monitor, said the dollar carry trade is larger than before.
Cautious: Roubini says the asset bubble is going to become bigger globally and the bigger the bubble, the bigger the crash. Jin Lee / Bloomberg
The carry trade is a popular trading strategy used in the foreign exchange market where investors borrow in the currency of a country where interest rates are low and lend the proceeds in the currency of a country where interest rates are higher in hopes of profiting from the difference.
“Everyone is buying dollar at almost zero rate,” Roubini said in an interview, adding that this could lead to a unravelling of this carry trade. Edited excerpts:
You were with us a couple of weeks ago and we talked about this giant carry trade and fears of a new bubble as cash pours in. Are you seeing any turn in that trade?
My view is that this carry trade is actually becoming larger than before. The US has zero interest rates, (and) the Fed is expected to keep rates at zero for the foreseeable future.
So everybody is borrowing in dollar, the dollar is weakening, you can borrow at zero rates. Given the dollar weakening, you are actually borrowing at significantly negative rates of minus 15-20%, given how much dollar has fallen.
The traditional carry trade was just buying high-yielding currencies and assets like in Turkey, in Australia, in Brazil, where interest rates are higher. But now you can do the same carry trade in oil, energy commodities, in global equities, in credit, in almost every risky asset class.
This asset bubble we have seen since March, where asset prices have gone up globally across the board in a perfectly correlated way by 60% or 100% in emerging markets, is explained by this huge massive mother-of-all carry trades where the US dollar has become the funding currency for them.
Does the fact that the dollar is at or close to its one-month high change your view in anyway? Is there no way that the dollar could suddenly revalue up and pop or at least deflate some of this bubble?
The dollar moves trend-wise down and has been falling since March significantly. There has been a slight correction of the dollar upward but that is minor. My concern is that this carry trade is going to continue for a while because as long as the Fed is on hold, expect to stay on hold, and as long as the Fed keeps volatility on the long end of the yield curve low, then volatility is low and it is safe to take these carry bets and do it more and more again.
There is going to be eventually an unravelling of this carry trade. And once it is going to occur, you will have a very sharp snapback of the dollar like it happened a couple of years ago in the case of yen when the carry trade unravelled.
When the snapback of the dollar occurs, it is not going to be 2% or 3%, it is going to be more like 15% or 20% and then everybody will have to close their shorts on the dollar, they will have to sell these risky assets across the world.
Then you could have a huge asset bubble going into an asset bust. I don’t expect that, however, to occur in the short run because, for the time being, the Fed is on hold, they expect to stay on hold, they are not even finished buying all the treasury and agency debt. So it is going to eventually occur, but it is going to be six months from now or a year from now.
In the meanwhile, the bubble is going to become bigger globally and the bigger the bubble, the bigger is going to be the crash.
Can this be orderly in your view, for instance if the Fed changes their language, may be not today, but early next year, can they project some clarity to the market, to the point where the dollar does not snap back so violently?
I worry that as soon as there is going to be a shock like the Fed signalling that they are not going to buy any more treasuries, RMBSs (residential mortgage-backed securities), or the Fed is going to start increasing rates, or you could have other types of surprises. Like for example, if you are going to have a U-shaped kind of recovery, or a double dip, then there will be an increase in risk aversion, and like last year, when risk aversion goes up, the dollar snaps back.
So right now we are creating such a large amount of carry trade. Everybody believes they are smart because they are long in risky assets and they say, I am keeping my finger on the trigger and I am going to get out of it as soon as there is a significant reversal of the dollar. It is like a rush to the exit. When everybody is going to try to do that at the same time, there will be a stampede, risky asset is going to collapse, and the dollar is going to snap back. So the risk is that there is not an orderly way of doing it unless you more aggressively signal, and central banks are not doing it, they are going to phase out this quantitative easing sooner rather than later. But that is not what the Fed is telling us, that is not what the other central banks are telling us.
The carry trade has played a big role in what has been happening but it seems like your thesis is going to count out any ideas that some of this growth in the overseas markets is coming because they have seen real growth, they have seen a lot of spending, they are still buying and snapping some of the stuff up. Do you discount any of that in the equity build that we have seen around the globe?
No, I totally agree that of the increase in risky assets including equity, a good chunk of it could be due to fundamental improvements. We avoided near depression, asset prices should be higher. There is light at the end of the tunnel regardless of whether it is a V or a U-shaped recovery, asset prices should be higher. We are now having lower risk aversion, and therefore, investors are moving away from lesser risky assets like short-term treasury into equities, commodities, credit and emerging market asset classes.
So part of that increase in asset prices is fundamental. But that has become so rapid, so fast and so perfectly correlated across the world. In emerging markets, asset prices have gone up by 100-150%. The real evidence are now in China and Asia; real estate, commodities, equity are getting out of hand, price-earning ratios are out of hand. So it is a signal of a bubble and that is what many policymakers in this country are also concerned about.
There is a clear case that part of this increase in asset prices is not just fundamental but this is the beginning of a very risky asset bubble like we had before and we know what happens when an asset bubble goes bust. And now it is global, it is not just the US asset bubble.
So you don’t believe there is any chance that economic fundamentals—jobs, housing, anything like that or capex, business investment—can catch up in time for this bubble not to happen?
My fundamental view is that there is going to be a recovery, but it is going to be U-shaped rather than V-shaped because the labour market is extremely weak. There is no labour income; consumers are shopped out, saving less and debt-burdened. They have to save more, consume less that means lower growth, capacity utilisation is 70%. Why would anybody want to do capex when the total capacity is not utilised and globally right now you have a situation in which an overspending country like the US are retrenching while over-saving countries like Japan, China, Germany are not compensating with an increase in their own demand and that means lower global economic growth.
Finally, the fiscal stimulus is going to become a fiscal drag by the middle of next year. So you put all these factors together; to me it looks like a U-shaped recovery when the markets are pricing in a V-shaped recovery that they don’t see in the data.
Your critics will say that now Roubini is trying to find a framework in which to explain the huge market rally that he missed since the beginning of the year.
As I said, the fundamentals explained part of the market rally. But if you look around the world, policymakers in Asia and in Latin America are becoming so worried about this hot money flowing in that they are intervening aggressively with spot and forward intervention. They are intervening like in Brazil. We are essentially having capital controls. And at the G-20 meeting of the finance ministers and governors of the central bank, this issue of the asset bubble is going to be front and centre of their debate. It is not just Roubini is worrying about it. Globally, people have started to worry about it because it is getting out of control. That is the reality of it.