Rebounding dollar will hurt risky assets
Jan 08, 2010
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A key reason the dollar was so weak last year was the dollar carry trade, whereby investors borrowed greenbacks at near-zero interest rates, and invested in higher-yielding currencies or other risky assets.
According to Credit Suisse, the dollar carry trade could be worth $1.4trn-$2trn. That would imply sharp falls in risky assets ranging from developing market currencies and commodities to stocks if the dollar rebounds and investors rush to close their short dollar positions.
So which currencies would be most vulnerable to a reversal of the carry trade? The ones that rocketed last year as investors chased high yields. The Brazilian real rose by 34% against the dollar last year, followed by the Australian and New Zealand dollars (28% and 25%) and the South African rand (24%).
Interest rates in Brazil and South Africa are at 7% and 8.75% respectively, and 3.75% in Australia. The antipodean dollars, apart from being commodity currencies, also "benefited strongly from their links to Asia", which appears to have weathered the global downturn well, says Geoffrey Yu of UBS.
Elizabeth Andrew of Nordea Markets reckons that the real and the rand are most vulnerable to investors unwinding their carry trade bets, while UBS's Di Luo recommends selling the Hungarian forint. John Cairns of Rand Merchant Bank expects a dollar recovery to knock 9% off the rand-dollar rate by the end of 2010.
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