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The Carry Trade And The Danger To Sterling- H S B C

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http://www.timesofmalta.com/core/article.php?id=223146

A

Currency outlook

Influence of carry trades on sterling

HSBC

Considerable developments are taking place in the currency markets and one of them is the influence on sterling by carry trades. The latter is a strategy where an investor borrows in another country with lower interest rates and invests the funds in the domestic market, usually in fixed-income securities.
A move in US short-term interest rates above those in the UK has been a fairly rare event over the past 30 years, but it has happened again.
In fact, ever since the Monetary Policy Committee of the Bank of England cut interest rates in the summer of last year, the market has been discounting it.
Does it matter for sterling that US dollar interest rates are higher? HSBC Research believes the answer is twofold. The first is dependent on the behaviour of model funds based on carry trading and the second is the influence this event may have on overseas deposits held in the UK. The negative impact on sterling of this event could be quite large.
A popular way in which carry trades operate is by buying a basket of high yielding currencies against low yielding ones. When US interest rates move above UK interest rates this will mean that the US dollar is about to enter the carry trade baskets as a high yielding currency in place of sterling. From a carry basket perspective and as far as some model funds are concerned sterling needs to be sold and replaced by US dollars.
To be able to evaluate this risk it is necessary to look at the UK's external position. In both bonds and equities, the UK position is balanced. However, the large net external asset position in direct investment is more than offset by an even larger net liability position in 'other' assets which are primarily short term deposits or so-called ''hot money''.
There are a number of reasons why this liability has grown so much over the past ten years. First, the UK has benefited from a prolonged period of strong domestic demand growth, especially when compared to mainland Europe. Second, UK interest rates have been relatively high, ensuring strong 'carry'. Third, the UK probably benefited from the perception of a safe, flexible and respected policy framework that combined transparent monetary policy alongside prudent fiscal policy. Finally, the UK was probably attracting money because of London's status as a major financial centre.
All these factors were important in attracting buyers of sterling. However, these reasons are disappearing fast. Domestic demand growth relative to Europe is slipping, the carry argument has all but disappeared, particularly against the US, and the policy framework is also coming unstuck with a large and growing fiscal deficit. The UK is carrying a net deficit on ''hot money'' of over GBP £360 billion or over 30 per cent of GDP.
Although the net position is important, it is really the liability side that is of concern. In other words, it is unlikely that UK residents will pull their assets back from overseas as UK rates fall relative to the rest of the world. Therefore, it is the liability position on "hot money" that is of concern as it is that element that is at risk.
Given the net data is the difference between two big numbers, the "hot money" situation looks even more dramatic when one argues that it is just the one side of the balance sheet that is at risk. The UK liabilities in terms of the 'other' category is twice as big as the liabilities on direct investment, equity investment and bond investment combined.
Another issue is that this category is very volatile. In other words, not only is the level exceedingly large but the flows are very volatile. For example, the volatility of the liability flows on ''hot money'' are nearly six times greater than the flows on direct investment, five times as volatile as bond liabilities and twice as volatile as equity flows. There is an enormous liability that is twice as big as the other asset classes combined and far more volatile.
The market has been discounting US rates moving above UK rates for more than six months, but now that it is actually happening it may still have a negative impact on sterling. This is because there may be a change in carry baskets to replace sterling with the US dollar as a 'high yield' currency.
In addition, and perhaps more importantly, the UK balance sheet is exposed to a very large volume of short-term overseas liabilities that may start being liquidated. On both these factors it appears the risks for sterling are heavily skewed to the downside.
This report was compiled by Peter Calleya, manager Corporate Strategy and Research, HSBC Bank Malta plc, on the basis of economic research and financial information produced by HSBC International Bank.

Sterling is perhaps one of the most over-valued currencies in the world today--it has even been rising against the Euro lately despite the ECB indicating a possible .50% hike soon and Gordon unable to put rates up in view of the frailty of the economy and unemployment growth. Sterling seems to be pushing its luck.

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Yes, one would think that sterling would be falling dramatically against the dollar. However, since the dollar interest rate was bumped above sterling's, the reality is that the pound has fallen massively against the dollar, from around 0.57 to around 0.54 - which represents a loss of about 5%. Why is this happening, anyone?

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you mean the dollar has fallen vs the pound, presumably.

reason - because of bernanke's booboo.

Which he has since tried to correct, a pointless exercise. All he has done is convince the market that his word can't be trusted, and that he has no cojones.

US will need rates of 7% plus to stop the rot. They are more likely to capitulate and allow a massive devaluation (which will bring on an economic war with teh east, for one thing).

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you mean the dollar has fallen vs the pound, presumably.

reason - because of bernanke's booboo.

Which he has since tried to correct, a pointless exercise. All he has done is convince the market that his word can't be trusted, and that he has no cojones.

US will need rates of 7% plus to stop the rot. They are more likely to capitulate and allow a massive devaluation (which will bring on an economic war with teh east, for one thing).

I tend to agree that 7% may be needed to correct imbalances and reign in destructive spending. The Carry Trade HSBC refer to has not yet begun to erode the pound but we can accept it as a heads up on what is around the corner for Gordon's "Miracle Economy" as the debt we have created is real whereas our house prices or "wealth" is just opinion.

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you mean the dollar has fallen vs the pound, presumably.

reason - because of bernanke's booboo.

Which he has since tried to correct, a pointless exercise. All he has done is convince the market that his word can't be trusted, and that he has no cojones.

US will need rates of 7% plus to stop the rot. They are more likely to capitulate and allow a massive devaluation (which will bring on an economic war with teh east, for one thing).

Soon Merv will have to see if he's got the "cojones". Personally, I think he has.

There will be no run on Sterling. The BoE are ready to act and they have plenty of room for hikes from 4.5%.

I'd say when we get to 5.5% IRs (next year) a bit of froth will be blown of the FTSE, but the UK property market will be in serious decline.

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you mean the dollar has fallen vs the pound, presumably.

reason - because of bernanke's booboo.

Which he has since tried to correct, a pointless exercise. All he has done is convince the market that his word can't be trusted, and that he has no cojones.

US will need rates of 7% plus to stop the rot. They are more likely to capitulate and allow a massive devaluation (which will bring on an economic war with teh east, for one thing).

Yes, that's what I meant.

WHat was Bernanke's Booboo? Was it the dropping money from helicopters speach?

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He hinted to the markets that the current trend of increasing US interest rates may be coming to an end soon. Afterwards he tried to placate the markets by claiming that the press had misinterpreted his comments, but to no avail.

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The Euro may not do so well either due to overvaluation against the dollar:

http://uk.biz.yahoo.com/07052006/323/euro-...imbalances.html

unday May 7, 05:10 AM

Euro surge threatens eurozone but helps global imbalances

PARIS (AFP) -
The euro has risen strongly against the dollar recently, posing a threat to the early stages of economic recovery in Europe
but acting as a correction to global financial imbalances.
On Thursday, the single currency rose to its highest point for nearly 12 months at 1.2724 dollars in response to a scarcely veiled signal from European Central Bank governor Jean-Claude Trichet that eurozone interest rates will rise in June.
For the eurozone, which appears at last to be recovering from a weak period lasting several years, the rise of the euro is not necessarily good news: although it helps contain the rise of the dollar price of oil, it also tends to increase the price of eurozone exports.
There seems to be little concern so far in Europe about the rise of the single currency. However, the European aerospace group EADS (Paris: NL0000235190 - news) warned on Thursday that the recent fall of the dollar would reduce its profits for 2006 by 860 million euros (1.09 billion dollars).

As they say, when the US catches cold Europe gets the flu?

He hinted to the markets that the current trend of increasing US interest rates may be coming to an end soon. Afterwards he tried to placate the markets by claiming that the press had misinterpreted his comments, but to no avail.

Bernie will learn to wait and see before giving off the cuff remarks as a week in economics can be a long time:

http://www.suburbanchicagonews.com/courier...WALLMAIN_S1.htm

Inflation fears rile U.S. bond market

By Eileen Alt Powell

THE ASSOCIATED PRESS

NEW YORK — Is it really time for the Federal Reserve to stop raising interest rates?

That's the question the markets have been grappling with since the Fed's new chairman, Ben Bernanke, told Congress late last month the central bank may be ready to pause in its drive to raise short-term interest rates to head off inflation.
Yet no sooner had the markets absorbed that idea when suddenly there were signs everywhere that inflation was on the rise
— in prices paid for materials in the manufacturing and service sectors, in higher gasoline prices and in the sharp jump in workers' wages reported Friday by the Labor Department.

THe worldwide trend in IR is up--not down. The Fed will have to step inline with Asia and Europe whether it likes it or not. After all, it was Alan "Big Al" Greesnpan's idea that caused all the imbalances in the first place--low IR to inflate always rebounds with high IR to deflate.

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i don't think we can use cable as a comparison - the US has it's own fundamental issues which will play out and the dollar was tanking well before bernanke opened his trap this time - sterling is increasing in value because people expect it to give a better return than in recent times i.e. IRs to go up vs the dollar - the market is forward thinking i.e. buy sterling now in expectation of IR rises, not after they have happened

repatriation of funds to the uk would be £ positive

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i don't think we can use cable as a comparison - the US has it's own fundamental issues which will play out and the dollar was tanking well before bernanke opened his trap this time - sterling is increasing in value because people expect it to give a better return than in recent times i.e. IRs to go up vs the dollar - the market is forward thinking i.e. buy sterling now in expectation of IR rises, not after they have happened

repatriation of funds to the uk would be £ positive

If IR do rise then the thing which made the UK "wealthy" is killed off: HPC and MEW. Once the goose is dead there will be little incentive to repatriate funds as an economy in deep recession will be unattractive to overseas investors.

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If IR do rise then the thing which made the UK "wealthy" is killed off: HPC and MEW. Once the goose is dead there will be little incentive to repatriate funds as an economy in deep recession will be unattractive to overseas investors.

Do you mean "HPI and MEW"?

Billy Shears

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Do you mean "HPI and MEW"?

Billy Shears

Yes--sorry--got carried away with "crashes" after reading Warren Buffett's comments on the coming sharp downward trend in house prices! With Warren in the bear camp its plain sailing from here on out. I can see all the headlines in the US papers tomorrow--"Warren says its time to sell!" I wonder if the UK press will carry the story? Maybe the FT and Telegraph. :)

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http://www.telegraph.co.uk/money/main.jhtm.../07/ixcoms.html

Economic agenda

(Filed: 07/05/2006)

Global tightening will rein in the bulls

Prophecies of doom for the US economy have been doing the rounds for years and yet it has continued to bound ahead. Has the danger passed?

The problem | No let-up

The problem

For several years, the US economy has been expanding more rapidly than most other industrialised countries. This has produced a yawning current account deficit, now running at about 7 per cent of GDP.
Solution
It is true that China (along with other creditors) is in a Catch-22 situation. If she acts in such a way as to weaken the US dollar then she will register a huge capital loss on her enormous holdings of dollar assets. But if she carries on as now, building up more and more dollar assets, then the size of the eventual capital loss, as and when the dollar finally falls, will be even larger.
So from her point of view it would be preferable to have an adjustment to the American imbalances which did not involve a sharply lower dollar.
Is that possible? One way is through a sharp slowdown in American spending. But to eliminate a deficit of 7 per cent of GDP, America would have to be plunged into recession. Not only would this not be good for America but it would also be disastrous for the rest of the world - including China.
That is why outsiders who urge the Americans to solve the problem by saving more miss the point. There may well need to be more American saving but this needs to be offset by less saving in China, Japan, the euro-zone and the oil-exporting countries
.

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Yes--sorry--got carried away with "crashes" after reading Warren Buffett's comments on the coming sharp downward trend in house prices! With Warren in the bear camp its plain sailing from here on out. I can see all the headlines in the US papers tomorrow--"Warren says its time to sell!" I wonder if the UK press will carry the story? Maybe the FT and Telegraph. :)

Ooooooooooooo I do enjoy a good buffet, and that certainly sounds like a good buffet :D

One word of caution for FTB'ers, remember this is no ordinary buffet, there will be a penalty to be paid for being first in the queue. Being later to the table is the way to play this one, as the choices will be more plentiful and the prices more palatable :)

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Guest Riser

If IR do rise then the thing which made the UK "wealthy" is killed off: HPC and MEW. Once the goose is dead there will be little incentive to repatriate funds as an economy in deep recession will be unattractive to overseas investors.

More evidence that the next Rate move is likely to be up.

DJ MARKET TALK: Weak Longs Bail Out Of Short Sterling

5 May 2006 08:06 - Short sterling futures are a "one-way bet" at the moment and weak longs are bailing out, says trader. "Recent bargain hunters have been forced to get out as prices continue to go lower.".......

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More evidence that the next Rate move is likely to be up.

DJ MARKET TALK: Weak Longs Bail Out Of Short Sterling

Riser. Excellent point. Some of the long positions are looking very shaky at the moment due to the trend in Gilt yields. That implies IMO the start of a strong bear market in SS. Personally, I thought there'd been too much of a sell-off by last midweek, but it kept going.

Not good if your investment is dependent on interest rates. This is the pre-warning of an imminent tidal wave of interest rate rises. Seek cover if you're exposed NOW.

Edited by karhu

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Hope the pound stays strong against the dollar for another month at least, because I'm off to San Fransisco for the first week of June, and I want to buy a new camera... B)

Don't worry about Sterling. A few rises from the BoE will keep it right where it is.

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Riser. Excellent point. Some of the long positions are looking very shaky at the moment due to the trend in Gilt yields. That implies IMO the start of a strong bear market in SS. Personally, I thought there'd been too much of a sell-off by last midweek, but it kept going.

Not good if your investment is dependent on interest rates. This is the pre-warning of an imminent tidal wave of interest rate rises. Seek cover if you're exposed NOW.

But how do I minimise the risk to me as a cash saver with a large deposit? I'm only 15% Gold (physical) and the rest is being cycled around various accounts earning me an estimated 4-4.5% net per annum. I have more in my cash ISA than I do in Gold. If interest rates are rising rapidly, is cash not the place to be? Or should I be running for cover with more Gold?

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Europe and Japan's growth is sclerotic and america's got the absurdly high twin deficits.....so i don't think the £ will necessarily tank against either of these..........Russian Rouble and others maybe

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But how do I minimise the risk to me as a cash saver with a large deposit? I'm only 15% Gold (physical) and the rest is being cycled around various accounts earning me an estimated 4-4.5% net per annum. I have more in my cash ISA than I do in Gold. If interest rates are rising rapidly, is cash not the place to be? Or should I be running for cover with more Gold?

Cash is one of the better places to be - something inflation linked, even better. Recently, money in the bank was depreciating and asset prices have been growing faster than interest rates (essentially free money for investment to get the economy fired up). Thus it made sense not to have cash and to borrow to the limit to buy assets. This is about to change. Money needs to be drained from assets and back into bank accounts and government bonds.

Interest rate sensitive assets are now to be avoided like the plague.

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Hope the pound stays strong against the dollar for another month at least, because I'm off to San Fransisco for the first week of June, and I want to buy a new camera... B)

I just returned from a week in Texas. Checked out the camera prices and found them to be about the same as the UK. My bellweathers are Nikon Digital SLRs (I have a D70). I shop at Costco in the US and UK as they have about the best prices anywhere. A Nikon D50 with kit lense is about £400 at Costco UK including VAT. IN the States it is $699 plus around 8% sales tax (depending on State). A near wash.

Globalisation is bringing prices into line very quickly. Restaurants in the US seem about the same as are clothes. Cars are still 2/3rds the price on average and houses are dirt cheap if you stay away from the hot coastal markets. Even decent plonk wine is about the same at $7 compared with £4 in the UK.

IMO, the dollar will not stay low against sterling as we share about the same fundamentals with regard to debt and housing bubbles. However, the US economy is far stronger than the UK. If Bernie hikes next week and there is no mention of a pause the pound could revert back to recent historical norms at around 1.74 or so. Longer term (end of 2006), I see 1.60's for the pound because the US can absorb further rate hikes whereas the UK cannot.

Edited by Realistbear

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Cash is one of the better places to be - something inflation linked, even better. Recently, money in the bank was depreciating and asset prices have been growing faster than interest rates (essentially free money for investment to get the economy fired up). Thus it made sense not to have cash and to borrow to the limit to buy assets. This is about to change. Money needs to be drained from assets and back into bank accounts and government bonds.

Interest rate sensitive assets are now to be avoided like the plague.

Reassuring. Cgnao reckons that Gold will only stop when interest rates surpass M4. So Gold is sensitive to interest rates? I'm concerned that if I balance into too much Gold, then there's an increased risk of loss on my part. It's allvery well being able to create a sell order in GM and dispose of a kilo or two in a flash... but shifting physical would be a challenge.

I'm happy with the protection it brings right now. But when do you see Gold's donward trend beginning?

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Reassuring. Cgnao reckons that Gold will only stop when interest rates surpass M4. So Gold is sensitive to interest rates? I'm concerned that if I balance into too much Gold, then there's an increased risk of loss on my part. It's allvery well being able to create a sell order in GM and dispose of a kilo or two in a flash... but shifting physical would be a challenge.

I'm happy with the protection it brings right now. But when do you see Gold's donward trend beginning?

Yes, Au may be sensitive to interest rates. It's place of refuge when all other instruments have poor risk/return. Assets were providing good risk/return (two years ago) - that's over now. If interest rates go up and solid economic growth returns then government bonds & thus bank accounts denominated in reputable currency may provide a better risk/return than Au.

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So Gold is sensitive to interest rates?

Gold is primarily sensitive to people's faith in fiat currency: which is largely based on how fast it's being printed, which is largely based on interest rates. If US rates go up to 10%, gold will almost certainly drop, but who knows exactly which rate will convince owners to get back into paper money?

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  • 301 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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