Investors should take note: Thursday, the dollar’s three-month London Interbank Offered Rate, or Libor, for the first time since August 2009, moved back above the Japanese yen’s three-month Libor rate.
Three-month Libor yen (loans) dropped yesterday to 0.251%, compared with three-month dollar (loans) at 0.252%. The Libor is a daily reference rate based on the interest rates at which banks borrow unsecured funds from other banks in the London wholesale money market (or interbank market).
Believe me, this is important. I’d like to say the dollar probably now can declare that it's not the most attractively priced currency for carry trades any more.
This is without any doubt a positive for the dollar, as long as the three-month dollar will be more expensive than the three-month yen.
Further down the road, we’ll have to see what impact it will have on equities, commodities, emerging markets and all that tends to move inversely to the value of the dollar.
By the way, it could be refreshing — and maybe somewhat frightening — to some readers to look back to what Nouriel Roubini wrote on Nov. 1 in the Financial Times on what the unwinding of the dollar carry trade could mean.
A carry trade is a strategy in which an investor sells a certain currency with a relatively low interest rate and uses the funds to purchase a different currency yielding a higher interest rate.
“But one day, this bubble will burst, leading to the biggest coordinated asset bust ever,” he wrote. “If factors lead the dollar to reverse and suddenly appreciate — as was seen in previous reversals, such as the yen-funded carry trade — the leveraged carry trade will have to be suddenly closed as investors cover their dollar shorts.”
He predicted that “a stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a coordinated collapse of all those risky assets — equities, commodities, emerging market asset classes and credit instruments.“
Why will these carry trades unravel?
“If U.S. growth surprises on the upside in the third and fourth quarters, markets may start to expect a Fed tightening to come sooner, not later. There could be a flight from risk prompted by fear of a double dip recession or geopolitical risks, such as a military confrontation between the US and/or Israel and Iran,” he said.
“As in 2008, when such a rise in risk aversion was associated with a sharp appreciation of the dollar, as investors sought the safety of U.S. Treasuries, this renewed risk aversion would trigger a dollar rally at a time when huge short dollar positions will have to be closed …”
The bottom line: Watch the three-month Libor in the yen and the dollar.
The three-month Libor dollar will probably become, for some time to come, “costlier” than the three-month yen Libor.
© 2017 Newsmax Finance. All rights reserved.