Is a reversal of the carry trade behind the rise of the US Dollar?

This morning brings us back to what has been a regular topic in 2018 which has been the US Dollar. Let’s look at it from the perspective of the sub-continent.

The rupee weakened further and dipped by 54 paise to 73.04 against the US dollar Monday, owing to increased demand for the American currency from importers amid increasing global crude oil prices.

International benchmark Brent crude was trading higher by 2.04 per cent at USD 71.61 per barrel.

Forex traders said besides increased demand for the US currency from importers, the dollar’s strength against some currencies overseas weighed on the domestic unit.

From India’s point of view this is not as bad as it has been as twice the Rupee has fallen through 74 versus the US Dollar. However the overall trend has been down as we recall promises it would not go through 70 and the fact it is 11% or so lower than a year ago. The recent dip – until this weekend’s OPEC meeting – did not benefit the Rupee much in comparison.

For Pakistan things have been even worse as it own troubles have led it back into the arms of the International Monetary Fund ( IMF). The Pakistan Rupee is at 134.3 versus the US Dollar or 28% lower than a year ago.

The Euro

This morning the Euro has dipped to 1.125 and Bloomberg is on the case.

The euro fell to its weakest in more than 16 months on Monday as traders fret political risks from Italy to Brexit.

Actually Bloomberg mostly ignores the Euro and concentrates on Brexit which of course is an influence but far from the only one. The weaker phase for the Euro area economy where quarterly economic growth has fallen from 0.7% to 0.2% does not merit a mention. Nor does the expansionary monetary policy of the ECB with its negative interest-rate and ongoing QE which still has a couple of months to run in monthly flow terms. On the other side of the coin is the ongoing trade surplus which supports the Euro but not so much today.

President Macron of France made a suggestion on this front on CNN over the weekend.From Politico.

Macron also talked in the interview about the need to strength the euro’s position as a global reference currency — not as a challenge to the U.S. dollar but as an alternative for purposes of stability.

I guess it and the Chinese Yuan will have to compete but I am not sure how several reference currencies would work? The Euro is of course very widely traded but still a long way behind the US Dollar.

Returning to economic policy this will give both Euro area inflation and the economy a boost. With inflation already around its target the ECB will not welcome the former but will the latter as economic growth has faded. Should it be out of play for a while in terms of monetary policy then the Euro area would have to deal with any further slow down with fiscal policy. That would be awkward after spending so much time telling Italy that it does not work.

The Dollar Index

If we broaden our view and look at an index of which President Macron would approve ( because of the high Euro weighting) we see that the Dollar Index has hit a 2018 high of just above 97.5 this morning. Whilst that is not up an enormous amount on a year ago ( less than 3%) there has been quite a push since it fell below 89 at the opening of the year.

The move has technical analysts in a spin as some see this as the start of a big move higher and others see this as an inflexion point. This proves that it is not only economists who can tell you that a market may go up or down!

US Monetary Policy

Economics 101 will be pleased that at least some of it can be brought out into the sun as the so-called normalisation of US monetary policy leads to a higher dollar. We seem set for another interest-rate increase next month as well as 2/3 more in 2019 meaning US interest-rates look set for the 3 handle.

Also there is a quantity issue as US Dollars are being withdrawn via the advent of Quantitative Tightening or QT. That is happening at the rate of 50 billion dollars a month which is a large sum in spite of the fact that these times have made us somewhat numb about such matters.


The media seem keen to find reasons for this burst of US Dollar strength which have nothing to do with the US itself. Personally I think the US holiday may be a factor in today’s move but as well as the change in monetary policy stance something else has been at play in 2018. This is the apparent shortage of US Dollars which back on the 18th of May was affecting relative interest-rates.

The problem is a spike in the differential between LIBOR and the Overnight Index Swap, or the premium over the risk-free rate non-US banks pay to borrow dollars outside of the US.

The spread has risen to 42 basis points, the highest since February 2012, and up from 25 basis points at the start of last month and just 10 basis points in November.

While the rise does not pose a systemic risk, it has nevertheless raised the cost, and reduced the availability, of dollar-denominated loans for non-US banks by a considerable margin and in short space of time. ( Bank Pictet).

That improved but has returned to some extent ( 30 earlier this month) and of course in the meantime US interest-rates are higher. On September 25th we looked at the way a new carry trade had developed but apparently stopped.

 The overall amount of dollar credit to the non-bank sector outside the United States has climbed from 9.5% of global GDP at end-2007 to 14% in the first quarter of 2018. Since end-2016, however, the growth in dollar credit has been flat.

What if that reverses? We know from what happened with the Swiss Franc and Japanese Yen that reversals of international carry trades can have powerful effects. At this time of year there is also usually demand for US Dollars for the end of the year. Although frankly if you are thinking of it now you are likely to be too late. For now at least it is time for Aloe Blacc.

I need a dollar dollar, a dollar is what I need
Hey hey
Well I need a dollar dollar, a dollar is what I need
Hey hey

As the US observes Veterans Day let me give a plug to They Shall Not Grow Old which was on BBC 2 last night and was quite something.







5 thoughts on “Is a reversal of the carry trade behind the rise of the US Dollar?

  1. Great blog as usual, Shaun.
    I don’t know how much attention the markets pay to his pronouncements but PM Trudeau of Canada was in the news this morning saying that American duties and retaliatory Canadian duties on aluminum and steel may be removed by the end of November, and this would likely help boost the greenback against European currencies. An agreement to end this trade dispute could be signed at the same time as an official signing of the new USMCA when the Mexican and US presidents and the Canadian PM get together at the G20 meeting in Argentina on November 30. A Mexican official has said that Mexico won’t sign the USMCA until US duties are removed. Trudeau specifically refused to make such a threat when interviewed by CNN, but would very much like to see the duties removed. As Mark Warner noted in an interview with Bloomberg (see the top video in the attached link):
    given that Trump invoked national security concerns to impose the duties, he would look like an idiot if he simply removed them now. They would have to come with quotas, similar to those negotiated for the auto sector as a part of the USMCA. Of course, it is possible that the US will only come to an agreement with one partner rather than both, or only on aluminum tariffs rather than steel tariffs. (For Canada, at least, an agreement on aluminum should be easier than one on steel; Canada has already partially rescinded its retaliatory tariffs on American aluminum to avoid a price spike on beer in cans.) Even a partial agreement would help the US economy, but a general agreement would certainly seem feasible with good will on all sides.
    On the weekend it seemed that French President François Macron wants to take over from Trudeau as the global leader of the Anti-Trump Resistance Army and if Trudeau is wise he will let him.

    • Hi Andrew and thank you

      No that piece off news did not get much of an airing over here. The Armistice events did of course and it was noted that your Prime Minister stood in the rain unlike some ( or rather one). Today has been swamped by Brexit news which has at some point occupied pretty much every position it could!

      Looking at the Loonie I am surprised in some ways it has not moved more in the Trump era. There has been a small drop and a rally but in essence 1.32 isn’t far off where it was when the Donald era began.

  2. The second sentence should start: “I don’t know how much attention the markets pay to his pronouncements…” Sorry.

  3. … because it would then become a Wiki web site where authentication and data security become truly massive issues compared with your present, dare I say “legacy” site. There’s a lot to be said for “legacy”, in that “if it ain’t broke, why fix it?” The complexity change is very significant. Ask Wikipedia what their issue are! (Trolling, faking, vandalism and last but not least, self aggrandisement!). And you, “the owner”, could literally lose control! Hope this helps. (Bit techy, soz!).

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