The Dollar Carry-Trade

What is that? The dollar carry-trade is what we get when interest rates are near .25%. This is the path the Fed has chosen to help us re-flate our assets. How? Well, if you are a hedge fund, a government, or some other institutional player, with interest rates near .25%, you can effectively borrow a large quantity of US $ for nearly no cost, and you can probably lever it 10 or 20 to 1 and invest the dollars you borrowed elsewhere. If you borrowed the dollars yesterday, and the dollar goes down a penny or two, your real cost of carry to borrow the dollars was negative. If you invested in gold, commodities, or stocks yesterday, the falling dollar has increased the value of those riskier assets today (in dollar terms).

What this means is that investors are being incented to buy any asset paying (or returning) more than .25%. If inflation is coming, taking out a large mortgage here makes sense, since mortgage rates are so low; buying stocks and commodities makes sense in real dollar terms too.

The Fed is committed for the short term to maintain this extremely easy money policy, which will add stability to markets. But...when the trade reverses, look out. There are a LOT of people on that side of the trade. What could cause a reversal? It appears that the Fed is targeting the unemployment rate in lieu of the value of the dollar. Our US$ is a fiat currency after all, since we can just print more dollars. When unemployment drops below 8%, and we start to show some serious economic recovery (last week's ISM report showed positive manufacturing growth to restock inventories), then the Fed will have the necessary courage to tighten up the money supply.