Dollar Carry Trade - Easy Money in Difficult Times

What is driving asset prices to scale newer heights in year 2009? Answer is simple - weak dollar and near zero interest rates in US. It is very simple for global investors to make quick and easy money. Borrow at near zero interest rate in US, short dollar and invest that money in any asset in the country whose currency you have bought. Lets examine all the options available to global investors to make easy money :-

• Scenario #1. Borrow dollars in US. It is almost free to borrow since you have to pay near zero interest on the dollar borrowed. Put this money to work in US itself by buying any high yielding asset like stocks, commodities, gold etc. As these assets appreciate you will be making money from capital given to you almost free of cost by US Govt. Isn't this a simple equation for making easy money?
• Scenario #2. Borrow dollars in US. Then sell dollars to buy another currency of a country where interest rate is higher, say India. This arbitrage situation if tapped in India can fetch a global investor about 5% profit through interest differential for doing next to nothing.
• Scenario #3. Borrow dollars in US. Sell dollars and buy currencies of different emerging markets especially the BRIC countries. Then employ this money in various high yielding risky assets and enjoy rapid appreciation.

Well global investors are doing all the above and maybe more. Dollar has become the international currency for carry trade, a position that yen and Swiss franc used to enjoy till some time back. This drives dollar to depreciate as there is massive supply of dollar for buying various other assets. And that is how we are witnessing this spike in prices of all assets, from stocks to commodities to gold, while the dollar is plummeting.

I am certainly not complaining for what is presently happening across all assets because of dollar carry trade. If it is dollar carry trade plus other positive reasons like turn around from recession, then all the more reason to rejoice! Let us enjoy the spike till it lasts. But the question that begs an answer is 'till when?'. Certainly till US Feds keep the interest rates to near zero. Simple as that! But once the interest rates are hiked in US then the following can happen:-

• Investors who are short in dollar will cover their positions, making the dollar to appreciate with a spike.
• Massive unwinding of carry trade will take place with tremendous rush to buy back the dollar after exiting all trades like emerging market stocks, commodities, gold, et al.
• With dollar rallying significantly, prices of all other assets will plummet which will have the effect of bursting of asset bubble.

Asian Stock Market Blues - Frequently Looking to the West

This has become a routine for Asian Stock Markets - shake like an aspen leaf at every sneeze in the US. On 17th November almost all major Asian stock markets closed nearly in red, after trading the entire day in red. This was after US markets in last trading session had made a spectacular up-move, closing at a new high of 2009. So the least one expected was a slightly positive mood in Asian markets. But that was not to be! I am told that Asian markets wore such a sullen look on 17th November because Ben Bernanke made some not very rosy comment on US economic recovery. But tell me frankly, don't we already know all that.

Not withstanding the above ramblings, the reasons why markets across the globe are exhibiting high volatility are listed below :-

• Stock markets moved up from March 2009 lows primarily driven by huge liquidity, which in turn came into existence owing to generous stimulus packages from respective nations. Now there is apprehension that since the recovery in stock markets has been spectacular, there might be a case for withdrawal of stimulus packages by most nations. But the fact is that leaders of G-20 nations have promised to keep the stimulus packages in place for some more time. Premature withdrawal of stimulus can result in a prolonged depression as was witnessed during the Great Depression of 1929.
• Weakness in Dollar is pushing the commodity prices, oil prices, gold prices and also the stock prices higher. But any short term technical strengthening of dollar from here can send the other asset prices spiraling downwards. The moot question is when and that is creating nervousness in global markets. Lets see who blinks first!

It is certain that there is correction lurking in the dark, and suddenly it will spring a surprise on all of us. I have to admit that this forthcoming correction will be quite serious. In absolute terms I will venture to say that the corrective wave will wipe off about 1500 points from Nifty. If Nifty can climb to about 5500 in the current run up as predicted in my 8th November post (http://archana-archdeb.blogspot.com/2009/11/sensex-and-nifty-expected-movement.html), then the correction can make Nifty trade at 4000 level. That is how serious the anticipated correction can be!! No wonder the market participants are getting so easily spooked by every shred of negative news.

Coming down to brass tacks, we need to apply caution after Dow reaches 10500. Similarly in Indian markets we have to watch out for the selling zone between 5320 and 5580 in Nifty, after Nifty crosses 5182.

Trans Atlantic Triggers - Did You Receive Those Signals?

Did you receive those wealth creating signals we discussed in the blog post on 08 Nov 2009. For your quick reference here's the link - http://archana-archdeb.blogspot.com/2009/11/sensex-and-nifty-expected-movement.html. In that post we had understood that Nifty and Sensex will get a boost to scale higher heights only if there were positive signals from US markets. In that scenario Dow would close above 10160. We named those signals as Trans-Atlantic Triggers or TAT in short.

On 06 Nov 2009 Nifty closed at 4796 and Sensex closed at 16164 before the weekend. After markets opened from weekend break, Dow roared across 10160 and closed at 10227. Benign signals from US markets or positive TATs have helped Sensex touch 16914. Similarly Nifty could manage to touch high of 5018. If you were able to discern those positive TATs then you would surely have made some neat profit in trade.

Now is the time which is baffling and puzzling. As discussed in the last post (http://archana-archdeb.blogspot.com/2009/11/is-dow-jones-following-rule-book.html) Dow Jones has reached its target of 10360, which means that there will be serious correction in US markets from here on. However Nifty and Sensex have yet to reach their short term targets before tipping over. Nifty should find rigorous selling pressure in the selling zone of 5320 and 5580. Sensex on other hand should experience serious selling bouts in selling zone of 18000 and 18880. All these selling zones have already been discussed in my 8th November post which can be accessed from the first link on this post. But the dilemma is that since Dow has achieved its target, will Nifty and Sensex now achieve their targets as outlined above?

Lets see what the future holds for Indian markets from here on. Nifty and Sensex should reach their respective selling zones before correcting. Whatever be the case, its time to observe some caution on the long side since Dow has reached its short term top.

Is Dow Jones Following Rule Book? - A Reality Check

Thus far I have been quite satisfied with the disciplined behaviour displayed by Dow Jones. Right from the very beginning more than a century back, Dow Jones has always played by rules of the game. If we check the super-cycle bull run of Dow as per Elliot Wave, then we find that the 2nd motive wave up from year 1988 to 2000 corrected by about 50% by the year 2003.

After that, 3rd motive wave took Dow up by about 61.8% of 2nd motive wave. That is how we found Dow at its highest point of 14280 in Oct 2007. From there Dow again lost about 50% to trade at sub 7000 level in Mar 2009. Everything seems to be happening absolutely by the rule book!!

From the low of Mar 2009 Dow Jones, like a disciplined soldier, should have exhibited a pullback of 50% to reach 10360. That is exactly what I had anticipated on 02 Oct 2009 in a post titled "Dow Jones- Amazing Bull Charge". Check out the link here - http://archana-archdeb.blogspot.com/2009/10/dow-jones-amazing-bull-charge.html

On 11 Nov 2009 Dow Jones reached 10357.38 to qualify as having completed 50% pullback. Would you not agree that Dow has always maintained a very high degree of discipline? All its moves are by the Rule Book! If you agree to my point of view then do remember that after completing 50% pullback Dow has to retrace its steps from around the level of 10500. By now if you have already checked out the link to my 2nd October post then you must be privy to the likely retracement levels. If not then go right ahead and check out retracement levels from the link given above. Remember that forewarned is forearmed!!

Sensex And Nifty - Expected Movement Ahead

The correction in Indian markets has been swift and surgical. Now the pullback to the correction is in place. This throws up the most important question - how far will this pullback reach in Indian markets? That's a million dollar question! To find answer to this baffling question, we will resort to some calculations and some crystal ball gazing. Let us embark on this interesting voyage.

First of all we need to realize that from here on Sensex and Nifty will move in any direction as per signals received from across the Atlantic. Let us call these signals as Trans-Atlantic Triggers or TAT, which basically are triggers from US markets. In case there is absence of TAT then Indian markets will just drift sideways. This situation is of low probability. To make comprehension easier we shall deal with each situation separately as outlined below:-

• Absence of triggers from US markets will result in sideways movement in Indian markets. In such a situation you will find Dow Jones oscillating between 10150 and 9650. Likewise Sensex then could be lolling between 15000 and 16000, and Nifty could be lazying between 4700 and 5000. But if you ask my frank opinion, I will promptly label this situation as least probable.
• If there is positive TAT, then you will find Dow Jones closing above 10160 and racing towards 10360/10500 in subsequent sessions. In that situation you can expect Sensex to reach its tipping point between 18000 and 18800, and Nifty could be seen at level between 5320 and 5580.
• In case there is negative TAT, then Dow Jones will be closing below 9645 and tumbling towards 9100/9000 in subsequent sessions. In such a case Sensex could be seen trading between 14800 and 14200. Similarly Nifty could drop down between 4400 and 4200.

Whatever be the scenario, there seems to be one certainty. In next couple of sessions, Sensex will move to the zone between 16410 and 16660 and you will find Nifty trading in the zone between 4860 and 4930. After that, the story will unfold as per TAT received. Keep your antennae operational at peak performance!