Forex Trading

• Carry Interest is Rising But a Lack of Risk Doesn’t Translate Into Strong Fundamentals
• Central Banks Keep Rates Unchanged Yet Policy Officials Cautious
• Growth is Emerging as the Underlying Driver of Market Sentiment

Event risk was torrential this past week with a round of central bank rate decisions that covered both the most hawkish and dovish extremes of the policy scale as well as a slew of headline growth indicators. Naturally, one would expect extreme volatility and the establishment of new trends from this mix of fundamental fodder; but instead, we have seen exactly the opposite. The presence of so much event risk has frozen risk trends as market participants wait to absorb the releases rather than trading against a potentially influential event or piece of data. Since this week started with growth numbers on Monday and will end with US NFPs on Friday; there has is a consistent damper on swells in risk appetite. This has been seen across all of the capital markets. The S&P 500 has stalled below 950 just after hitting a seven month high; gold’s advance has seized within $10 from once again testing $1000/oz; and the Carry Trade Index has pulled back after a brief incursion to highs not seen since before the height of the financial crisis last October. It is not a stretch at this point, that this is merely a break within a rather momentous bull trend. However, looking back further than just the past three to six months, there is reason to believe that this advance could also be a correction in a much larger trend. The Carry Index is still nearly 28 percent off its record highs. It is unlikely that we will see the level of sentiment that preceded the crisis for a long time.

It is hard to be skeptical in a bullish market – much harder than doubting a long-term decline. Investors are hard-wired to buy assets as they find their way into the market. However, there is a difference between an influx of capital into the market and the appreciation an asset enjoys when speculation supports its strength. Sidelined money is returning to a market space that has shrunk (reducing the opportunities for liquidity) and the pool itself has been severely diminished through the market collapse and global recession of the past few years. Eventually, the market will bear as much of the risk-seeking capital as participants are willing to invest (unless another crisis unexpectedly arises); and then fundamentals will to come back into view. The burden of risk has not completely dissipated. The grip of recession is still tight (even if there are signs its pace is slowing) and the eventual recovery will be fraught with difficulties. Upon the recovery, government’s will have to unwind their aid, which restrict credit and saddle the market with toxic debt that is currently being held on the central bank’s accounting books. Widening rates on US mortgages and TALF loans are already showing signs of strain. What’s more, a revival of investment will require attractive returns. With central banks maintaining interest rates near multi-decade lows and keeping open the option to further loosen policy and expand quantitative easing; it is clear that there is little hope to see a significant increase in yields anytime soon.

Written by John Kicklighter, Currency Strategist
Article Source - Carry Interest is Rising But a Lack of Risk Doesn't Translate Into Strong Fundamentals