The Dollar Carry Trade Is Ending

One can usually assume that any talk of the carry trade is in reference to the Japanese Yen. In this case, however, it is the Dollar that is being driven by a shift away from the popular strategy of borrowing in one currency and investing the proceeds in assets dominated in another. In explaining the recent Dollar rally, analysts have tended to focus on the pall of risk aversion that has descended upon global capital markets, coupled with the spread of the credit crisis from the US to the rest of the world. While these are certainly contributing factors, perhaps they should also look at the repatriation of Dollars that were initially sent abroad over the last decade in search of loftier returns. Hedge funds and other institutions, including those based outside of the US, took advantage of record-low interest rates to borrow Trillions of Dollars and invest them abroad. Due to a combination of margin calls and client "withdrawals," however, such investors have been forced to not only unwind such positions, but return the proceeds of the US. The Guardian UK reports:
Data collected by the Bank for International Settlements shows that European and UK banks have five times as much exposure to emerging markets as US and Japans banks, with surprisingly big bets in Latin America and emerging Asia - where they rely on dollar funding rather than euros.
Read More: Dollar roars back as global debts are called in

U.S Is Expected To Cut Interest Rates

The United States is expected to cut interest rates on Wednesday, a measure Japan, the European Central Bank and Britain are forecast to follow by the end of next week to bolster economies facing recession.
Hungary became the latest country to seek finance from global lenders, agreeing a rescue package worth $25.1 billion to shore up its currency and markets.
Main lender, the International Monetary Fund, said if the crisis was prolonged and many more countries came calling for help, it would need more money.
The Federal Reserve is widely expected to cut U.S. rates by at least half a point to 1 percent, the lowest level since June 2004.

Stock markets firmed on the expected rate cuts. Japan’s Nikkei ended up 7.7 percent after the Dow Jones industrial average and S&P 500 indexes recorded their second-biggest points gains ever on Tuesday.
European shares climbed 3.2 percent.
But analysts said the market recovery would be short-lived.
But given the severe recession into which the global economy is slipping, it is likely that we have not seen the bottom of the stock market yet.

Funds Crush GBP

The British Pound is perhaps one of the worst victims of the credit crunch, having fallen 25% against the USD in the year-to-date. According to analysts, hedge funds deserve much of the blame. Apparently, most hedge funds, including those that are based in the UK, denominate their portfolios in terms of Dollars. As a result of the exodus away from emerging markets, such funds have found themselves awash in cash, which they have promptly converted into Dollars. The reasoning behind this investment strategy is twofold: first, as the incredible strength of the Dollar has illustrated, the prevailing wisdom among investors is that the US is currently the least risky place to invest. Second, the interest rate gap between the US and the rest of the world looks set to narrow, which means the yields on US security will become relatively attractive. The Telegraph reports:
Worldwide interest rate forecasts are being revised downward, which has increased interest in the US where rates have already been slashed.

USD rose against the JPY

Forex - Bank of Japan cut interest rate by 20bp to 0.3%

The Dollar rose against the Yen on Thursday, but was little changed against the Euro, after gains in world stock markets and an interest rate cut by the Federal Reserve on Wednesday helped ease the recent flight into the dollar.

Adding to pressure on the Yen was growing speculation ahead of the Bank of Japan interest rates cut this night by 20bp to 0.3%.