by Phoenix Capital Research on 11/10/2014
… When the Fed cut interest rates to zero in 2008 and flooded the financial system … everyone around the world, from traders to hedge funds to financial institutions and even global banks could borrow US Dollars at 0.25%… and invest in emerging markets, emerging market currencies with higher yields, infrastructure projects, corporate takeovers, etc.
In simple terms, the US Dollar became one of, if not the largest carry trade in the world. Globally the US Dollar carry trade is believed to be north of $3 trillion (the emerging market component alone is $2.7 trillion).
Now, a carry trade only works when the currency you are borrowing in remains weak. As soon as it begins to strengthen, your profits not only evaporate but you can end up deep in the red (remember you’ve borrowed $100 for every $1 you have in capital).
… the US Dollar has broken out of a massive wedge pattern that has been forming over the last eight years. …
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So where has all the risk pooled up in the system? In foreign exchange (FX) markets, that’s where. …
The consensus is that the Fed ending $1 trillion/year in QE money issuance is no big deal because the Bank of Japan (BoJ) and the European Central Bank (ECB) are printing more money, which is taking the place of the Fed’s QE issuance.
Not so fast, Slick. Roughly two-thirds of the emerging-market debt that must be liquidated or rolled over is denominated in dollars, which means the borrowers still need dollars, not yen or euros or yuan. So the strengthening dollar will still bite all these emerging-market borrowers with very sharp teeth.
Printing yen and euros is not a direct substitute for the dollars that have ceased flowing. …