Just how “sustainable” is the rally in stocks, commodities (particularly crude), and the breakdown in US treasuries…..and where is gold going……and when? For an answer to that let us look at the currency market. More often than not the behaviour of currency markets precedes that of other asset classes. This behavioural “trait” of world financial markets has become even more pronounced over the last few years with the behaviour of the “yield” or “carry” trade leading commodity, equity and treasury markets.
By just looking at the behaviour of high yield currencies relative to that of low yield one can gain a detailed understanding of the likely direction of other asset classes. Why is this so? Well just look at who the high yielding currencies are……….in essence they are the currencies of commodity producing countries and/or emerging markets. In practical terms the behaviour of these currencies are barometers of world economic growth or the crowd’s appetite for “risk”, or something of that nature.
So what is happening on the carry trade front? Well popular opinion would have it that the yield trade is going nowhere. The ETF DBV ( a popular proxy for the carry trade) has essentially gone nowhere since mid October last year (some 6 months) perhaps little wonder why the CRB Index and the US 30 year have also tracked sideways in this time. Does this suggest that a top in the carry trade is imminent? Well to find the answer we will dig a little deeper.
If we expand our universe for the carry trade to the G24 instead of the G10 (on which DBV is based) we discover something rather interesting. The “carry trade” is actually at a multi-week high already. Below is the UBS V24 Carry Trade Index:
The same macro force that is pushing the UBS V24 Carry Trade Index higher is also pulling the spread between yields on emerging market sovereign debt and US Treasuries lower. Note the JP Morgan EMBI Spread Index (below) traded at a multi-week low last week.
Yes the carry trade is alive, well, and kicking. Prepare for a breakdown in US Treasuries and material upside in commodities, and prepare for it sooner rather than later. And if you have to hold currencies of the paper variety put them into a basket of emerging market currencies.
