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FX Crossroads

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The great carry bubble

Mon, Nov 10 2008, 10:20 GMT
by Danske Research Team

Danske Bank A/S

Summary and conclusions

Since last edition of FX Crossroads, we have revised our FX forecasts due to the recent extraordinary market developments, see Revised FX forecasts: G10 and EM. Most notable is that we expect the USD to strengthen even further against most other G10 currencies, the JPY excluded. We will publish November's edition of FX Forecast Update and Emerging Markets Briefer as scheduled on 14 November.

During the last few months we have seen an historical carry unwinding. In the first article of this edition of FX Crossroads we argue that the recent carry unwinding marks the end of what could be described as a carry bubble on the currency market, and that the large carry losses have merely corrected large imbalances. We furthermore analyse the dynamics of the carry trade and show that, following a sharp carry correction, the probability of new sharp losses tend to fall. Finally, we argue that it is still too early to turn positive on carry, and that investors should at least look for a turnaround in the OECD leading indicator.

October has been a challenging month for Danmarks Nationalbank (DN). The DKK has been under pressure; the DN has intervened and the Danish lending rate has been raised to 5.5%, bringing the policy spread between Denmark and Euroland to 175bp. The pressure is currently easing on DKK and deposit spreads are normalising. Thus, the potential for the DN to follow the ECB in cutting rates next week is emerging.

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Published on  Mon, Nov 10 2008, 10:23 GMT