Why Are Currency Traders Now Borrowing Dollars?

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THE STASH SEPTEMBER 14, 2009

Why Are Currency Traders Now Borrowing Dollars?

For years the term "carry trade" was synonymous with the Japanese yen. Because of the country's zero-interest rate policy, traders borrowed yen on the cheap and purchased higher yielding assets in other countries and markets, pocketing the difference.

But in recent weeks, a key borrowing rate for the dollar -- the 3-month Dollar Libor -- has fallen below the 3-month Yen Libor. That means the dollar has added "carry trade currency" to its other titles: safe haven and world's reserve currency. And the dollar's decline against other world currencies only makes the trade more attractive (because it's even cheaper to pay back). As one prominent currency trader tells Bloomberg: “The reason why people are borrowing the U.S. dollar for carry trade is A: It’s very cheap to fund, and B: The expectation is it’s going to go down.”

The Bloomberg article links the new role for the dollar with its declining value amid increased concerns over the deficit:

Borrowing dollars and then selling them is adding pressure on a currency that's already weakened 14 percent since March as the budget deficit exceeded $1 trillion, the government sells a record amount of debt and the Federal Reserve floods the financial system with $1.75 trillion to pull the economy out of a recession.

But according to this paper, fiscal concerns in the U.S. may not be the central part of the story:

...the speculative yen carry trade has a significant impact on the exchange rate. If the long position of the yen is larger, the dollar will depreciate against the yen.

In other words, the attractiveness of the dollar as a carry currency may be largely the result of the unwinding of the yen carry trade (the yen's value rises relative to the dollar as traders convert back to yen to close out their trades) and the deleveraging of the financial system, post-crisis.

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posted in: the stash, economy, bloomberg, federal reserve system, trader

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