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“If money is a moral contract between government and its citizens, we are being
violated. The rest of the world, meanwhile, simply wants to avoid being duped. That is
why China and Russia—large holders of dollars—are angling to invent some new kind of
global currency for denominating reserve assets. It’s why oil-producing Gulf States are
fretting over whether to continue pricing energy exports in depreciated dollars. It’s why
central banks around the world are dumping dollars in favor of alternative currencies,
even as reduced global demand exacerbates the dollar’s decline. Until the U.S. sends
convincing signals that it believes in a strong dollar—mere rhetorical assertions ring
hollow—the world has little reason to hold dollar-denominated securities.”

                             Judy Shelton

FX Trading – A primer on carry!
Stocks, and currencies to a degree, meandered all day yesterday in wait of Intel to
report earnings after the bell. The chip boys didn’t disappoint. Stocks jumped after
hours on the news, rallied everywhere else overnight, and the S&P futures are up 14+ as
I scribble. You likely know the rest of the story—currencies are no longer meandering
and the pack is higher against the buck.

Carry, as they call it, is alive and well and seems to be getting stronger. Carry, in a
sentence, is to borrow proceeds in a low yielding currency, and reinvest said proceeds in
higher yielding or higher capital gains opportunities—the desire for those opportunities
has been coined by the phrase risk appetite.

We find plenty of good risk appetite opportunities in the US stock market. But because
the biggest capital gains opportunities are perceived to be offshore, outside the US in
faster growing and higher interest rate countries, risk appetite investing is part and
parcel to money moving out of the US dollar.

Let’s look at an example comparing the US to South Korea on yield and growth. Below is
a two-year yield spread between the US and South Korea:

This chart shows that 2-yr government notes in South Korea are yielding around 3.4%
more than 2-yr government notes in the US. That is a whopping big yield difference.
Just think of what you could do with another $3,400 per year on every $100,000
invested. And if the South Korean currency were to increase in value against the US
dollar at the same time, as it’s now doing, you get a double-kicker.

After knowing this big yield differential, you also notice South Korea is growing faster
than the US, and emerging quickly from the credit crunch days, you can see why
investors seeking total return would risk moving money into South Korea instead of the

The next chart shows South Korean industrial production. It has rebounded
tremendously after being crushed by the credit crunch.

Growth, or the expectation of above average sustained growth, is often a powerful
driver of longer term capital investment (foreign direct investment). This represents
long-term capital flow (expected to stay in a country for many years) wanting to be
positioned capital gains opportunities that are expected to follow.

So at the moment, South Korea is winning against the US in terms of relative yield and
capital gains opportunities—in a big way. This is a pattern we see in many countries
around the globe when comparing them to the US; especially among the emerging
market countries.

From a pure qualitative perspective, an input we can’t measure by numbers but feel,
there seems a growing palpable difference between what we are seeing the emerging world and the US: the emerging markets are anxious to grow. They are putting in place
policies to attract capital. They are fiscally much better off and a lot more disciplined
than the US. Most emerging market countries want to do business, and understand the
great advantages of capitalism, while the US seems to be spending more time bickering
about health care and climate change and how to expand government programs—or
put another way, how to destroy the goose that laid the golden egg instead of
reinvigorating its entrepreneurial class.

So, as long as the US stays mired in its current funk—a self induced funk indeed—carry
will live and capital gains will continue to be offshore we think.