Wednesday, November 08, 2006
You may recall that the emerging market (and other markets) correction from last spring started in part due to the unwinding of the carry trade. The poster child for this risk aversion trade was the Icelandic krona.
In the last three months it seems like the carry trade has come back better than ever, the anti-risk aversion trade.
This chart shows various high yielding currencies against the yen for the last three months. The kiwi is up more than 10%, the Aussie is up just under 5% and the Hungarian forint is up 6%. Not so much Australia but New Zealand and Hungary are facing some big obstacles. Relative to the world currency trading the risk taken for the extra yield seems to be quite high. And last spring market participants were falling over themselves to unwind these trades. For now they clearly have confidence that the high yielders won't decline, that is they are willing to maintain more risk than they did last spring. Put differently this could be construed as letting their guard down and being optimistic about the near term.
This could be the market correctly saying all systems go for global markets or it can be taken as a contrarian indicator that now is the time to cut back risk. You can decide for yourself. Clearly the market is not as afraid as it was a few months ago.
The point of this post is that the goings on in the currency markets can help assess the market's perception of risk similar to the VIX index but with more of a global flavor.
Posted by Roger Nusbaum at 6:15 AM