Is US Dollar Carry Trade a Menopause in the Currency Markets?

I had taken my then life savings earned from a job pushing shopping trolleys at the supermarket, and sent them overseas with a friend.

I was 16 years of age and my life aspiration was to travel the world. I’d figured out that to do so I’d be needing (strong) foreign currency. My friend banked my money in Australian dollars and this was to be my very first major currency trade. I was long AUD/ZAR – a great trade for me over the following few years.

I would look up the foreign exchange rates in the back of the newspaper my Dad brought home each night and I’d quickly calculate my P&L.

This was my first experience with currency volatility and the ride was more uncomfortable than the notorious Cresta run.

Cresta skeleton run in Switzerland

I’d remember feeling elated when my holdings had increased showing me a profit, and terribly depressed when the inevitable opposite happened. My moods could probably have been easily predicted by that one currency pair.

Many years later I’m the proud husband of a beautiful wife and this is where I’ve realised that understanding currency markets is the key to understanding women. I knew currency markets before I knew women so I think I had a “heads up”. No excuses, heh!

The ancient Greeks first attempted to explain mood swings over 3000 years ago but only in the last century did psychologists begin to figure out that we humans go through cycles from birth. These depend on the level of hormones pumping through our bodies at any given point in our lives. Husbands all over the world have to deal with this once a month. At least we know what’s coming and we can prepare by retreating to our “man space” to retain sanity.

Just the other day a male friend of mine was telling me about why he’s spending so much time on the golf course lately. It turns out there is a correlation between time spent on the golf course and his wife hitting menopause. One minute everything is fine and the next his wife is a slobbering, weeping wreck with the psychological stability of half set jelly.

I was curious so I looked it up and lo and behold, between the ages of 45 and 50 women go through this. Thank God I’m male but imagine that. It’s predictable to within a 5 year window!

Which does beg the question: where can we find such predictability in the markets?

When looking at short-term cycles we have the business cycle which lasts roughly 5 to 8 years. Then we have longer term cycles such as the long-term debt cycle, secular cycles and so forth. The important thing to understand is not that these cycles exist, as any half decent macro investor understands this, but to understand what drives these cycles, what the catalysts may be causing them to rise and fall and then to further figure out where we may be in any given time-frame in any given market.

In short, it’s probably worth knowing when your wife may be hitting menopause so you can prepare accordingly. So too it’s valuable to understand what cycles we’re in when looking at global financial markets. Today as I write this we have MASSIVE warning signs in the carry trade. Something I detailed last week here and which we delve into with great detail in our US Dollar Bull Market report.

Last week I answered (or at least I hope I did) a reader’s question around how the massive US dollar carry trade has reached over $9 trillion. My answer hopefully showcased that we’re dealing with a cycle here.

This brings me to another question brought to us by a reader:

Dear Chris and Brad,

First of all I would like to express all my gratitude and admiration for you and your newsletter. I am working in a large Real Estate buyout firm in London, but your pieces made me re-evaluate my career path and look for a more entrepreneurial path within the investing space; I thank you for that.

I am contacting you as your articles on China and the Yuan has captured my interest and I have to agree with all the points you make. My only concern, is that a long USD/CNH trade entails a negative carry of ~3% p.a., which makes the timing of the trade very important (given the 3trn+ USD reserves, could the PBoC delay even further the breaking of the peg while continuing with monetary easing?).

I was wondering what are your thoughts on a long position in USD/TWD instead; it has a very low cost of carry and benefits from the majority of the dynamics seen for the USD/CNH. What are the drawbacks/offsetting factors to the long USD/TWD trade that I am not considering?

I put this to Brad who responded.

You are correct with the USD/CNH being a negative carry trade. However, this isn’t a concern for us as this negative carry is built into option prices already. Furthermore, we see this negative carry narrowing over the coming months as the US begins to lift rates and China continues to cut.

Lastly, in terms of timing – if time is cheap then timing the market is not important. Call options on the USD/CNH are extremely cheap. So given that we think that it is almost a “certainty” that the renminbi will devalue against the US dollar over the next couple of years we think that it will prove very costly to try and time the big move in the renminbi. So we will buy long term calls on the USD/CNH and continue to buy ourselves more time until the move gets underway.

As far as the TWD goes – we don’t really have any definite view on this currency (in any event we think that if we get the USD/CNH right then the payoff will more than suffice). Our other big “call” is for a material depreciation in the Singapore dollar (upside in the USD/SGD). This is already playing out with our option positions up some 500% in the last 12 months.

Thanks for reading and have a nice weekend. Perhaps playing golf?

– Chris

“In fiction: we find the predictable boring. In real life: we find the unpredictable terrifying.” – Mokokoma Mokhonoana


Leave a Reply