Thursday, January 8, 2009

The Debts of the Lenders: Forex And Risk Appetite

Forex will tell the story. Look at the yen/aussie and yen/real pairs. These are both carry trade instruments.

The aussie and real are not really falling. It is the yen that is selling off against them. So it SEEMS like they are gaining in value. In fact, the macro-economics are quite the opposite.

The more the emerging markets cut their interest rates, the faster they debase their own currency. This hurts their native consumers (like govt ministers care about their own people) but attracts foreign money to invest in their countries.

That has been the emerging market growth formula for the past 20 years. In 2007 and 2008, emerging markets had kept interest rates high to stave off inflation (see high oil). But now they are cutting in a desperate attempt to re-attract foreign investors. And its working...for now anyway. Remember - the classic correlation between interest rates and bonds are INVERSE movements. When yields fall, bonds rise.

This situation won't last forever. (Sovereign default among the emerging markets remains a very real possibility). But it might last a good deal longer. There are trillions parked in Treasuries waiting to be unleashed.

So where will the money flow?

The equity front remains in miserable condition with news of corporate defaults, job layoffs, and other bearish news. However, the debt side should attract the bulk of investor sentiment because the sector is considered safer. This remains equally true among the emerging markets and developed nations.