Monday, September 12, 2011

Risk Aversion Is Driving Global Economic Paradox

As a follow up to my post last week on economic dynamics:

Carry Trades Lose Most in Year as Slow Growth Boosts Dollar

Sept. 12 (Bloomberg) -- Slowing economic growth around the world is punishing investors who bet on Australian and Brazilian assets using money borrowed in dollars and yen with the biggest losses in more than a year.

A UBS AG index tracking the performance of carry trades where investors sell currencies with low interest rates to buy ones in 24 markets with higher yields has tumbled 2.6 percent this month after losing 2.2 percent in August and 3.1 percent in July, the biggest back-to-back monthly drop since May and June 2010. The dollar has appreciated 6.2 percent against a basket of nine developed-nation peers from its low this year on Aug. 1, with the yen up more than 5 percent from the same day, according to Bloomberg Correlation-Weighted Currency Indexes.

Traders are betting that falling commodities, declining stocks, sluggish U.S. growth and Europe’s sovereign-debt crisis will diminish the appeal of currencies that benefited earlier this year from higher interest rates. The Federal Reserve’s target rate of zero to 0.25 percent and the Bank of Japan’s zero to 0.1 percent overnight lending rate compare with Norway’s 2.25 percent, Australia’s 4.75 percent and Brazil’s 12 percent.

“Risk aversion is a main driving force in the market,” Ian Stannard, the London-based head of European currency strategy at Morgan Stanley, said in a telephone interview on Sept. 6. “The yen and the dollar are likely to benefit from this demand.”

Global and US economic growth slows, the US dollar and US treasuries start going up. This is the reverse of what happened last year – as the global economy recovered and emerging markets proved resilient, the Dollar fell and borrowing costs rose in the US. It all goes back to the (perceived) risk premium; if risks are perceived as low then investors start chasing yield, and vice versa.

For the currency markets, this herd behaviour is swamping economic fundamentals, and has done since the beginning of the crisis in 2008. Back then, the collapse of Lehman Brothers triggered a massive flight to the USD, not away from it as economic theory would lead you to expect.

Locally BNM had to sell international reserves to meet the demand for USD that the domestic banking system couldn’t meet, amounting to nearly a quarter of the total within about 5 months – note that our international reserves have only just recovered to the level reached prior to the crisis erupting in September 2008 (RM millions):


We’re not seeing that kind of demand now only because market uncertainty isn’t as high as it was back then. But if the outlook grows grimmer, we’re going to start to see downside risks to emerging market currencies increasing, including for the Ringgit.


  1. if Ringgit is appreciate, it is good for the economy ,isn't it? at least strong currency could import cheaper goods to ease inflationary pressure at home, isn't it?

  2. There are pros and cons - a stronger ringgit does mean cheaper imports, which raises welfare generally. Also, a stronger currency is correlated with a high income economy.

    But a higher exchange rate also reduces export competitiveness, which reduces incomes to exporters (and their workers). Considering Malaysia's high trade exposure, there will be a negative impact. In fact, there's no doubt that manufactured exports have suffered ever since the Ringgit was floated in 2005.