The Carry Connection

Personally I think it's suicidal to be engaged in any carry trades right now (one of the only reasons to be in them is to leverage up your AUM and with carry trades the leverage is often 10:1 but can be as high as 200:1 which can make a very small move in the currencies absolutely devastating to your position), however as we have seen numerous times in the past, Amaranth Advisors or Long Term Capital Management, sometimes the smartest guys in the room are so smart they need to be carried inside from the rain, or in other words, they do suicidal things thinking they can outsmart the market; it didn't work out too well for either of these firms and the second almost took down the US financial system and this was the dream team founded by two Nobel Prize winners in economics including  Myron Scholes who won for his work in the Black and Scholes options pricing model.

In any case, the point being, I'd think by now FC "carry traders" would be completely unwound, but apparently they aren't.

 This is the daily chart of the AUD/JPY (one of 3 popular carry trades from November of 2012 to April of 2013), you may remember these white FX charts as I was tracking the carry trades every day looking for the reversal in them which I found around April/May this year.

The carry trades were started just previous to the November 16th market low.

 USD/JPY 1 day

A closer look at the daily chart of USD/JPY which shows the carry is underway as the market bottoms on November 16th of 2012 and it tops in the April/May Period.

The more specific point is another site that does good work or is submitted good work from other sites, made the argument this morning that the USD/JPY carry suddenly and VERY abruptly switched from US equities and Treasuries around 4 a.m. this morning on the better than expected German Zew Business confidence survey and instead went in to European peripheral sovereign debt, the example they used was Spain, which  I think is a hard case to make as Spain's Bond Spreads were already trending lower yesterday, gapped down lower and about 2 hours after the open saw a severe draw down, meaning Spanish debt was being bought with the USD/JPY carry rather than US equities and Treasuries,  they make a pretty convincing argument, but provide only one European peripheral sovereign to back up the claim. There are a number of reasons the PIIGS Bonds could be bid which include secondary market intervention from the ECB, perhaps just a simple rotation or it could be the USD/JPY did flip and that would make sense if the market were finishing up on the pullback we expected, it's hard to knock a market down when it's receiving carry support, but that doesn't seem to be the whole story in my view; I don't think 1 chart can explain a situation credibly, you need confirmation.


I did notice last week that the AU?D/JPY carry cross did slip in as market support for a short time last week in leu of the USD/JPY so I looked closer in to the pairs and the single currency futures that make up the pairs.

*Remember when we look at a pair like USD/JPY moving up, that means the first currency is the long in the pair and the second currency is the short of the pair. So the USD/JPY moving up means there's $USD strength and relative JPY weakness, buying USD/JPY is like being long the $USD and short the JPY.

Looking at the correlation with /ES futures (SPX E-minis) here's what we get.

 This is the USD/JPY 1 min overnight and to the present in the candlesticks vs ES in purple.

According to this chart it does look like Carry traders jumped ship before pre-market today as ES fell and the USD/JPY carry held strength suggesting it was put to work somewhere else, what would cause such a sudden and large shift is hard to imagine, I doubt the German ZEW poll alone could do it, but perhaps if they needed to create a final flush to the pullback we have expected and that has been taking place right under out noses, then that makes more sense.


The thing is the AUD/JPY carry cross looks VERY similar to ES, ES is a bit more extreme, but that happens when stops are hit. Could the AUD/JPY have switched out like it did briefly last week? It seems it has.


So now we have to look at the single currency futures to better understand what each carry trade is likely to do, we'll start with the JPY first, anything that looks like JPY strength is going to be bad for either carry cross and ultimately the market. JPY weakness is good for the carry and market strength, AS USUAL, TIMEFRAME ANALYSIS IS ESSENTIAL TO UNDERSTANDING THE MOST LIKELY SHORT TERM AND LONGER TRENDS.

 JPY 1 min short term shows some strength building, this would suggest some near term market weakness or that the JPY is just starting to build a larger base of support that would match up with our ultimate "Big Picture" market view, the JPY would strengthen and weaken all carry crosses and help send the market lower.

The 5 min JPY is seeing positive divergences, but it's missing the process, so it looks like the start of more positive action, but more like it will spend more time building out that positive divergence in the area.

The rules of the "Reversal Process" apply to the huge FX market just as they do to the equity market.

The 15 min JPY shows "top" weakness and since the decline the kind of positive signals we look for in a pullback, again suggesting the JPY is likely working on a larger reversal that would likely sync up with our "Big picture " view of the market and help it move to the downside.

As far as the long $USD charts...

 $USDX 1 min intraday the $USD looks like it will lose some strength, that would not be good for the market or if the USD carry traders are indeed operating exclusively in European peripheral bonds, then it wouldn't be good for them.

$USDX 5 min the 5 min chart shows weakness which matches up with the $JPY strength building so this makes sense, it's a question of what timeframe will this effect, is it building for near term movement or longer term divergennces?

$USDX 15 min The 15 min chart is showing weakness RIGHT NOW, but it has a base with a good amount of accumulation that should push the $USD higher before it loses momentum, short term though it may indeed fall, it comes back to the timing question which is difficult to answer.

$USDX 60 min. Ultimately the 60 min seems to confirm the $USD has more strength in it.

As for the $AUD...

 The $AUD 5 min chart on the other hand looks stronger than the $USD short term so if it is the carry cross operating in US equity and treasury markets, it looks like it has the ability to provide market upside support along the lines of our expected bounce.

The $AUD 15 min also shows the same support.

Longer term though at 60 mins, the $AUD has failed.

Right now, THE AUD/JPY LOOKS LIKE THE CARRY CROSS MOST IN LINE WITH MARKET EXPECTATIONS OF A NEAR TERM BOUNCE, BUT "BIG PICTURE" WEAKNESS.

I have a feeling the other site had it half right, but didn't follow all of the clues.

It seems the AUD/JPY is now steering the US markets and the way it looks, it seems to make perfect sense with our market expectations.