A Healthy Carry Trade Today

Charts: The S&P 500 closed at 1093, up .6%. Uptrend intact. Resistance at 1100.

Fundamentals: The greatest danger to the dollar carry trade is emerging market countries depreciating their currencies by buying dollars or establishing capital controls or both. China is hinting that it might prevent this from happening by increasing the value of the Yuan. If China allows its currency to appreciate then virtually every other emerging market currency is effectively depreciated and these countries will probably stop attacking the carry trade. China allows its currency to rise by slowing down its purchase of dollar denominated assets like treasuries. In response, the other tiger economies will not step up their purchase of dollars and the greenback keeps falling. There are three dangers in basing the global recovery on an ever falling dollar: 1) Oil will keep going up until it hits $100 and crushes the recovery. 2) The US government has trouble financing its gargantuan debt, causing interest rates to spike. 3) The dollar can’t fall to zero.
Today we saw the dollar down, oil down, and treasury yields down, an atypical pattern. So problems 1 and 2 did not occur at least on the day and we had a much healthier version of the carry trade. We should start thinking of the carry trade in these terms: healthy or unhealthy. Here is the definition of an unhealthy carry trade: the dollar goes down causing interest rates and oil spike.

Geopolitics: The Saudis said that they had cleared all rebels from their territory two days ago. But now fighting appears to have spilled back into the Kingdom because a spokesman for UNICEF (a UN agency) said that 240 Saudi villages along the border are being evacuated, a sign there is fighting again on Saudi soil. Also, the Saudi and Yemeni Navies are intercepting boats carrying weapons and possibly fighters into the border region. These small sea craft are probably sponsored by Iran, so the Ayatollah is taking harder action than I predicted. Long story short: the Yemen war is pretty hot.

And the war in S. Waziristan is getting hotter. 17 good guys were killed and 22 bad guys in extremely heavy fighting Thursday. This was the highest single day body count for the good guys and (unfortunately) a relatively low body count for the bad guys. The Army’s three pronged assault now looks like one huge circle with three smaller circles inside. Three Taliban fortress cities continue to hold out. And fighting is also flaring up in the Swat Valley. Nevertheless, the Pak Army is winning.