The Mother of All Carry Trades?

October 27, 2009 9:38 AM EDT

Like a moth to a flame, we can't seem to avoid listening to what Nouriel Roubini has to say. Yes, we know he’s a perma-bear. And yes, we recognize that he has made at least one good call in a row. But from a publisher’s standpoint, there is usually a good headline in any interview he does. So, whenever we see that snarling face on TV, we are compelled to turn up the volume.

Monday on CNBC's Squawk Box, Roubini didn't disappoint, labeling what is happening in the markets right now "the mother of all carry trades." In case you don't spend your days crisscrossing the globe looking for ways to exploit interest rate and currency spreads, a "carry trade" occurs when investors borrow money in a country with low interest rates and then invest somewhere else where rates and/or returns are expected to be higher. Thus, the investor winds up “carrying” their trade with money borrowed in one currency and hoping to work the spread to their advantage in another.

For many years, this strategy was commonly referred to as the "Yen Carry Trade" due to the fact that Japanese interest rates were lower than just about everywhere else in the world. The play was simple; borrow in Japan at 0.5% and invest in, well, just about anywhere else in the world.

Assuming you have the sophistication to be able to set up accounts and borrow money in different countries, the "carry trade" works great – as long as interest rates or the currency doesn't rise in the country you’ve borrowed money. Because, if you happened to be levered up on the order of 20-to-1, any uptick in rates or the currency you’ve borrowed the money in could cut into your profits in a big way.

Nowadays, it is the good ol' USofA that is the country and currency of choice for the globetrotting carry traders. Short-term interest rates are at or near 0% and the greenback has been falling steadily for quite some time now (remember, a falling dollar is good for investors from other countries). In short, this combination has made the "Dollar Carry Trade" quite popular indeed.

To hear Nouriel Roubini tell it, "there is a wall of liquidity... chasing assets" because of this brand of carry trade. Then Roubini went on to tell CNBC Monday morning, "Now we are in the mother of all carry trades," thereby suggesting that the trade might be getting just a little crowded.

A card-carrying member of the glass-is-at-least-half-empty club, Roubini says that prices of all kinds of assets have been inflated by the cheap funds afforded by the dynamic duo of a falling dollar and interest rates being held at zero by the U.S. central bank. But, he says, the dollar cannot keep falling forever and there could be "a market crash all over the world" when the U.S. dollar reverses.

Perhaps concerned about his reputation as being less-than optimistic, Roubini adds that a crash is not likely to happen soon because the U.S. economy remains very weak and the Fed is likely to keep rates close to 0% for quite some time. Phew, we thought he was going to say something negative!

**For More of David Moenning's Market Analysis, Stock Portfolios, and Trading Ideas, visit: TopStockPortfolios.com

Related ETF:
PowerShares DB US Dollar Index Bullish (NYSE: UUP)

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