MercoPress. South Atlantic News Agency

US and Japan record low interest rates funding global “carry trades”

Guru-economist Nouriel Roubini has warned about the risks and consequences of carry trade

The International Monetary Fund said that record low US interest rates are funding global “carry trades” and the dollar is still overvalued as concerns mount that new financial imbalances are forming.

“There are indications that the U.S. dollar is now serving as the funding currency for carry trades,” the IMF said in a recent report. “These trades may be contributing to upward pressure on the Euro and some emerging-economy currencies.” While the dollar “has moved closer to medium-run equilibrium,” it is still “on the strong side.”

With investors able to borrow at near-zero rates in the US, some economists are concerned that markets may become distorted as traders invest those funds into riskier assets. Nouriel Roubini, the economist who forecast the financial crisis in 2006, said earlier this month that investors are milking the “mother of all carry trades.”

The dollar has dropped about 13% against a basket of currencies from its major trading partners in the past seven months. Meanwhile, the MSCI All-Countries World Index of global equities has gained about two-thirds since March and sugar has soared 90% this year. The Euro has risen 15% against the dollar in the past nine months

Last week at the end of the a two-day policy meeting the Federal Reserve reiterated their intention to keep interest rates “exceptionally low” for “an extended period.”

Speculation that the Fed will keep rates on hold into next year was further fuelled by US Labour Department figures that showed the unemployment jumped to 10.2% in October, exceeding 10% for the first time since 1983.

In a carry trade, investors borrow in countries with low interest rates to invest in higher-yielding assets. Benchmark interest rates of 0.1% in Japan and as low as zero in the US compare with 7% in South Africa and 2.5% in New Zealand, making the Yen and dollar favoured targets for investors seeking to fund carry trades.

The IMF also said that China’s Yuan is “significantly undervalued.”

The Chinese currency “has depreciated in real effective terms in tandem with the US dollar and remains significantly undervalued from a medium-term perspective” the IMF said.

China has kept the exchange rate at about 6.83 to the US dollar since July 2008, after letting the currency strengthen 21% in the previous three years. Appreciation was halted to help sustain exports amid a global recession.

Chinese central bank Governor Zhou Xiaochuan admitted “the pressure from the international community to allow yuan appreciation is not that big,” deflecting calls from Europe and Japan to let it rise.