Reacting to Roubini's Predictions: The Economy, Dollar Carry-Trade, Housing

In this interview with CNBC on Nov. 4, 2009, Dr. Nouriel Roubini, professor of economics at the Stern School of Business, New York University and chairman of RGE Monitor, cautions investors of the coming asset bubble and crash caused by the dollar carry trade, and at the same time shared his views on the economy and housing.


Video Source: CNBC

This is the second time in many weeks that Dr. Roubini warned of a growing dollar carry trade and threatening to cause a global implosion. The following is a summary of his CNBC interview along with my comments.

The Economy

Roubini: The recovery will be U-shape rather than V-shape due to "extremely weak" labor market resulting in lower consumer spending, and low capacity utilization (currently at around 70%) discouraging business investment. But the market is pricing in a V-shaped recovery, where in fact the recovery is going to be U-shaped.

My Take: By predicting a U-shaped economic recovery, Dr. Roubini implicitly diverged from his assertion less than two weeks ago that we have averted a depression. Note: I refuted his macro view in my article dated 11/03/09.

Dollar Carry-Trade

Roubini: The current monetary policy of the Fed will further weaken the dollar and thus, prolong the dollar carry trade. Eventually the carry-trade will be unraveled. Once this occurs, the dollar could have a sharp snap back probably 15-20% creating a huge asset bubble 6 month to a year from now.

In the Meanwhile the bubble's going to become bigger globally and the bigger the bubble the bigger is going to be the crash.

This unraveling process is not expected to be "orderly", unless the central banks start more aggressively phasing out the quantitative easing, which is not the indication right now.

My Take: Carry trade has been around for decades. People involved in carry trade are among the most sophisticated investors. There could be 15-25% correction, but the unwinding process will most likely be gradual and orderly. The “crash trade” scenario could happen only with a once-in-a-life-time event such as the 9/11.

Housing

Roubini: Quantity has bottomed out with supply and demand both falling 80% from peak. However, the gap between demand and supply is so large that home price could fall another 10% before the end of next year, off 40% from peak. The situation in the commercial real estate sector is even worse.

My Take: Commercial real estate valuations have been falling over 35% since October 2007. Over the next three years, about $1.5 trillion in commercial real estate loans are coming due. If anything is going to implode,commercial real estate would trump carry trade as the number one candidate.

Author's Disclosure: No Positions

Comments

[501327:]

I think it s somewhat naive to suggest that people involved in carry trade are sophisticated investors. Fact of the matter is any and every investor/speculator in the US is playing carry trade to some extent. Margin financing is available at extremely low rates even to retail investors and day traders. A look at the domestic mutual funds suggests that fund managers have discovered an easy way to add to their returns by buying stocks in emerging markets on an unhedged basis - they tried some of these same tactics in 2007 (even when interest rates were high), got burnt badly in the global sell-off and ended up compounding market woes by trying to exit their positions all at the same time. So, much for sophistication.

Nov 06 07:35 AM

[Bruce909:]

A U shaped recovery does not imply a depression. It could be simply a series of recessions much like the Japanese have experienced. We did avert a depresion in 2009: This does not imply that we will not enter a depresion starting in 2010.

Nov 06 11:57 AM

[Gary A:]

But the carry trade will be stopped by fear and a rise in the dollar. I see both commercial RE and the bubble of the carry trade as being factors that could cause a massive crash. Banks still have to hunker down to the new rules coming in the face of bad charts about real estate: hubpages.com/hub/We-Al...

Nov 06 12:19 PM

[Socialism c...:]

U-shaped is too optimistic. It will be L-shaped at best. At worst, it could be M-shaped.

Nov 06 03:30 PM

[Nathaniel C:]

I have to disagree with the author's comment regarding the carry trade. The US dollar has never been used as a funding currency for the carry. Not even in 2002-2004 when interest rates were low. It has always been the Yen.

As someone who has used the carry trade I can tell you that there are no "orderly and gradual" corrections. They are often very sharp and very violent because everyone in the carry trade is leveraged 5-20 times and have to sell at certain predetermined levels. If you want an example of how the carry trade unwinds take a look at AUD/JPY in 2008. It feel from approx. 100 to 55 in less than 6 months. As long as the market has this dollar down market up mentalitiy, a sharply rising dollar due to the carry unwind could cause a large drop in equity markets.

Nov 07 03:18 PM

[fwi:]

The dollar is an orphan, having been not only ignored but abandoned by Ben Bernake. The others in this administration think that the dollar is akin to political pamphlets. Print them up, and give them away to voters.

Roubini is right about this. THe trade long commodities/short the dollar was the same trade a year and a half ago that blew up overnight. And he is also right that this time oil would only need to get to $100, not $145. WHen any trade gets this crowded and this "easy" it is over.

Nov 07 07:11 PM

[littlescherzo:]

Carry trade has already been with us. Dollar loans in China based banks have already exploded and depleted their dollar liquidity pool. In the meantime hot money influx into China has also exploded in a terrific reversal from July. The actors in this game are certainly very sophisticated.

These actors may not be found in large and mainstream number in the US Wall Street, they are certainly in large and mainstream number in the Chinese Wall Street.

Therefore, the impact of this carry trade certainly will be felt positively in the Chinese asset market, but not necessarily positively elsewhere in the world, at least up to this point.

Roubini's case is compelling, since the bubble in China, at least, seems already under way, and may not be far elsewhere in the world, as the global economy continues to improve. However, tepid economic contidition in the US may continue to hide the matter from the view and worsen the situation. The Fed is not seen set to phase out QE until late 1st quarter next year.

It's precisely due to the fact that these actors are sophisticated, the reversal will be particularly sharp, notice how sharp the forex influx reversal towards China was between July and September, as smart money doing their thing in unison.

Roubini is an academic, and there are plenty of people ridiculed him from the angle of a market participant in a particular economy, in particular the US, but there is good truth and insight in his proclamations.

Nov 07 10:20 PM

[Doc H:]

It is "M" shaped, but take out he "V" inside the M and replace with "U". In reality it is going to be much more of the appearance of an N, with the "U" phase (the upcoming phase) should be represented as such to replace the "V" in those last two legs. We have to be heading down (whether two months or two years from now., it doesn't matter as it is all a giant manipulation and we are the suckers, or the higher intelligence - you tell me). There is simply zero justification for the market to head up to 11500, or 1250 between now and then, though it appears that is where we are headed (and so be it, but buy puts and collars, or be prepared to sell and be satisfied at any level that YOU ARE OUT). I digress, but my sense is that these idiots are taking us there regardless. They are idiots. Common sense tells us we are headed into a secondary disaster whether people tell you (Crammer - love ya Man, but you are full of shit) multinational corporate presence or not (we are just too big of an economy still and although we are "losing" our global supremacy in terms of consumerism, we are still to this day a pint or two (or three or four) of blood and the host will go into cardiac arrest without "our blood". The call is up to you, but get your ego out of this one and prepare to take your profits from march 9th, don't be an idiot, 40-60% and more pre-tax returns is quite a year and let the bigger kids play with their weapons. Dry powder always wins the day. These guys are crooks and it is not a robust and fair market. It is a Crack den, and they are all on the same drug. Bale.

Doc

Nov 11 12:10 AM

[Nadeem Walayat:]

Roubini's track record -

www.marketoracle.co.uk...

Nov 11 03:49 AM