Data Diary

AUDYEN and the unwinding of financial leverage

Posted on 14 May 2010

Just closing up shop for the week, and quietly reflecting on the liklihood that the RBA would very soon be dropping interest rates in our fair land, when this report on AUDYEN pops up (see here for the FT Alphaville article).  In summary, it says that punters on the carry trade have pushed positions to historic highs.

Now we have nodded to AUDYEN recently as an indicator to watch for the unwind of the carry trade (see here and more recently here).  That positions have increased into the recent weakness in the cross points to the stresses that financial leverage can place on the economic ecosystem. Only time will tell whether these punts are wisely placed or not.  The odds appear to be stacking up against them though – at least over a medium term horizon.

See in my view of the universe, the system we have grown to know and love is undergoing fundamental change. Whereas we have gotten used to financials creating liquidity out of leverage, and thereby becoming a staple of global market capitalisation and offering high incomes for the chosen few, the times are a changing.  Just as the great deleveraging is washing through the retail market (first in the US, now in Europe, next up Asia), so too it is running its course through the financial complex.

Leverage through derivatives has reached its zenith (at least for the foreseeable future).  The mortgage backed slice and dice is gone.  Now it is the turn of the leveraged carry trade.  Out of this will come the unwind of the commodities punt and any other remaining bastions where banks can leverage their balance sheets against the punts of their clients.

I’ve been working on some analysis of how this deleveraging could impact commodity prices – but for the moment, the AUDYEN trade can take its place in the margin of history and how the unwind of financial leverage will deliver us into a much smaller financial globe.