Risk Off Yet Carry On
The market is clearly still suffering from ‘tapering indigestion’ but Bernanke would have not chosen the words used unless he was confident enough that sentiment would stabilise. Yet, barring miracles in global growth, stabilise does not mean rebound as investors will need to contend with structurally higher (real and nominal) yields brought about by a qualitative shift in policy. The dollar is set to do well in this ‘yield-differentials’ framework which resembles a risk-positive carry environment, but this is hard to reconcile with growth and deflation headwinds. Given the last few years’ worth of central bank experimentation has redefined monetary policy, the corresponding market frameworks usually derived from policy (differentials), such as the carry trade, should also be redefined.
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