GBP/JPY and More

I realize the recent drop in g/j has been quite fierce, but putting the long-term picture into perspective, a trip to 210 and then 200 medium term isn't a fantasy. Back in September of 98 this pair fell from 232 to 193 in just a month. Further, one can hardly ignore the multi-month head and shoulder top on the daily/weekly chart which subsequently is also seen on the Dow Jones currently (although the Dow has yet to penetrate the neckline). Also troubling is the fact that the Dow closed at the lows today (neckline) after having one of the worst weeks in many many years. We also see the DAX and Nikkei 225 looking extremely heavy here. Ironic is the fact Greenspan was touting ARM loans back in 2004, and in early 2007 he was one of the first to start tossing around the R word (recession). 

Although it may seem like good buying opportunities, you have the dig deeper and understand the dynamics involved behind it. The carry trade has created significant artificial demand of carry-able assets around the globe forcing normal asset value appreciation into bubble-like magnitudes. When recession fears emerge and equity markets look extremely top-heavy, central banks begin their tightening cycles. History shows us that the carry trade ends when this happens. We're already seeing it in the US, UK, Canada, and soon in Euro-zone. The ECB is currently facing a catch-22 with unrelenting near-term inflation, but also the softer growth numbers we've been seeing in the last few months and particularly the effects of the stronger euro on their exporters. So despite Trichet's hawkishness, I feel EU's downside risks to growth will be greater than the upside risk to inflation forcing them to back out of a corner and tighten. With such a large amount of money tied up in carry trades, and implied volatility relatively still mild right now, this could be a recipe for disaster. The carry trade may be in its last throes, for now...