BNP Paribas warns of further carry trade liquidations

Currency traders should not get fooled by rebounding equity markets according to research by BNP Paribas analysts who note that cash rich retail investors seem to follow a ‘buy the dip strategy’ but with hedge funds reporting heavy losses, liquidation in this market segment is likely to continue.

Withdrawing funds from leveraged accounts does require a 45 day notice period note BNPP analysts and since payouts are only done at quarter ends the 15 of August will be an important date. By the end of that day hedge funds will know how much of their managed funds will be withdrawn from there accounts. So far, hedge fund liquidation has been due to P&L considerations, but now as funds are withdrawn hedge funds will have to liquidate even more aggressively. Liquidation will hit most liquid markets leading to ‘irrational’ markets. Those markets facing poor liquidity conditions might not see most of the liquidation pressure even if fundamentals are bad and the further outlook poor. Liquidation is going to hit those markets liquid enough to cash in on assets. ‘Irrational’ markets itself could impose a systematic risk to quant driven funds similar to the LTCM debacle in 1998. The difference between now and 1998 is that at that time LTCM was the only meaningful quant player while nowadays there are ample quant funds. However, the aggregate risk nowadays has certainly been higher than it was when LTCM went bust. Accordingly, BNPP analysts expect low yielding currencies to continue moving higher putting the YEN, CHF and the CZK into demand.