Very possibly Mikebr,it's just hard to imagine the new carry...

Very possibly Mikebr,

it's just hard to imagine the new carry trade will start to unwind unless US rates go up - or a new crisis causes folks to pull their money out of international markets. US rates aren't going to go up for a long time...

The return of the deflation narrative might do it - but I'm not sure. If it's not a full blown crisis then I'm not sure the deflation would be enough to halt the carry trade. As you point out - AUD is probably trading both on the carry trade as well as its perceived commodity status. Deflation would presumably ease prices on commodities - but with australian interest rates going up before the end of the year, it's hard to image the AUD is going down. At the same time - it's very hard to decide either way because of all the variables.

Consider:

http://www.marketoracle.co.uk/Article13701.html

Jim Willie on the carry trade. (I tend to think he's a bit of a nut - but he does come up with some sophisticated stuff on occasion). 2000 gold in the us seems feasible, but I think it will be all monetary. As Japan has shown - not all countries will try to debase and therefore gold may not go up in all currencies. Here's my reasoning:

First of all, I think it's absolute genius of the new Japanese Government to pursue a strong yen policy - and Europe should not be too concerned about having a strong Euro either. The naysayer argument is of course that these export driven economies will be crippled by their strong currencies. But then at the same time EVERYONE admits that the current state of play in global trade is unworkable going forward and that the imbalances are one of the major contributors to the current situation. To fix these imbalances - export nations need to stimulate their own consumers to CONSUME! and what better way to do it than by flooding their economies with cheap money issued by zero interest rate countries with trade deficits.

The big problem for the US - of course - is that the outflow of capital caused by the carry trade will harm their efforts to inflate - just as it did in Japan for 10 years. Low interest rates in Japan, in my opinion, did nothing to help reflate, not really because of their insolvent banking institutions, but because the cheap money only ever really went out of the country. Zero interest rates aren't working generally - not necessarily because leverage is too high, but because of global trade imbalances.

So unless Bernanke wins the inflation perception game quickly and manages to get Americans going nuts with their wallets soon, then a continuing slow burn deflation narrative, with all the accompanying pessimism will set in, and we'll get a decade of new beatnik style literature coming out of new york for the next ten years.

On the other hand, the exporting countries should do quite well in the long term. Their exporters will suffer - but that extra capacity is no longer needed anyway and they have to face it. If they do - they can begin the process of retooling their economies to fit the realities and better serve their own markets. Accepting strong currencies is the measure of the degree to which they are facing up to the facts.

With respect to the AUD - it remains hard to make a call. factors at play include:

1) the carry trade
2) commodities
3) china
4) risk/ risk aversion

3 really is a corollary of 2. Going through them one by one.

1) is likely to stay in place for some time given that the US won't be exiting from 0 interest rates for some time. But the question is to what degree will it overwhelm or offset commodity based weakness?

Which brings us to 2 and 3 - china indeed will stop stockpiling at some point. But also, they aren't one of the countries sensible enough to let their currencies appreciate... at least, they don't seem to beyond purchasing shorter dated treasuries as opposed to the longer dated ones. But that means they aren't allowing their economy to re-structure to the new market reality. This issue is also contingent on Bernanke's rabbit. If he gets the consumer spending again then China's ploy will pay off. But who knows? If it fails then at some point China is going to take a whopping confidence hit - and that'll be bad bad bad for commodities. At the same time this could all take years to play out - so may not figure at all into current bets on the AUD.

Finally - there has got to be some chance of another crisis - in which case watch the AUD sink like a stone - carry trade or not (well definitely not at that point). Hard to say what could cause another crisis. Probably will have to wait for the fed to completely exit corporate debt if a crisis is going to start there again. Remember - the crisis happened because the corporate debt markets froze. They froze because various companies had invested in sub-prime cdos and no one knew who, or how much. With the corporate debt market being the most conservative and risk averse market around every just parked their cash and went home. But is that sort of perception still in play? How many companies are holding on to alt-a packaged debt? Will we start seeing hedge funds going bust? Those are the things to look out for.

Anyhoo - too long a rant.

Short of China breaking or there being another crises, one has to think the odds are on a strong aud for the time being. But if there are signs of either of these happening watch AUD tank and gold in AUD zoom.