BIS: highest CDO issuance ever but slowed overall derivatives trading

However, overall international derivatives trading on exchanges slowed in the fourth quarter of 2006, with a fall of 7% between October and December to $431 trillion of turnover in notional amounts of interest rate, equity index and currency contracts. This was caused by a seasonal tail-off in interest rate trading. Currency contracts, however, grew 19% to a record level of just under $5 trillion, due to strong trading in sterling and central European currencies.

Hedge funds’ returns were found to be partly driven by carry trade payoffs. BIS figures showed that speculative trading on yen weakness in futures traded in the US rose from the middle of 2006 to late February 2007, especially during yen depreciation. This is the first time the BIS has measured the effect of carry trades on the foreign exchange market.

However, BIS researchers Patrick McGuire and Christian Upper warned it was difficult to measure the size and importance of the trade, due to incomplete data on carry positions and trading activity. "Hedge fund returns appear to be sensitive to carry trade payoffs, but the results are far from conclusive," they wrote.

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