Unwinding the carry trade...

[markrmau]

At some point in the not too distant future, the japanese gov. will start to increase interest rates.

[Or will it? Perhaps cancerous deflation is the end game for all economies?]

Anyway, assuming the carry trade will end, what will this affect?

Carry trade: borrow yen, buy assets.

ie short yen, long assets (commodities, shares, other higher yield currencies).

Will there be an orderly correction? How large is the carry trade?

At some point in time, we should sell our commodities shares and buy the yen. But when?

 

[coyotte]

Looking more and more like the end of the Alan Bond years --- BUY @ ANY PRICE

CASH and PMs starting to look better and better ???

cheers

 

[Gundini]

A lot of talk this week in various financial reports all over the world.

I recall the Bears talking about this as far back as 2005.

Could the eventual unwinding of the Yen Carry Trade be the catalyst the big crash? I also read about Yen/Brasil carry trade and the net margin is 14%+ Obviously a more risky market.

But isn't it a given that the USD will fall against the Yen, thereby cutting the net margin, and triggering a sell off? And heaven forbid if the Japan Fed started raising rates after 4 Quarters of growth! Surely a Global Financial Disaster would ensure. What are your thoughts?

*************************************************


Yen Carry Trade Set To Raise Japanese Stocks
Altogether, some experts estimate the total yen carry trade at a trillion dollars. And it is all short. That is, the success of all these trades depends on the yen NOT going up. Which is what makes it so dangerous to the entire world financial system...and so attractive to the investor willing to go long....

Bill Bonner -
Fri 16 Feb, 2007



“Carry on living dangerously,” says the headline in The Economist. It was talking about the global borrowing binge based on selling the Japanese yen – also known as the yen carry trade. Here we stake out a contrarian position:

Want to make some money in 2007, dear reader? Buy Japanese stocks. To explain, we start with our own money lenders at home.

Ben Bernanke sat down in front of a team of Congressmen and told them that everything was fine. Inflation, quoth he, would be ‘moderate.’ Growth would be ‘moderate.’ If there was anything not moderate, Bernanke didn’t see it.

All this moderation went to investors’ heads. As we watched the reports on CNN last night, every stock market in the world seemed to going up. The Dow ended up 87 points.

Maybe Bernanke will be right about the moderation; we don’t know. But if the world enjoys another year of comfort, it will do so at great expense...great risk...and great future discomfort. Because behind the moderate GDP growth numbers are some other numbers that are outrageous.

We could refer to central London property prices...to compensation in the financial sector...to the Shanghai stock market...or the latest figures from the art world...or any number of other things...but today, we focus not on the symptoms, but the cause...or, at least one of them.

Speculators borrow yen, trade the currency for dollars, and then buy Treasuries or U.S. properties or U.S.
stocks. The Bank of Japan lends money at only 0.25%.
This it has been doing ever since the mid-‘90s, when the BOJ sought to get the Japanese economy out of its funk by making money easier to get. A hedge fund, for example, can take advantage of this low interest rate by borrowing yen at, say, 1% and buying US bonds at a 5% yield. Or, he can be more aggressive and go for 7% by buying New Zealand bonds.

What makes the transaction dangerous to the speculator is that the yen may rise. What makes it dangerous to everyone else is that there are so many people who owe so many yen. And what makes it so attractive to contrarian investors is that with so much money counting on the yen to go lower...it is almost sure to go up.

If the yen were to rise 6% the speculator’s profit would be wiped out. And since these transactions are almost always highly leveraged, his capital could be wiped out too. This is exactly what happened when the most famous hedge fund of all time blew up in the late ‘90s. The yen went up. The Russians had a financial crisis. Speculators looked at their holdings and decided to unwind some of the leverage. That meant selling their assets and repaying yen. Of course, to repay yen you have to have yen. So, you’ve got to go into the currency market and buy them – which pushes up the price of yen. In 1998, the yen rose about 25% against the dollar in the space of a few weeks and Long Term Capital Management went bust.

Nobody knows how much of this ‘carry trade’ there is...but today, there is almost certainly a lot more than there was ten years ago. Today, there are thousands more hedge funds and many more speculators – with billions more to work with - all betting that the yen will stay put.

And as we know, now even homeowners have become speculating geniuses, so we shouldn’t be too surprised to find that homeowners are financing their homes in yen. Yes, that’s right. According to the Financial Times, “households in Latvia and Romania have developed so much enthusiasm for borrowing in yen that the trend has provoked surprise – and unease – from central bankers half a world away in Tokyo.”

Altogether, some experts estimate the total ‘yen carry trade’ at a trillion dollars. And it is all short.
That is, the success of all these trades depends on the yen NOT going up. Which is what makes it so dangerous to the entire world financial system...and so attractive to the investor willing to go long.

What surprises us is that America’s sub-prime lenders have not yet caught on to the financing opportunities of yen loans. If buyers were willing to go for Neg Am, I.O, limited doc ARMs why not Neg Am, I.O. limited doc, yen ARMs?

But therein lies the risk and the opportunity. Yen, like dollars and derivatives, are subject to ‘adjustable rates.’ True, the rates have not been hiked in a very long time. And true too, the yen has cooperated by going down (naturally, people have to sell the yen they borrow in order to buy higher- yielding investments). This has only heightened the risk. The lower the yen goes the higher it is likely to bounce when it finally hits bottom. The Economist’s Big Mac index, comparing the cost of buying a Big Mac around the world, finds the yen already 40% too cheap.
So, there’s plenty of room for adjustment.

“Now, as in 1997,” Hans Redeker, who heads currency strategy at BNP Paribas, explains “low-yielding currencies have been used as the global cash machine, pushing liquidity into asset markets. In 1997 the Asian crisis marked the end of this development. This year we suggest that emerging market assets and equity markets could set the turning point, sparking carry trade liquidation.”

You want to make a good investment, dear reader? Buy Japanese stocks. Either the stocks will rise...or the currency will. If the economy continues on its ‘moderate’ course...Japanese equities should do well.
If moderation gives way to panic, the yen should go up.

Regards
Bill Bonner
for The Daily Reckoning

 

[theasxgorilla]

Bonner has this remarkable ability to make me contemplate slitting my wrists every time I read him...hence I rarely, if ever, attend the Daily Reckoning website anymore. It gets in the way of my making money.

 

[IFocus]

Gorilla

Yes agree, in fact I have often wondered about the purpose of such a commentary if its not about creating fear and then selling the solution to end the pain………


Focus

 

[It's Snake Pliskin]

Carry trade liquidation will happen if rates go up in Japan.
Hardly significant though when NZ is 7% higher.

 

[brendan87]

I can see a more orderly unwinding of the carry trade.

Don't forget the feedback effect arising from higher interest rates and a higher yen:

1) Japanese demand for imports would increase as their purchasing power grows... undermining the yen. Higher imports = lower output which also undermines the yen (and interest rates).
2) Demand for foreign investments (by yen-holders/borrowers) increases as higher interest rates push the yen higher. Ie. Yen-borrowers are paying more in interest, but are able to purchase more foreign assets because their yen is worth more.

While these effects are most certianly secondary to the argument that higher interest rates in Japan will deter the carry-trade. I don't disagree with the notion itself - but the feedback and adjustment in foreign exchange markets (the economy's in-built automatic stabaliser) will partially counter the unwinding and lead to orderly adjustments in asset prices in the West.

 

[wayneL]

Interesting article in the UK telegraph:

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/02/18/ccliam18.xml

SNIP:

The tens of billions of pounds of global investments made off the back of carry-trading - investments that are supporting asset prices in every-thing from the FTSE100 to antiques and fine wine - would then suddenly look very grim.

If that sounds far-fetched, the last time yen carry-trades built up was in 1997 and 1998. Back then, a seemingly innocuous event - a minor Russian debt default - caused global investors suddenly to re--examine their appetite for risk.

As a result, the yen rallied by almost 30 per cent in just a few weeks as the carry-trades unwound. That caused the collapse of Long-Term Capital Management, a US hedge fund, ultimately leading to a rather serious global slowdown.

The parallels with today are ominous - except this time the hedge funds are more numerous, the carry-trades are worth more, the global liquidity bubble is bigger and investors are now leveraged on a much, much scarier scale.

And when you think about the extent to which even mainstream investors - not to mention pension schemes - have bought into hedge funds, it becomes clear why the yen carry-trade needs to be defused in an orderly fashion.

 

[Gundini]

Bit more unwinding today I would think!

 

[wayneL]

Anyone watching the Yen carry trade unwind?

Against the background of the USD appreciating strongly against most currencies, its tanking against the yen.

Here are yen futures (JPY/USD) (note: forex is USD/JPY)

 

[reece55]

Anyone watching the Yen carry trade unwind?

Against the background of the USD appreciating strongly against most currencies, its tanking against the yen.

Here are yen futures (JPY/USD) (note: forex is USD/JPY)

Long the yen Wayen, long the yen...... All the BOJ has to do now is whisper of an interest rate rise....

This is a market turning on it's head - the Yen has appreciated so quickly, I wonder how the hedge funds interest rate and currency swaps are going now....

All we need now is a swap provider to default - can you imagine that???

Cheers

 

[CanOz]

Been watching all day Wayne....time for bed though...looked like a rally for the USD earlier...but can it hold?

All i know is that i'm going to sleep well tonite..no trades on and all in cash

Cheers,

 

[dhukka]

Long the yen Wayen, long the yen...... All the BOJ has to do now is whisper of an interest rate rise....

This is a market turning on it's head - the Yen has appreciated so quickly, I wonder how the hedge funds interest rate and currency swaps are going now....

All we need now is a swap provider to default - can you imagine that???

Cheers

Yep, decision on rates due next week. In the face of some strong economic data the BOJ held off raising rates until the elections were over. Now the elections are over we've seen some weak data this month.

Fukui has been pretty adamant that weak GDP numbers would not deter them from raising. There are never any surprises in Japan, everything is done by consensus, still this one is up in the air.

 

[dhukka]

Interesting piece on Minyanville.com today on 'duration' carry traders.

The Duration Carry Trader
Mark Bloudek Aug 08, 2007 2:29 pm


...when the carry trade changes, big changes are in store for all asset markets...

The USD/JPY is right at its highs for the day and week. Why? Once again the spread between JGBs and US Treasuries are at their widest levels of the week. (JGBs are Japan Government bonds, which are the equivalent of U.S. Treasuries.)

The USD/JPY has tracked very well with this spread for some time now. If this correlation changes, I think it would represent a very important moment. The reason this is important is because duration carry traders using JGB's versus Treasuries have two distinct risks.

The first risk is the spread risk. Let's look at an example of this. When a carry trader buys a 10 year Treasury and sells a 10 year JGB, the basic bet here is that the rates will converge (narrow) or stay the same over time, which allows the trader to earn the spread.

If they diverge (widen), the carry trader loses. When this spread widens it makes the trade more appealing (If one is looking at starting a position) because the spread is larger and the potential gains on the convergence of rates is larger.

But there is a second risk that this carry trade endures. And that is the currency risk. In the above example the ratio of USD/JPY is the currency risk.

The carry trader has exposure in the form of short JPY and long USD. Therefore the carry trader gains if the USD/JPY exchange rate increases and losses if it decreases. When the USD/JPY increases it makes the carry trade a less attractive trade to initiate because one is paying up for USD versus the JPY.

So when the interest rate (Between JGB's and UST) spread widens, making the carry trade more attractive to initiate, while at the same time the USD/JPY exchange rate increases, making the carry trade less attractive it presents an interesting scenario.

So as one risk makes the trade more attractive the other makes it less attractive and we have an interesting symmetry of opportunity for carry traders. But what if this symmetry breaks? It would signal a major shift in the actions of the carry traders and how/why it is being put on or taken off. And when the carry trade changes, big changes are in store for all asset markets, in my opinion.

Will duration carry traders get nervous that the Chinese are going to blow this symmetry up by selling USD, and by extension U.S. Treasuries, raising interest rates significantly?

 

[reece55]

Well, it's taking hold again... that good ole unwinding of carry trades is happening tonight, with 300 pip moves in EUR/JPY and 500 pip move in GBP/JPY...

Add to that, the key level of 112 for the USD/JPY has now been broken....

Potential explanation as follows::::

***

[Dow Jones] USD/JPY sinks to a fresh 1 year low of 111.32 while EUR/JPY is off nearly 200 sen on the day to 164.10. A UK bank trader says the move is on the back of talk China will make aggressive moves on interest rates Friday. Adds if there is no move by China by late morning then there could be a huge snapback in both USD/JPY and the crosses as this morning's speculative selling is unwound.

 

[tayser]

thank you carry trade unwinders~!