Friday, March 02, 2007

Possible reversal of fortunes

As Guambat noted recently, "Whatever reason you may want to put on it (e.g., excess liquidity, diminishing supply of stocks, fund manager's warming to globabl risk), the linkage between the theories and the real world of making money these days has been the carry trade: borrow cheaply in yen or yuan, invest richly in Brazil or that other debt-ridden country, USA."

For more on the carry trade, see this and this.

It appears that the chain links are just possibly jumping off the gears.

MOF's Watanabe says carry trades not one-way bet By Natsuko Waki
Japan's top financial diplomat urged investors on Thursday to recognise a two-way risk in high-leverage carry trades and said the authorities were monitoring the impact from their possible reversal.

Hiroshi Watanabe, the vice finance minister for international affairs, also said he expected Japanese interest rates to rise further, which will boost the interest receipts in households and lead to higher personal consumption.

His comments to a conference in London followed a sharp rally in the Japanese currency this week, as investors rushed to cut their exposure to risks involved with borrowing the low- yielding yen to purchase higher return currencies.

"We should not be complacent. We should recognise the two-way risk," Watanabe said, echoing the statement from the Group of Seven finance ministers meeting in February.
Then, he went and got all complacent on us:
Asked about a sharp rise in the yen this week, Watanabe struck a sanguine note.

"I don't think there was an unwinding situation, it's adjustment. Even today the market is getting calmer. This is not defined as a reverse movement in yen carry trades. Unwinding is kind of a maximum one-way movement of the situation."

Watanabe added there were no statistics to gauge the size of carry trades, he estimated the size of yen carry trades to be several 10 trillions of yen, around half of what he said some market players estimate -- $1 trillion.
Then, he again raised the spectre of a heavenly wind strong enough to carry away the trade:
"If the total transaction is moving suddenly in the wrong direction it will cause turmoil. But these (carry) trades are not easily reversible."
Little wonder the markets don't seem to know which way to turn at the moment.

Yen Rises as Traders Unwind Bets on the Currency's Decline By Min Zeng
The yen touched an 11-week high against the dollar and rose versus the euro as declines in global stocks pushed investors to unwind bets on a decline in the Japanese currency.

At 0.5 percent, Japan has the lowest borrowing costs in the industrialized world compared with 5.25 percent in the U.S. and U.K. Switzerland's benchmark is 2 percent, while the European Central Bank's rate is 3.5 percent.

The yield advantage of U.S. Treasury 10-year notes over similar-maturity Japanese government debt shrank to 2.87 percentage points from 2.93 percentage points yesterday. A narrowing gap dims the allure of dollar-denominated assets relative to those in Japan.

Investors also exited the so-called carry trade -- borrowing in yen to buy higher-yielding assets elsewhere -- as traders trimmed their appetite for riskier assets and moved into U.S. government debt. Signs of a slowdown in the U.S. economy also contributed to the yen's gain.

"The market is getting nervous," said Alan Ruskin, head of international currency strategy in North America at RBS Greenwich Capital Markets Inc. in Greenwich, Connecticut. "Falling equity shares and the rally in Treasuries put carry trade under pressure. You are going to see yen strength as risk appetite is compressed."

"People are still shaky," said Christian Dupont, a senior currency trader at Societe Generale SA in Montreal. "People are moving out of riskier assets. Carry trade is the first to suffer."

The yen gained the most in more than 19 months against the dollar on Feb. 27 as U.S. stocks tumbled the most since September 2002 after China's shares dropped the most in 10 years.

But this market ruction of the last few days may likely just turn into a tiny tsunami in a teacup. We've seen it all before. Guambat had a post in May of 2006, Popularising the pullback:

"So Japan's central bank has made it clear that, as the economy returns to normal, so will its pricing of money.

"Japan has been an extraordinary fountain of liquidity for the world, the biggest source of global liquidity.

"This is known as the yen "carry trade". But this game is coming to an end. The Bank of Japan is now supplying about 14 trillion yen a day to the market, and is signalling that, as Japan's recovery progresses, it will continue removing its excess monetary stimulus.

"As this great ebb tide of global liquidity begins to gather pace, it is time to move away from risk. That's exactly what is driving Wall Street's sharp sell-off; investors are selling shares to take their cash and retreat into safety."


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