Here is an excellent article from the UK Daily Telegraph on the Yen carry trade. This article scared the crap out of me, since I had no idea that such a huge problem had developed. Read on and be afraid, be very afraid......
"Say the words "yen carry-trade" to someone at random and they will probably ask you to repeat yourself, before admitting they don't know what you're talking about.
Utter the same phrase to a central banker or a currency dealer, though, and you could unleash a torrent of opinion, soul-searching or even anguish.
The yen carry-trade is one of the hottest topics in global finance. The implications of it could be disastrous. Or they could be benign. But whoever you are and whatever you are invested in, you should be closely tracking the yen carry-trade.
The story starts in Japan, where interest rates are incredibly low. For the past six months, Japanese borrowing costs have been at 0.25 per cent. Sophisticated global traders exploit this by taking out cheap loans in yen, then converting that money into, say, dollars and investing it in American assets.
With US interest rates at 5.25 per cent, a full 5 percentage points higher than in Japan, the profit-making potential of "carrying" credit between the yen and the dollar in this way is enormous. Likewise, there are huge gains to be made by switching borrowed yen into sterling, euro and a host of other relatively high-yielding currencies.
Recent months have seen a frenzy of such carry-trading. No one knows the true scale of the flows - most of the deals are done by private hedge funds on unregulated markets - but the world has been flooded with cheap yen.
With its ultra-low interest rates, Japan has become a massive "easy-money" machine for the rest of the planet. The resulting liquidity boost has flattered asset prices everywhere, pushing major stock markets to multi-year highs while fuelling booms in housing and commodities too.
So what's the problem? Well, the scale of the carry-trade is now so big, and there are so many borrowed yen around, that Japan's currency last week plunged to a 21-year low on a trade-weighted basis.
That matters. Japan is a major global exporter. The rock-bottom yen is now causing headaches elsewhere, with Western manufacturers furious that it gives their Japanese competitors an unfair advantage.
But that's just the start of it. The real, systemic danger is that if - when - the yen starts rising, the carry-trades could suddenly "unwind", triggering financial shockwaves across the globe.
That's because many people agree with Western manufacturers that the yen is too low. Japan is, after all, in the midst of a prolonged recovery - figures out last week put annual growth at a chunky 4.8 per cent.
So, given that the yen is being artificially suppressed by all this carry-trading, the currency could well spring back. If that happened, all those investors holding yen-denominated debt would instantly owe more. At the same time, the investments they have made, having borrowed those yen, would be worth less.
In other words, if there is any sense the yen is about to rise quite sharply, for whatever reason, the carry-trades could be dumped - making that appreciation not only a self-fulfilling prophecy but also far bigger than it should be.
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.
All this puts policymakers between a rock and a hard place - as shown by last weekend's meeting of the G7 finance ministers. The world wants a stronger yen, to reduce Japan's advantage. That led to calls for direct G7 intervention - the buying-up of yen to support the currency artificially - and/or for the Bank of Japan to increase interest rates when it meets on Wednesday.
But if either move causes the yen to rise sharply, that could, given the extent of the carry-trades outstanding, spark a wave of global risk aversion and a major financial shock.
Little wonder, then, that the G7 fudged. Finance ministers merely hinted the yen was not a "one-way bet" - amounting to a veiled threat to intervene.
The markets reacted defiantly, driving the yen lower still. Traders were convinced, probably rightly, that the G7 hadn't got the guts to bolster the yen. The carry-trades mean Western leaders are petrified of lighting a fuse that causes a financial explosion.
And yet, the lower the yen goes, the greater the potential of "financial whiplash" when the currency eventually changes course.
If the Bank of Japan does raise rates on Wednesday, it could cause the carry-traders to trim their sails and slow down gradually. Or it could cause them to panic. No one knows.
And that's why yen carry-trade" is so much more than a piece of inane financial jargon. It is a reminder of the often-forgotten lessons of recent financial history."
"Say the words "yen carry-trade" to someone at random and they will probably ask you to repeat yourself, before admitting they don't know what you're talking about.
Utter the same phrase to a central banker or a currency dealer, though, and you could unleash a torrent of opinion, soul-searching or even anguish.
The yen carry-trade is one of the hottest topics in global finance. The implications of it could be disastrous. Or they could be benign. But whoever you are and whatever you are invested in, you should be closely tracking the yen carry-trade.
The story starts in Japan, where interest rates are incredibly low. For the past six months, Japanese borrowing costs have been at 0.25 per cent. Sophisticated global traders exploit this by taking out cheap loans in yen, then converting that money into, say, dollars and investing it in American assets.
With US interest rates at 5.25 per cent, a full 5 percentage points higher than in Japan, the profit-making potential of "carrying" credit between the yen and the dollar in this way is enormous. Likewise, there are huge gains to be made by switching borrowed yen into sterling, euro and a host of other relatively high-yielding currencies.
Recent months have seen a frenzy of such carry-trading. No one knows the true scale of the flows - most of the deals are done by private hedge funds on unregulated markets - but the world has been flooded with cheap yen.
With its ultra-low interest rates, Japan has become a massive "easy-money" machine for the rest of the planet. The resulting liquidity boost has flattered asset prices everywhere, pushing major stock markets to multi-year highs while fuelling booms in housing and commodities too.
So what's the problem? Well, the scale of the carry-trade is now so big, and there are so many borrowed yen around, that Japan's currency last week plunged to a 21-year low on a trade-weighted basis.
That matters. Japan is a major global exporter. The rock-bottom yen is now causing headaches elsewhere, with Western manufacturers furious that it gives their Japanese competitors an unfair advantage.
But that's just the start of it. The real, systemic danger is that if - when - the yen starts rising, the carry-trades could suddenly "unwind", triggering financial shockwaves across the globe.
That's because many people agree with Western manufacturers that the yen is too low. Japan is, after all, in the midst of a prolonged recovery - figures out last week put annual growth at a chunky 4.8 per cent.
So, given that the yen is being artificially suppressed by all this carry-trading, the currency could well spring back. If that happened, all those investors holding yen-denominated debt would instantly owe more. At the same time, the investments they have made, having borrowed those yen, would be worth less.
In other words, if there is any sense the yen is about to rise quite sharply, for whatever reason, the carry-trades could be dumped - making that appreciation not only a self-fulfilling prophecy but also far bigger than it should be.
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.
All this puts policymakers between a rock and a hard place - as shown by last weekend's meeting of the G7 finance ministers. The world wants a stronger yen, to reduce Japan's advantage. That led to calls for direct G7 intervention - the buying-up of yen to support the currency artificially - and/or for the Bank of Japan to increase interest rates when it meets on Wednesday.
But if either move causes the yen to rise sharply, that could, given the extent of the carry-trades outstanding, spark a wave of global risk aversion and a major financial shock.
Little wonder, then, that the G7 fudged. Finance ministers merely hinted the yen was not a "one-way bet" - amounting to a veiled threat to intervene.
The markets reacted defiantly, driving the yen lower still. Traders were convinced, probably rightly, that the G7 hadn't got the guts to bolster the yen. The carry-trades mean Western leaders are petrified of lighting a fuse that causes a financial explosion.
And yet, the lower the yen goes, the greater the potential of "financial whiplash" when the currency eventually changes course.
If the Bank of Japan does raise rates on Wednesday, it could cause the carry-traders to trim their sails and slow down gradually. Or it could cause them to panic. No one knows.
And that's why yen carry-trade" is so much more than a piece of inane financial jargon. It is a reminder of the often-forgotten lessons of recent financial history."
Hey! You've won a ride back to the top
0 comments: