The Carry Trade, Unveiled At Last
26 October 2008Tim Coldwell, in his comment on the item below, points to a video made Friday by FT correspondent John Authers, pointing to the tight correlation between the Yen / Dollar ratio and the S and P 500. In the U.S. on Friday afternoon, the same chart was being shown by Dennis Gartman on CNBC.
SNS members will hark back to February of 2007, when I was able to figure this puzzle out for the first time. In March I gave warning on CNBC Europe that the carry trade had created too much liquidity, leading to asset bubbles, and recommended that people go into cash. I put the same advice out to members the prior month.
The currency re-adjustments of Friday are carrying several stories, I think, but this is the most important: that a very large amount of the equities positions in the world were funded by “free money” from Japan. What we saw Friday was the above charts, showing Part I of the unraveling, as investors sold leveraged equity positions to get back into Yen to pay off their debts, and Part II, a rush into U.S. Treasuries at any price.
The Yen ended up the strongest it has been for many years, followed by the dollar, and all other currencies took massive hits, or stopped trading altogether.
I’ll be writing more about the meaning of this carnage, where it goes next, and who the real winners might be, in our SNS Newsletter. (New readers can sign up at www.stratnews.com. )
Meanwhile, for what it is worth, it appears that Friday’s trading has put proof to the theory that led to the initial warnings of a global liquidity contraction. At this stage, one can only hope that the big kids stop putting out each new brushfire, and turn their attention (perhaps at the coming Bretton Woods meeting Nov. 15th) to the global systemic problems that allow this kind of arbitrage.
3 Responses to “The Carry Trade, Unveiled At Last”
October 27th, 2008 at 5:27 am
Why the record-breaking falls
Robert Peston 27 Oct 08, 10:57 AM
Today’s fall in stock markets across the world puts us on track to set new records for monthly declines in share prices.
So far this month, share prices in the US and Europe have fallen on average by more than a quarter, those in Asia by a bit more.
Unless there’s a sudden bounce, the cumulative monthly falls in October for most major markets will be as big as has been by anyone alive.
http://www.bbc.co.uk/blogs/thereporters/robertpeston/2008/10/why_the_recordbreaking_falls.html
October 27th, 2008 at 9:35 am
Another very well-informed insight into the world-wide banking crisis. While most of non-bank corporate Amrica deleverage as a result of the 2001 recession, the banking and consumer sectors are just now deleveraging and it is going to be very painful!
What is yet to be broadly reported is the extent to which public-sector legislators at all levels of government throughout the industrialized world have dramatically over-leveraged the tax base.
For example, the State of Washington’s economist was predicting a $3.2 billion tax collections deficit on a $34 billion general fund revenue projection for the 2009-2011 period. That’s almost a 10% shortfall – and does not take into account the sharp dropoff from the highest spike in construction sales tax collectons in the State’s history, or any of the other impacts on the forthcoming recession.
While the State does have a $600 million ‘rainy day fund’ – but that will be exhausted before the end of 2009. Raising taxes cannot cover the deficit – in fact businesses that can would move as much of their work to other juristictions as fast as possible, further eroding the State’s tax base – and accelerating the growth rate in the State’s unemployment level.
Lastly, the US Congressional champions of affordable housing that reduced the statutory primary capital requirement in the 1980’s for S&L’s to 4% (25 X leverage leading to a $500 billion crisis and the 1987 market crash)and then reduced Freddie’s and Fannie’s statutory primary requirement in the 1990’s to 3% (33 X leverage for $4 trillion of America’s $11.4 trillion mortgages) are still in office. These members of Congress have succeeded in deflecting all the blame to Wall Street greed for the problem.
Leaving these guys in charge of regulating the US banking system is like putting the Enron board and management back in charge of managing our nation’s energy trading!
October 30th, 2008 at 2:56 am
Fears mount in Japan over complex yen products
Leo Lewis in Tokyo
Traders in Tokyo have given warning that about $90 billion (£55billion) of complex foreign exchange products, sold mainly to Japanese households and institutions, are on the brink of falling “like a house of cards”.
A rescue effort by the product issuers – large Japanese, European and American investment banks – is expected to involve extensive hedging measures that will throw global currency markets into even deeper turmoil.
The products, which are known as power reverse dual currency notes (PRDC), were sold to Japanese households as simple products offering higher yields than regular savings but the bonds were in reality hugely complex structures “with 15 moving parts and multiple points of pain”, derivatives experts at RBS in Tokyo said.
http://business.timesonline.co.uk/tol/business/markets/japan/article5042278.ece
More Yen structured schemes go awry except for those who sold them. Tim