Worth posting YT, a balanced view wouldn't go astray as it gets noisy at times.
Carry Trade Fears “Grossly Exaggerated”
FN Arena News - March 13 2007
By Greg Peel
As the dust settles over the risk-based correction we've just
experienced which many thought was overdue anyway, there is at
least consensus that the Chinese stock market collapse was in
itself insignificant – merely a little trigger for
overstretched global markets. With that in mind the blame
shifted to the unwinding of the yen carry trade, and this sent
shivers down many a trader's spine.
The market perception is that the world holds massive yen
borrowings at low rates which have been invested in everything
from gold to copper to Brazilian stock markets, New Zealand
bonds and emerging corporate paper. These risk trades have
fuelled global asset appreciation in the twenty-first century
and crushed risk premiums to uncomfortably low levels. If this
turns around, the world is going to hell in a handcart.
One estimate of the total stock of yen carry trades (there is
no formal, reliable measure) from the Vice Minister for
International Affairs of Japan's Ministry of Finance, Mr
Watanabe, is about US$150 billion.
Let's put that in perspective, says Morgan Stanley's
London-based global economist Stephen Jen. In the first five
days of the global correction, US$3 trillion in equity market
capitalisation was wiped out. That's a bit of an overreaction
if it was sparked by fear of US$150 billion being unwound. The
global equity market capitalisation stands at around US$43
trillion. On Mr Watanabe's numbers this means the yen carry
trade equates to a mere 0.36% of world equity value.
"Blaming the unwinding of the ‘JPY carry trades' for causing
havoc last week is almost as bad as blaming the sell-off on
the Chinese equity markets", says Jen, "To me, what happened
in the last two weeks was the result of excess leverage,
extreme mis-pricing in some markets and investors having the
same trades. JPY shorts may have been a popular trade, but it
is by no means a dominant position in the market, in my view".
Another misconception, notes Jen, is that the yen carry trade
is an activity only undertaken by hedge funds looking for the
quick buck. However, the trade is "as much structural as
What this means is that if the carry trade were only cyclical,
the implication is that money borrowed in yen for investment
in various risk instruments is done so simply on the basis of
the interest rate differential. Borrow at under 1% and invest
in, for example, Aussie bonds at over 6%. (The risk lies not
in the Aussie bond itself, it lies in the potential for the
currencies to shift).
But this perception discounts the massive savings of an aging
Japanese population which is simply looking for a return on
its retirement funds. Returns on overseas equities have far
exceeded simple interest rate differentials. This is a
"structural" trade, where investors are chasing capital
appreciation more so than any interest rate "arbitrage".
Nevertheless, open interest at the International Monetary
Market (futures exchange) in Chicago showed extremely high
levels of short yen contracts (around 114,000 compared to the
decade average of 30,000) which were then reduced by about
half in the week of turmoil. This showed hedge funds in
action, and explains the sudden jump in the yen against the US
dollar. But at the same time, notes Jen, Japanese retail
investors "have been remarkably calm". Japanese institutional
investors were in fact net buyers of dollars, not net sellers.
The conclusion is thus (a) the "unwinding" of the yen carry
trade was only carried out by rattled hedge funds with
overextended risk positions and (b) the buyers of yen have
been foreign institutions not local ones. In terms of cause
and effect, the equity sell-off prompted the currency
adjustment, not the other way around.
"With the very positive global economic outlook and abundant
global liquidity, I see risk-taking recovering rapidly from
the latest correction, though there should be better
differentiation between assets than in the past" Jen
concludes. "In other words, this is a great opportunity for
investors to ‘upgrade' their portfolios".