Swiss get into a twist over carry trading craze
By Ambrose Evans-Pritchard
Last Updated: 2:08am GMT 30/11/2006
telegraph.co.uk
Switzerland's central bank has issued its bluntest warning to date that funds borrowing massively in Swiss francs for speculation worldwide could be in for a shock.
Jean-Pierre Roth, the Swiss National Bank chairman, said "euphoria" had gripped the markets, blinding investors to the risks of monetary tightening.
"Currency traders thinking only of short-term profits are borrowing in countries with low interest rates to re-lend in high-yield states without any regard for the exchange risk," he said.
"These are troubling signs and prudence is called for. It is dangerous to extrapolate trends and imagine that profits can continue to accelerate. We need to be on our guard because it is an illusion to think that past problems have disappeared. A little common sense would not go amiss," he said.
Switzerland has become the world's second biggest source of carry-trade credit after Japan as hedge funds and banks borrow tens of billions to lend elsewhere, especially in Eastern Europe.
More than 80pc of all new mortgages in Hungary are in francs, with a similar pattern emerging in Poland, Croatia and Romania. Swiss francs are also tapped by private equity groups as a source of cheap capital for Europe's takeover frenzy.
The practice came into vogue earlier this decade when Switzerland slashed interest rates to 0.5pc to fend off deflation. Rates have since crept back up to 1.75pc. Mr Roth made it clear that rates would have to go much higher to stop overheating, a warning that markets ignore at their peril.
"The Swiss economy is operating at full employment. It will therefore be necessary to continue raising rates," he said.
Japan's vast trade is viewed as a threat to global financial stability. Interest rates were zero until this summer, offering a free money machine for hedge funds. Carry trade outflows have led to acute weakness in the yen and Swiss franc, but this can change abruptly when global markets smell fear, as occurred briefly in May.
In 1998, the yen strengthened from nearly yen130 to yen 110 to the dollar in just two days after Russia's default on panic unwinding of carry trade bets. Such a fall today could set off mass defaults, given the much larger scale of derivative contracts. |
