Now we're cooking on the downside... Someone asked me the other day what would hurt markets in a major way, and the first thought that came to mind was if Japan raises interest rates, which they are going to do it seems, it would cause a liquidation of US stocks and ko the yen carry trade.
In other words, the free money is going away,
and the fallout could be really ugly.
But not if you play it both ways.
Dunno what the yen carry trade is all about?
Here's an example of a "yen carry trade": let's say a trader/punter/hedgie borrows 1,000 yen from a Japanese bank, converts the funds into U.S. dollars and buys a bond for the equivalent amount. Let's assume that the bond pays 4.5% and the Japanese interest rate is set at 0%. The trader stands to make a profit of 4.5% (4.5% - 0%), as long as the exchange rate between the countries does not change. Many professional traders use this trade because the gains can become very large when leverage is taken into consideration. If the trader in our example uses a common leverage factor of 10:1, then she can stand to make a profit of 45%.
The big risk in a carry trade is the uncertainty of exchange rates. Using the example above, if the U.S. dollar were to fall in value relative to the Japanese yen, then the trader would run the risk of losing money. Also, these transactions are generally done with a lot of leverage, so a small movement in exchange rates can result in huge losses unless hedged appropriately.
____________________________________
Where we are today>
The yen rose the most in more than three months against the dollar on speculation Japanese investors will bring home cash as the central bank prepares to raise interest rates.
The currency headed for its biggest weekly advance against the euro since February after newspaper reports suggested the Bank of Japan may raise borrowing costs this month that are the lowest among major economies. The yen fell 1.1 percent against the dollar last year as investors used the so-called carry trade to borrow in the currency to buy higher yielding assets abroad.
``This is really an unwinding of the carry positions,'' said Thanos Papasavvas, head of foreign exchange at London-based Investec Asset Management, which oversees $53 billion in assets. ``There may be a bit of repatriation of yen back to Japan, and the BOJ may raise rates again.'' |
