Jittery Markets Deflate Trades Centered on Yen
By WAYNE ARNOLD
August 18, 2007
SINGAPORE, Aug. 17 — The recent volatility in global stock markets has raised the prospect that a distinguishing feature of the financial world for years now, an investing strategy known as the yen carry trade, is losing some of its appeal.
The tactic emerged several years ago as the Bank of Japan kept interest rates low while other central banks, beginning in 2004, started to raise rates, creating an incentive to borrow cheaply in Japan and invest the money in countries where returns were higher.
The tactic helped weaken the yen against the dollar and the euro, creating nervousness that a chaotic unwinding of carry trades might become a source of financial instability — as it is today.
The unwinding of carry trades sent the yen soaring Friday to its highest level against the dollar in 14 months and sent the Nikkei 225 index to its worst single-day loss since the Sept. 11, 2001, attacks on the United States.
The rise of the yen comes as investors have been selling stocks amid concerns that the mortgage loan mess in the United States will hurt global economic growth.
“Japan gets hit by a double whammy,” said Patrick Mohr, a strategist at Citigroup in Tokyo.
“With higher risk aversion,” Mr. Mohr said, “you see unwinding of the carry trade, so on top of a lower appetite for equities, that’s compounded by concerns for export earnings.”
Analysts have been observing a reversal of carry trades for several weeks now, explaining in part why the dollar has fallen about 10 percent against the yen since June. But the trend appeared to have picked up sharply on Friday.
Few of the world’s finance officials will shed any tears at the tapering off of the carry trade, a highly speculative venture that the Group of 7 has tried to discourage, at least rhetorically.
But the market volatility created by the unwinding of carry trades, which has rippled through all kinds of assets, is something most people could do without. And it feeds on itself: volatility in exchange rates makes cheap-yen borrowing increasingly risky, necessitating more unwinding.
It is unclear why investors were prompted to accelerate their repurchases of yen so suddenly Friday, but analysts said increasing volatility in emerging markets was raising the risks inherent in the carry trade.
It has “become a race to reduce risk,” Satoru Asatani, a fund manager at Shinko Investment Trust in Tokyo, told Bloomberg News. “People don’t care about the valuations now, they’re just selling whatever they can.”
Ed Merner, manager of the Atlantis Japan Growth Fund in Tokyo, said, “If you’re investing overseas and the yen starts to go against you, or what you’re investing in goes against you, then you start to sell that and maybe the yen gets stronger — that panics people into covering.” .
A rising yen makes Japanese exports more expensive for consumers abroad, particularly in the United States, where the widening panic over tightening credit and housing loans is raising concerns that consumer spending may suffer.
While much of the carry trade is conducted by hedge funds, analysts say Japanese retail investors are also a big contributor. Overseas stocks and bonds are increasingly popular among investors who have little confidence in their own stock market and economy.
And while Japanese retail investors do not necessarily borrow the yen to buy these products, analysts say the effect is much the same. But now, with carry trades being swiftly unwound, the currencies that carry traders were buying have been falling as fast as the yen has been rising.
On Friday, the Australian and New Zealand currencies suffered their biggest weekly declines against the United States dollar in at least 18 years. The Australian central bank bought its currency for the first time in six years Friday to stem the steepest one-day drop since it was allowed to trade freely in 1983.
However unfavorable global market volatility may have made the carry trade in recent weeks, analysts said, the practice is unlikely to fully disappear as long as Japanese interest rates are so much lower than rates elsewhere.
"People can put their carry trade back on two weeks from now," said Christophe Lee, the chairman of the Alternative Investment Management Association in Hong Kong. "Yen interest rates remain very low" so there’s still room to maneuver, he said.
Japanese bank accounts typically pay less than half a percentage point of interest per year. That means that even parking funds in United States dollars is profitable to a Japanese investor, provided that dollar declines do not erase those gains.
Returns can be even higher if those yen are invested in places like Australia and New Zealand, where rates are higher and a commodities boom has been pushing up inflation and causing currencies to appreciate.
While conventional economic theory holds that lowering interest rates and thereby reducing borrowing costs stimulates economic growth, some in Japan say the reverse may be true. In a nation where the predominantly elderly population keeps most of its money in savings, higher interest rates could increase their disposable income and stimulate consumer spending.
Carter Dougherty contributed reporting from Frankfurt.
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Currency 'Carry Trade' Becomes Harder Play
Amid Aversion to Risk
By CRAIG KARMIN and YUKARI IWATANI KANE
August 18, 2007; Page B1
As if many hedge funds and other global investors weren't having a tough enough time during the market selloff, now one of their favorite bets looks to be in jeopardy: the "carry trade."
This popular strategy -- where investors borrow money in countries with low interest rates, such as Japan, to invest in assets in countries with higher rates -- has been a source of tremendous profits for currency speculators, companies and even Japanese small investors for years.
But the onset of a U.S. credit crisis has generated an aversion to riskier, higher-yielding assets. That has caused speculators to reverse course, buying back currencies they borrowed in before they get even more expensive. The quandary now is that after many lucrative years with the carry trade, there is no obvious strategy to take its place under the current market conditions.
"That's the problem," says John Taylor, chief investment officer at FX Concepts, a New York hedge fund that specializes in currencies and manages $13 billion. "We're basically out of [the carry trade] now and it gets more complex and harder to make money."
The biggest winner during the unwinding of the carry trade is likely to be the yen, which at one point on Thursday strengthened more than 4% against the dollar -- which would have been its biggest one-day gain since 1998, had it held all those gains.
Though the yen declined on Friday, the Japanese currency surged 3.8% against the dollar for the week, and more than 9% versus the Australian dollar and 11% versus the New Zealand dollar. But these moves are generally not welcome in Japan, where a stronger currency hurts exporters and could weigh on stocks.
The rapid unwinding of the carry trade in recent days strained the $2 trillion-a-day foreign-exchange market, usually among the most liquid of any market, even during crisis periods. But on Thursday and Friday, traders complained that at certain times, trading even small yen orders became a challenge because buyers were overwhelming sellers. Some traders said the prices offered them looked so odd they suspected that some banks weren't really prepared to trade the currency at all. "They just don't want to make prices," one trader said. "They don't know where prices are."
Earlier this year, Mr. Taylor said, his firm borrowed money in yen at near-zero rates and invested that money in New Zealand dollars and Australian dollars, where those rates recently have been 6% to 8%.
Since then, the firm has been looking for another strategy as reliable. It won't be easy. Goldman Sachs said earlier this year that one basic version of the carry trade -- selling the six currencies with the lowest interest rates, buying the six with the highest, and resetting the mix once a month -- has returned 19% annually since 1998. That made it both one of the most straightforward and profitable strategies over that period.
Yet when interest rates move and market volatility accelerates, traders can get crushed as they all head to the exits trying to reverse their bets at the same time. Once the yen begins to rally, traders want to buy it back so they can close out their open loan positions before the yen gets even more expensive.
Even so, some investors are hoping that the unwinding of the carry trade is merely a short-term reaction to the credit crunch, and that it will return to fashion as it did after a violent unwinding in February and March and the spring of last year.
"I don't think that will happen now," says Rodrigo Guimaraes, a Barclays currency analyst in London. He says that three conditions are usually necessary for the carry trade to thrive: a funding currency with low interest rates, low market volatility and plenty of trading liquidity.
Mr. Guimaraes figures Japanese rates will remain low for some time. But he thinks it may be a while before volatility eases and liquidity may not return to the abundant levels seen in recent years. Meanwhile, he sees further unwinding of the trade in the days ahead. "We think that long-term investors, such as corporates and Japanese individuals, are only just beginning to unwind their long carry positions," he said in a recent report.
While the dollar strengthened a bit on Friday to 114.21 from 113.88 yen, Mr. Guimaraes sees it going to at least 110 yen.
For now, Japanese currency authorities seem unperturbed by the yen's surge, encouraging traders to maintain their bullish outlook. Japan's currency-policy point man, Naoyuki Shinohara, said he was watching the market carefully, but declined to comment on specific currency moves. Many traders took this as a sign that the b>ministry will not intervene to stop the yen's rise soon. |
