This may answer your question. Daniel, I'd like to get your take on this too (if you do have an opinion). To me it provides yet another proof that when everyone moves to one side of a trade (in this case yen carry), it is the losing side. This is part of a larger research article that I read.
Sun Tzu
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Fourth, is the unwinding of the cross-border arbitrage plays that have long favored higher-yielding dollar-denominated assets. The great yen carry trade is classic in this regard -- as global investors have borrowed for next to nothing in yen-denominated markets and invested the proceeds in higher-yielding dollar-denominated assets. With spreads between ten-year JGBs and their Treasury counterparts having averaged 364 basis points over the 1995-97 period (and 408 bps today) -- more than sufficient to account for risk disparities between these two assets -- the carry trade was a no-brainer. Indeed, over the 1995-96 interval, net foreign purchases of Treasuries amounted to about $440 billion, nearly three times the previous two-year record and well in excess of the cumulative current-account deficits that totaled only about $260 billion over the same period. Now, however, courtesy of the global margin call stemming from the ever-widening currency crisis, such excess capital is being repatriated back to the world's creditor countries, resulting in a surprising strengthening of the yen. The dollar is a clear loser if these carry trades continue to be unwound.
It's hard to say if these increasingly bearish fundamentals for the dollar will continue to outweigh the positives that had boosted the trade-weighted currency by 30% from its all-time lows in the spring of 1995. But with this same dollar index now having retraced all of the 6% gains that had previously occurred in the first eight months of 1998, there is now good reason to ponder a global scenario dominated by a much weaker dollar than most had envisioned. This should not be viewed as a strong-yen or even a strong-DM story -- it's just a case of a dollar now being weighed down by clear negatives of its own. For the United States, such an outcome would have obvious and important implications for inflation, interest rates, earnings, competitiveness, and for foreign inflows into stock and bond markets. For the rest of the world, it's the mirror image of all of the above. It's just another example of a global economy turned inside out. |
