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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: russwinter who wrote (28098)	3/8/2005 2:01:30 PM
From: mishedlo	Respond to of 110194

"Mish, in a yen carry trade they hedge and largely neutralized against the currency risk. I'd say right now that carry trade is still alive and well, and will be as long as the rate differential is there, and in fact is getting larger. Just one more in a long string of synthetic economic set ups, that works until there is a sigma 6 event (*). And you won't want to be long US debt when a sigma 6 hits either." Russ go back to my last example which uses as best I can tell the amounts and interest rates Jim supplied Message 21114526 Lets assume for a second a perfect cost free hedge. Where there was no currency risk. Someone borrowed 30 million, put on the perfect hedge so there was no currency gain or loss and paid back essentially 31 million or so. The person supposedly made 5% per year or 10% so lets call that $3 million. Profit is 2 million on 30 million or 6.7% return. OK not bad. But... do you really think one could put on a hedge that perfectly. Really?! an 18% currency decline over 2 years that was perfectly hedged and cost free?!?? I do not buy it. Remember FNM lost 9 billion dollars trying to hedge treasuries. Currency hedges are not cheap. Someone would have to have been carrying puts on the US$ vs the YEN as a hedge. I suspect maintenance of those puts cost more than 7%. Jim did not mention hedges so I did not factor them in. But as you can see (I hope) to make even 7% on the trade assumes a perfect cost free hedge. Now, lets say they were able to hedge the currency play losing only 5% on their hedges. Fair enough. They have a return of 2%. That return is hardly risk free, automatic or anything else. The more leverage they throw at this the better their currency hedging better be! I do not think this is either as simple or as profitable as Jim makes it out to be. As I said, the big player is the bank of Japan and I do not think they are doing this to make a profit or that they are hedged either. The other problem in Jim's scenario is that he insisted upon 5% treasury yields. The only way to achieve that was to buy 10yr treasuries. In that case Jim is ignoring the potential risk on those. Now you know that I think that yields are headed lower so that is a theoretical problem. Also note that someone in the trade might need to somehow hedge movements in treasury yields as well. The further out on the scale in duration, the greater the need to hedge. That makes for a second costly hedge if you would. Conclusion: There is nothing easy about the YEN/US-TREASURY carry trade at all. With perfect hedges, gain seems to be about 7% and if playing with 10-yr treasuries there are not one but two hedges to be maintained if done with any leverage. Those hedges will without a doubt be cutting into any profits. I further doubt that the trade has been profitable at all unless one has been damn good at reading both movements in currencies and US treasuries. comments? Mish

To: russwinter who wrote (28098)	3/8/2005 6:09:00 PM
From: LLCF	Read Replies (2) \| Respond to of 110194

<Mish, in a yen carry trade they hedge and largely neutralized against the currency risk. I'd say right now that carry trade is still alive and well, and will be as long as the rate differential is there, and in fact is getting larger.> I'll start by saying that I DONT KNOW what the i-banks are doing on the carry trade at the moment and haven't looked to see what the future are implying... BUT: Normally a rate differential does not a HEDGED carry trade make because the currency forward or futures include this differential in their pricing. ie. The pricing of currency forward K's include the rate differential. Or in Mish's words from his ensuing post: <<Currency hedges are not cheap.>> In fact the price of the currency hedge is BASED on the interest rate differential.. there is no free lunch in general... of course there are times where day to day the i-banks can accumulate these trades due to flow factors in the market. Thats how they get these trades on, but they ARE NOT EVER collecting the entire i rate spread that I"ve ever seen. DAK