MOF's Watanabe says carry trades not one-way bet
Thursday, March 01, 2007 7:06:15 AM (GMT-06:00)
Provided by: Reuters News
(Recasts, adds more quotes, background)
By Natsuko Waki
LONDON, Mar 1 (Reuters) - Japan's top financial diplomat urged investors on Thursday to recognise a two-way risk in high-leverage carry trades and said the authorities were monitoring the impact from their possible reversal.
Hiroshi Watanabe, the vice finance minister for international affairs, also said he expected Japanese interest rates to rise further, which will boost the interest receipts in households and lead to higher personal consumption.
His comments to a conference in London followed a sharp rally in the Japanese currency this week, as investors rushed to cut their exposure to risks involved with borrowing the low- yielding yen to purchase higher return currencies.
"We should not be complacent. We should recognise the two-way risk," Watanabe said, echoing the statement from the Group of Seven finance ministers meeting in February.
He said the impact from the possible reversal in yen carry trades was likely to be limited, adding: "but we have to closely monitor the situation."
Asked about a sharp rise in the yen this week, Watanabe struck a sanguine note.
"I don't think there was an unwinding situation, it's adjustment. Even today the market is getting calmer. This is not defined as a reverse movement in yen carry trades. Unwinding is kind of a maximum one-way movement of the situation."
The yen surged 2 percent against the dollar on Tuesday, its biggest one-day jump in 14 months. On Thursday it was trading higher on the day at 118.21 per dollar <JPY=>.
Watanabe said yen carry trades by Japanese institutional investors in search of long-term higher returns elsewhere, or by European retail investors who are looking for cheaper yen-financed mortgages, were unlikely to reverse quickly.
"Even if you have a change of the yen value towards appreciation, housing loans are not easily all paid back," he said.
"If the total transaction is moving suddenly in the wrong direction it will cause turmoil. But these (carry) trades are not easily reversible."
Watanabe added there were no statistics to gauge the size of carry trades, he estimated the size of yen carry trades to be several 10 trillions of yen, around half of what he said some ,market players estimate -- $1 trillion.
Later comments were more specific:
"It depends on the definition of the market -- maybe 10-20
trillion (yen) but I don't know... we don't have statistics."
HIGHER RATES, POSITIVE IMPACT
Swelling carry trades and heavy selling of the yen over the past year stemmed from expectations Japan's interest rates would stay low compared with other industrialised countries.
Watanabe said Japanese interest rates were heading higher after the Bank of Japan's hike to 0.5 percent in February and that would benefit the economy.
"The positive impact is larger than the negative impact. Gradual moves are not going to harm the economy... We are going back to the normal level of interest rates," he said, adding that higher interest rates mean higher interest receipts for the Japanese, who were likely to spend more.
"As you see the (recovery of the) economy is sustained and led by the private sector... I'm confident that starting from 2007 we will have good consumption."
Watanabe said that Japanese price movements were worrying even though the country was at the end of deflation.
He said that while expected wage increases would put upward pressure on prices, falling oil prices added downward pressure.
Asked about Japan' foreign exchange reserves, the world's second largest, Watanabe said Tokyo will keep the same currency composition.
"The current position is of course we have a huge amount of FX reserves in dollars, not only in treasuries but dollar- denominated assets. In general we don't have any shift from dollars. We keep the same currency composition," he said.
Watanabe was in London at the start of a European roadshow to promote Japanese Government Bonds.
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Is the party over for the yen carry trade ?
Tuesday, February 27, 2007 11:51:30 AM (GMT-06:00)
Provided by: Reuters News
By Gertrude Chavez-Dreyfuss
NEW YORK, Feb 27 (Reuters) - The party for yen "carry trades" may be ending sooner than expected, after a 9.0 percent slump in Chinese stocks on Tuesday prompted investors to reduce some risk in their leveraged portfolios.
The Japanese yen jumped more than 1.5 percent against the U.S. dollar, and was up about 1.0 percent against the euro on Tuesday, as investors unwound trades in which they had borrowed yen at low interest rates and used the proceeds to invest in higher-yielding assets in other currencies.
The yen had slid to a four-year low against the dollar in January, as low Japanese interest rates and low volatility in global financial markets, resulted in the "carry trade" value soar to an estimated $1 trillion.
The Bank of Japan's decision last week to raise its benchmark interest rate to a decade-high of 0.5 percent did little to restrain investors from selling the yen and buying instruments with higher yields, until now.
Tim Lee, founder and president of Pi Economics, an investment advisory firm in Stamford, Connecticut, said the end of the carry trade regime could be a "devastating financial collapse."
"We would be seeing a lot of hedge funds and investment banks which have benefited from carry trades go under. When these trades reverse, they all reverse together and the yen is a crucial part of it," he added.
Analysts say the warning signs have been evident for the last few weeks.
The market's extreme positioning on yen carry trades, defaults in the U.S. subprime mortgage market, and geopolitical worries about a potential confrontation between the U.S. and Iran, have been unnerving some investors, and have helped to push the price of gold up to a seven-month high of $689.00 an ounce this week.
With capital outflows from Japan intensifying this year due to a surge in retirement payments which are expected to be invested overseas, some strategists predicted an even lower yen against the dollar by the end of the first quarter. Bank of America, for instance, has revised upward its forecast for the dollar against the yen to 122 from 120 by the end of the first quarter.
But some analysts warned that these yen transactions cannot carry on much longer.
"Playing the short-yen, long-dollar trade isn't the no-brainer it's made out to be," said Avery Shenfeld, chief economist at CIBC World Markets in Toronto.
"A modest exchange rate move can easily wipe out the difference in yields. After all, a four percent annual interest gap implies only a fraction of that over a month," he added.
The differential between U.S. and Japanese interest rates is about 4.75 percentage points, with the federal funds rate currently at 5.25 percent.
US SUBPRIME MORTGAGE UNWINDING
Recent defaults in the U.S. subprime mortgage market for borrowers who can't get standard loans to buy homes because of low income or tarnished credit may be the first crack in the carry's veneer, analysts said.
The U.S. housing market slowdown has hit subprime borrowers as a sharp decline in home prices since 2005 has limited the ability of homeowners with little equity to refinance or sell their property.
About 20 lenders in the U.S. subprime mortgage market have gone out of business in recent months.
"The subprime mortgage market, I think, is going to get worse and worse and there's no turning around," said Pi Economics' Lee. "The broader market seems to be ignoring it and that's a mistake. I think it's the first crack in the credit bubble."
The growth in subprime lending in the U.S. was fueled by a flood of global liquidity chasing higher returns in an environment of relatively low interest rates in the developed world, helped by sharply rising house prices in many countries.
As a result some lenders eased loan requirements on everything from houses to multibillion-dollar office buildings and introduced variable rate and deferred interest mortgages.
Analysts are concerned troubles in the subprime mortgage market could spread to other asset classes such as credit derivatives whose rapid growth have also been financed by low-yielding currencies such as the yen.
In the longer term, slowing economies in high-interest rate countries such as Britain and Australia may dim the attraction of carry tradese trades also. Britain's interest rates are currently at 5.25 percent, while Australia's are 6.25 percent,
"Economic data offer signs the string of recent rate hikes in the UK and Australia are starting to slow growth momentum," wrote Sophia Drossos, currency strategist, at Morgan Stanley in New York.
That should convince their central banks to keep interest rates steady or cut them if growth slows dramatically, curbing their yield advantage and diminishing carry returns.
By contrast, Japan's domestic economy has showed signs of life and its surging trade surplus should support the view that Japanese rates will rise further.
Finally, a further risk for carry trades is that so many investors have put on the same trade, meaning there could be a rush for the exits that will exaggerate price movements.
"The yen has already cheapened enough to allow inflation pressures to return. In that case, the central bank may have to tighten policy a lot more," said Chen Zhao, managing editor of BCA Research's Global Investment Strategy bulletin in Montreal.
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