Tuesday, February 13, 2007

A Yen For Your Thoughts

sopskysalat said...
Thinking aloud, can the recovery of nikkei be contributed by yen-carrying trade, borrowing yen to buy equities? Then, the weakness in yen can also be explained that yen were sold to reinvest into overseas "safe" instrument such as reits and bonds like you said earlier. I wouldn't think I will borrow yen and invest them into high risk instrument such as stocks in TSE. My opinion, learning to explain situation outside.

Actually, there is too much emphasis on the yen movement. The relatively big yen carry trade naturally creates a weak scenario for the yen going forward. You are correct in that they borrow in yen, convert (sell yen) and invest in other foreign currency assets (stocks, REITs, bonds or just currency deposits). Naturally this exacerbate the yen's weakness. Bank of Japan is at a quandry really. The economy has been improving and they would like to raise rates somewhat, but they also want the yen to be flat or weakish to keep the economic recovery to be sustained.

Is there a time bomb here in the making? The thing could get blown apart if the yen appreciates very fast over a short period causing many to cover their yen carry trades in haste, this could propel the yen's appreciation even further. Of course, this is a big IF.

Would a couple of BOJ rate hikes cause the yen to reverese course? Probably not yet cause we are talking of below 1% at the moment, even a couple of rate hikes will not be sufficient to narrow the interest rate differentials between the dollar/euro/aud and the yen. Moreover, what is driving the carry trade is the players know that the G7 would want the Japanese economy to recover more from here on, and that the BOJ would commit sepukku first than let the yen appreciate. The G7 of course would not want excessive weakness in the yen which would price their Euro products out of being competitive.

The yen carry trade is estimated to be totalling more than US$33bn now and rising. I would think this to be an excellent ye carry trade:
Borrow in yen and pay 1% or less, sell the yen to dollars, and buy Japanese ADRs or Nikkei ADRs in Nasdaq.

Part of the reason why the Nikkei has not been rising as much as expected is that the bulk of yen carry trades is into foreign currency investments. However, if you believe in the weaker yen story, the Nikkei's gotta rise alongside. The Euro is in a more precarious situation than the dollar as the yen seem to have weaken a lot more against the Euro. Even though there was no official statements from the recent G7 meeting, I am sure the G7 would have been concerned over yen's weakness. However, the G7 would have also realised that the EU economies have generally performed much better than the Japanese economy over the last 4 years, and they may be swayed to suffer slightly to allow the Japanese economy to recover more (i.e. allow yen to be weakish).

The ECB recently voted to maintain its key interest rate for its 13-member countries at 3.5%. However, ECB President Jean-Claude Trichet is expected to hint at a March rate hike, saying the ECB is watching monetary developments with "vigilance" or "strong vigilance." The current inflation rate is less than the ECB's goal of "just below 2%" despite German economic strength. Also, money supply is said to be growing twice as fast as the ECB's comfort level. One issue possibly keeping the ECB from hiking in the near-term is political pressure in regard to the weak Japanese yen. This will stop ECB from hiking too aggressively as that will only promote a weaker yen and a stronger Euro. While I do not think yen will be very weak this year, in fact it may stay firm as I believe the BOJ, Federal Reserve and ECB would be wanting to make sure that the yen carry trade does not get out of hand. They may actually get BOJ to start raising rates soon. The Japanese economy has been recovering well for the last 2 years, and a slightly stronger yen in 2007 would not hurt much. That is the "mis-calculation" by most of the yen carry trade investors. I do see the yen being allowed firm up slightly this year, partly to dissuade the carry trade. Then the Nikkei can carry on its march towards 20,000 this year without the yen carry trade distraction.


Rohan_888 said...


"Then, the yen starts to appreciate again – by a sharp 9% in one month - when a small emerging market economy defaults (Ecuador soon?) and a large hedge fund goes belly up (another Amaranth?). Then, suddenly one piece of good news comes out of Japan (a growth pickup?) and in a matter of 72 hours the yen appreciates by 12%. Then a major global macro hedge fund loses $2 billion dollars in 48 hours on the yen unraveling and decides to close shop; another one loses billions too and decides to restructure its operations. Carry trades unravel rapidly, margin calls are triggered, levered positions go belly up and the entire financial system goes into a seizure. Then the Fed is forced to cut the Fed Funds rate in between meetings by 75bps (in spite of still good US GDP growth) in order to avoid a financial meltdown, a collapse of US financial markets and a global recession.

Readers of this blog (Roubini) may think that the first paragraph above describes very precisely the current situation of the yen and of the global financial system in the last year. Indeed, news reports have been endlessly talking about the yen carry trades driven by low Japanese interest rates. Readers of this blog may also think that the second paragraph above is a typical Roubini "doom & gloom" fear mongering and describing a scenario that is totally unlikely to occur in 2007.

But what I was describing in the first two paragraphs above is not 2006 and a fear mongering scenario for 2007 but rather what actually and exactly happened in August-October 1998."

My guess is that the current situation is worse than in 1998.

Another worry seems to be realized at the moment, that the subprime lenders in the US are in much worse shape than most thought:


During 2007 more than 1 trillion ARM's will be reset, we only have just started.

Economists from the Austrian school (Marc Faber, Richebacher, etc) expect a bloodbath in the US caused by overspending by consumers, rising debt on all levels and no "real" investments that cause growth, the only thing they have been good in lately is "asset shuffling" (hedge fund managers and companies like Goldman & Sachs) as Faber calls it.

Almost all American economists however think that all will be well, because the US is so clever, surely they will find a way out.

To me the Austrian camp looks a lot more convincing.

sopskysalat said...

One thing which you did not highlight Dali, that is, why not borrow yen and buy into nikkei directly instead of going for ADR in Nasdaq and Dow?

I guess a lot of carry trades are going to other instruments than japan-linked. Nevertheless, today nikkei hit a new record. HSI and STI are taking a break.

Salvatore_Dali said...


To borrow in yen and then invest in equities is naturally a lot safer. The nature why the carry trade is so huge is that many prefer the double-whammy effect, but want to lock in the returns as well. So, to go short on yen, and going long on another currency maybe the only risk they want to take. To further boost returns, it could be an Aussie bond or Singapore REIT, ones with a fixed return somewhat plus currency gains.

To borrow in yen and go long in Nikkei is just a MARGIN STOCK ACCOUNT la... As usual the retail players are not that aggressive in Japan. As for institutions, that is akin to just being very leveraged, hard to explain to board of trustees.

sopskysalat said...


Alas, I phrased message wrongly. Sorry! I wanted to say borrow yen and buying into local Japanese stocks intead of going for ADRs.

But you may have explained that to go for double whammy, one gain on FX and other stable cum high yield instrument.

Perhaps, if the Japan equities are more attractive, then money will not be going elsewhere but Japan.

Salvatore_Dali said...


you are correct, if the investor was a Japanese investor, borrowing in yen to invest in Nikkei would be akin to Margin Financing, no big deal, happens all the time. For foreign investors, borrowing in yen and buying Nikkei stocks would actually be a very astute move (if they are as bullish as we are on Japanese stocks this year).

Guess, some of them are not that bullish on Japanese stocks. Of course the MAIN reason why they would not do that is that THEY EXPECT THE YEN TO WEAKEN, hence to invest in Japanese stocks on the Nikkei may see any gains being wiped out by yen's weakness - hence for a foreign investor, it is a difficult decision to go long on Japanese stocks. That is why I suggested Japanese ADRs as possibly the best instrument/investment this year.


The Leakers - Helmed by the often brilliant Herman Yau Nai Hoi (whom I believe was from Malaysia who became a great success in HK films). 7...