Sunday, March 04, 2007

What's It All About... Yen-nie?

The reversal of the yen carry trade has been cited as the major trigger for the current correction phase. Yes, and we have debated the yen carry trade for the last few weeks a number of times already. So is the reversal genuine? Yes and no, I would say there were some reversal but based largely on fear rather than on a sustained belief that the yen would strengthen even more significantly over the next few months. There is also some confusion as to where do the yen carry trade invest in? Some will cite the Asian hot stock markets as a possible destination. Just have a look at the size of the yen carry trade each month and map that to the inflows, there is some connection but not by much. Investors must be aware that the yen carry trade is not a recent phenomenon but rather one that has been on-going for the past 15 months. Then we can see a better dis-connect between certain markets and the carry trade.

Yen carry trade tend to stay largely in pure currencies or bonds as that would be the prudent play. You don't really want to be subjected to the vagaries and additional risk scenario from equities. Hence high yielding currencies such as NZ dollar and OZ dollar are the usual suspects. Next in line would be certain commodities such as gold. Other steadier investments such as REITs in good base currency would be highly welcomed, such as HKD and SGD.

Prior to the correction the yen was at 121-122 to the dollar. The yen is expected to be weaker in 2007, much as in 2006. Generally carry trade wants the yen to stay in the 120-125 zone this year and they would be happy to lock in the profits on invetsment. While the outlook on the yen is weak on fundamentals, most carry trade players are not looking at a much weaker yen to dabble to the carry trade. The main attraction is the 0.5% interest rate and the weighted risk to invest in higher yielding currencies, bonds and even equities. All they want is for the yen to be stable.

There is also a lumping of players involved in carry trade. Hedge funds always get the brunt but actually a lot of Japanese companies are involved in the carry trade as well and a number of high net worth individuals.

Now the yen has reached the 117-118 level. Let's look at the corresponding cross rates of various currencies, then you will get a better assessment of the actual quantum of reversal. There is some, but not much. Because if you look at the situation at 117 or 116, the interest rate is still at 0.5%, it is not going to cause panic but rather encourage even more yen carry trades. Because everyone knows if the yen goes up further, we can say goodbye to Japanese exporters, a scenario most central bankers would not want to see. G7 meetings have discussed the need for the Japanese economy to take back leadership in Asia, to take away some of the burden of motoring the global economy from the US, EU and China/India.

At the end of the day, its the interest rate differentials that will exert the most influence. BOJ while scaring people like there is no tomorrow, will not be raising rates anytime soon till at least 4Q2007. Figures coming in from the US sees some inflationary embers, so no rate easing there. Differentials stay, not narrowing. This round of carry trades started when the yen was around 112 in early 2006, so we are not taliign of a massive yen weakness movement since then.

Yes, we should worry when the yen carry trade actually starts unwinding on genuine concerns, as a trickle will turn into a stampede if its based on significant changes in fundamentals. Now is not the time, not yet anyway. Genuine unwinding will occur when players see the trend ending for a weaker yen - narrowing of interest rate differentials is the likely culprit. Either BOJ raises rate aggressively, or the EU/Fed lowers rate aggressively. While both are not likely in the next 2 quarters, if anyone were to make a move, its likely to be the EU/Fed, so watch their every move.


sopskysalat said...

"Nikkei down 3.3% to its lowest close since December as strong yen discourages investors."

The much talk about unwinding yen carry trade may have spook the investors lately and touted as one of the factor for the fall.

This round, the fall is swift and severe, having little signal to many before the collapse of great china wall.

So, as Dali as reiterate, the rate differential does allow plently of room for hedging, still. The media, finding no reason for the fall, is pointing to the carry trade and another by the swiss too. They can't explain it by human pyschology, as time and again, market is driven by fear, and as it kicks in, fear develops into selling - cutting losses or booking profits. The herd is selling, whoever buying is going against the majority. After the first wave of selling, contra players will contribute to the second while fund redemption, margin players will come in tandem, rocking the world equities.

If one had entered the market after the May selloff, the gain till date should be pretty comfortable to withstand the selloff and exit with a pretty full year gain.

Trend has changed for now, what's in many minds are whether we are in the first phase of downtrend or just some jitter correction which should see the bull rise again to higher high.

Whatever it is, the bullish mood is spoilt, and there is no point arguing with the trend and trade with ego to prove it wrong for market do no know what you are holding.

Nikkei, for once, looks nice for a recovery to 19000/20000, has taken a setback. Yen carry trade does has effect to world market, but why not when fund is repatriated back to Japan, it should do more good to the Japan equities than world equities.

Finally, market will repeat again, and investor will grow strong in term of better risk management, position size and trading system.

I end with one thought, has real economic fundamental changed? If market is any indication of future movement, we may be seeing a recession in the next 12-18 months.

sopskysalat said...

Interestingly, i just watched an bloomberg interview. The fund guy was asked, what triggered the selloff? He said, unwinding of carry trade. Guess what, he was shot on the toe. The bloomberg girl replied, "the differential is still huge!" the fund guy was taken back by that, trying to reason that the differential has dropped from 300bp to slightly lower...