The Carry Trade: Perpetuation Or Collapse

The yen fell hard Thursday. I was cruising around the net gathering some information about the carry. I was surprised to find four articles on the FT website, all in the same day, regarding the carry. The content really peaked my attention.

There are essentially two types of carry going on here: The professional traders and the professional retirees.

We all know the billions available to the professional traders. They are the stealth investors that have pushed the yen as low as they have over the past few months.

Then there's the professional retirees. The baby boomers of Japan. Their take lately on the yen's rise: "What, you mean my currency is valued higher than it was last week, so I can buy more bonds from overseas?" What the article in the FT tells us is that these investors don't even show up in the carry's estimated figures.

By some definitions Japanese investors in their 60s and 70s – who have been venturing abroad in increasing numbers because of low domestic interest rates – do not count as carry traders at all. Rather than borrowing to invest in non-yen assets, they simply transfer yen savings into investment trusts with foreign portfolios or into so-called uridashi bonds, foreign-currency-denominated paper issued in Japan.

They are the bargain hunters of the carry. They are also the long-term holders that are likely to perpetuate the carry along with the yen's weakness. The pro traders can get out in a few minutes. These investors are likely to move long after the yen has appreciated.

What's it going to take to get these investors to really budge? Two fold, the way I see it. First, it is going to take the yen to appreciate considerably. That's only going to happen because the pro traders run for the exit doors. Then, the BoJ needs to continue to move interest rates higher. It's going to be a see-saw with the retirees viewing any yen rise as an opportunity to buy more bonds from overseas. As this FT article says a bit differently about the same issue.

Maybe the carry will unravel slower than most perceive.

What happens if the carry collapses?

Ahh... here's something I've been mulling around in my mind for some time. If the carry collapses, will we all have to line up on San Francisco's Golden Gate Bridge, and like sheep, end our agony by jumping off?

Hardly.

To begin, just think of the opportunity that Japan, the world's second largest economy, would have for growth? I've written something about this once before. Japan suffers from a mild case of deflation. I believe that the Bank is actually perpetuating that with the ultra-low interest rates. By lowering their rates as low as they have, investors in Japan have moved just about every penny... er, yen, over to other investment opportunities overseas. The ability for the economy to expand has contracted with the dry up in cash. If the carry were to collapse, the Japanese economy would be awash with cash. The word deflation would fade into the history books. Then, another word would appear: stagflation. Then, the Bank would have to push rates up, and the investors would repatriate funds.

You'd think the BoJ would have caught on to this. Apparently not.

What would happen to other countries around the world? Well, a lack of liquidity would prompt Central Bankers around the world to provide the vacuumed liquidity. Interest rates would move lower. Much lower. Cuz, what liquidity we lose we'll need to be reapplied, a la the Big Easy Al policy. Now, wouldn't that also assist in the housing market right here? Likely, but let's not move that far forward.

I've gotten some concerns via emails regarding a doomsday event with regards to the carry collapse. I don't see that. I do see big moves in capital with the carry dissolving. That's about it. Nothing likely for us to want to head over to the bridge.

In the long run, I see big moves likely in the currency markets, and realignment in government debt markets. But, all of this can be fixed with some quick moves by Central Bankers.

This is a working thesis that I have right now. This is what I'm visualizing with respect to the yen.

I've also been asked how long I see this taking, and how where the yen's high will be. I'm thinking the yen is likely to move to about the 110.00 level in the next three months, and I am positioning myself for that. Where's the top? Perhaps we'll see the 100.00 level again. That's not going to happen too quickly. But, I could see it happening. It's within the real of possibilities in my thinking.

Comments

[scott146:]

Interesting ideas about the senior citizen Japanese savers. However, if the BoJ takes your advice the rise in the yen would damage the profits of the Japanese export sector. Since historically the BoJ has favored the export sector I don't see them pursuing the policy that you suggest.

2007 Mar 09 10:31 AM