Interest Rate Roundup

Sunday, February 11, 2007

G-7 G-ives G-o ahead for more G-onzo carry trades?

This weekend, top policy wonks from the Group of Seven nations (the U.S., U.K., Japan, France, Germany, Canada, and Italy) met to talk about the world economy. European delegates had one major beef going into the gathering -- the rapid, sizable decline in the value of the yen against the euro. They're mad because that is making Japanese exports more competitive vis-a-vis European ones on the global markets.

But when all was said and done, the G-7 failed to strongly support the yen in its post-meeting communique. One key reason: The U.S. isn't in a great position to support the yen ... and the Japanese themselves aren't eager to see the yen surge, either.

It's true that some groups here in the U.S. aren't happy about the Japanese currency's slide. Big U.S. manufacturers are at the top of the "angry" list. But U.S. Treasury Secretary Henry Paulson is in a tough spot -- the yen is NOT falling because Japanese policymakers are manipulating the market. It's falling because the Bank of Japan is dragging its feet on the interest rate front amid concern that higher rates will derail Japan's economic recovery. Paulson (and other Treasury secretaries before him) have repeatedly said that currency values should be set in open markets free of interference. A push to artificially inflate the value of the yen now -- when it's moving on its own accord -- would make U.S. policymakers appear completely hypocritical.

Why does this all matter so much for FINANCIAL markets? Because of the yen carry trade. Japanese interest rates are extraordinarily low (0.25% is the official BOJ target rate) when compared to rates in the U.S. (5.25%), the U.K. (also 5.25%), Europe (3.5%), and especially places like Australia (6.25%) and New Zealand (7.25%). That's encouraging global investors to borrow gigantic amounts of money at low Japanese rates and re-invest that money in assets in countries with higher interest rates. That buying, in turn, is inflating the value of foreign bonds ... foreign real estate ... stocks ... you name it.

How big of a factor is this? Here's an excerpt from a Bloomberg story that should make your skin crawl:

"Barclays estimates carry trades are at their most extreme since 1998, when Russia's economic crisis prompted traders to unwind their bets so rapidly that the yen soared 20 percent. Hedge-fund Long-Term Capital Management LP collapsed in the market turmoil."

At some point, this easy money-fueled madness will end. But the G-7's failure to specifically target the yen's value looks to me like a G-reen light for more G-onzo carry trades. We'll see.


Post a Comment

<< Home

Site Meter