BOJ interest rate rise and carry trade
21 February 2007, 11:54 AM
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BOJ interest rate rise and carry trade
With the Bank of Japan raising interest rates from 0.25 to 0.5%, how much of an effect will this have on the availability of easy/cheap credit in the UK?
21 February 2007, 12:25 PM
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I'm sure I've got my terminology and understanding confused then.
What I'm wondering is how much a weak Yen and low interest rates are linked to the ease of credit available in the UK. Could a stronger Yen and increasing interest rates result in a credit tightening in the UK?
What I'm wondering is how much a weak Yen and low interest rates are linked to the ease of credit available in the UK. Could a stronger Yen and increasing interest rates result in a credit tightening in the UK?
21 February 2007, 12:45 PM
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If a bank wants to lend money out, my understanding is that they lend out far more than they have in reserves thereby multiplying the interest many times Fractional-reserve banking - Wikipedia, the free encyclopedia . This is one way to make substantial profits.
Additionally, if you borrow money in Yen at low interest rates and lend it out in sterling at higher interest rates then you make further profits if the Yen remains weak and the interest rates stay low.
Alternatively, UK debt can be sold on beyond the bank frontage that is lending to you?
I'm sure the above is a simplistic view, and probably flawed, but I find international banking confusing and the cynical side of me feels that the smoke screen over the world financial systems is a way for them to transfer wealth to themselves.
So, if one of the cheap sources of money (the Yen) has flooded the world in liquidity and easy lending, when the Yen strengthens and the interest rates go up the cheap money underlying much of the world's credit boom may dry up? Thus crashing asset prices that have been pumped up by easy credit?
It struck me that rises from 0 to 0.25 to 0.5% are small in absolute terms, but relatively couldn't it knock the profits of financial instruments like derivatives that are stabilising (or destabilising if you prefer?) our financial markets?
What if the heavily geared positions collapse because of price/currency movements going against the recent trends? Could this then produce bad debts and failures in the financial system also leading to a credit bust?
Again forgive me if there are huge mistakes in my terminology or understanding. There are all sorts of views in the financial press that confuse me.
Additionally, if you borrow money in Yen at low interest rates and lend it out in sterling at higher interest rates then you make further profits if the Yen remains weak and the interest rates stay low.
Alternatively, UK debt can be sold on beyond the bank frontage that is lending to you?
I'm sure the above is a simplistic view, and probably flawed, but I find international banking confusing and the cynical side of me feels that the smoke screen over the world financial systems is a way for them to transfer wealth to themselves.
So, if one of the cheap sources of money (the Yen) has flooded the world in liquidity and easy lending, when the Yen strengthens and the interest rates go up the cheap money underlying much of the world's credit boom may dry up? Thus crashing asset prices that have been pumped up by easy credit?
It struck me that rises from 0 to 0.25 to 0.5% are small in absolute terms, but relatively couldn't it knock the profits of financial instruments like derivatives that are stabilising (or destabilising if you prefer?) our financial markets?
What if the heavily geared positions collapse because of price/currency movements going against the recent trends? Could this then produce bad debts and failures in the financial system also leading to a credit bust?
Again forgive me if there are huge mistakes in my terminology or understanding. There are all sorts of views in the financial press that confuse me.
21 February 2007, 12:56 PM
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Right i think i have an idea what you're getting at now, John. To cut a very long story short, everything resulting from today's hike will have been arbitraged out, there hasn't been a fundamental change in the playing field. The FX rate has adjusted to take account of the new BoJ rate, Yen hasn't suddenly become "expensive" realitive to anything else, and it won't have altered the banks' ability to lend cash or leverage up.
Do keep asking if i've not answered your specific concerns.
Do keep asking if i've not answered your specific concerns.
21 February 2007, 01:12 PM
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Thanks, very helpful.
How helpful do you think it is for the private investor to move between asset classes and countries in response to the economic climate? Most performance comparisons seem to be relative to the rest of that asset class in that country. However, it strikes me that the larger cycles seem to be between different asset classes and countries at different times.
A Fidelity mailing about their multi-asset fund was interesting, but I noticed it had fairly narrow adjustment ranges in which the fund manager could alter the balance between cash, bonds, stocks and property.
For a younger investor with more time it seems a bit boring to spread everything out thinly.
How helpful do you think it is for the private investor to move between asset classes and countries in response to the economic climate? Most performance comparisons seem to be relative to the rest of that asset class in that country. However, it strikes me that the larger cycles seem to be between different asset classes and countries at different times.
A Fidelity mailing about their multi-asset fund was interesting, but I noticed it had fairly narrow adjustment ranges in which the fund manager could alter the balance between cash, bonds, stocks and property.
For a younger investor with more time it seems a bit boring to spread everything out thinly.
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21 February 2007, 01:18 PM
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Only on a macro-economic level. Forget fiscal policy, that won't change anything in the grand scheme of things. You could argue that Japan raising rates makes this a good time to get in to Japanese stocks, as the BoJ are obviously reacting to what they see as mounting inflationary pressures, so if they haven't contained it with this move then the growth in the economy could be greater than we've seen for some time, unless and until the BoJ catch up and dampen this down - the classic capitalist cycle. Unfortunately it's very difficult to predict the next "hotspot" - you'd make millions if you could predict it accurately all of the time. Plus don't forget you might not want the risk profile that investing in Japanese equities, for example, could bring. The Nikkei isn't shy of a sharp move or two, although the graphs at the moment are certainly only pointing one way.
21 February 2007, 06:09 PM
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Hmmm, may be something to worry about in the future, but perhaps more for companies than individuals.
Business comment | City Comment | Business | Money | Telegraph
Business comment | City Comment | Business | Money | Telegraph
Originally Posted by Telegraph
Higher Japanese interest rates relative to rates abroad will lessen the attractions of the carry trade but that is not the big issue. If you engage in this trade, there is the little matter of exchange-rate risk to consider. Can't you hedge this risk, you might ask?
You can, but if you do you wipe out the profit because the forward rate of exchange (the rate at which you can contract now to exchange in the future) always differs from the spot rate by the extent of the differential in interest rates. So in order to make a profit you have to leave the exchange risk unhedged. And that is risky - big time.
If the yen were to rise then what seems like a no-brainer becomes a no-profit-maker. Indeed, it could be a huge loss-maker. For an asset held for a year, where the interest differential is 5pc, the currency only has to move by 5pc for the gain to be wiped out. And currencies can move by 5pc in a day. Now there is no necessary link between higher interest rates and a stronger yen. After all, even if Japanese rates rise, they would be well below rates elsewhere.
But a higher Japanese rate would also increase the risks of the yen strengthening and thereby set up the conditions for a self-fulfilling prophecy. For the fear of the yen rising could deter people from the carry trade, thereby helping to bring about a rising yen. The consequence would be major losses sustained by financial operators around the world and downward pressure on asset prices outside Japan.
For all the hype about China, for the time being anyway, Japan is the world's second-largest economy and while it remains in rehabilitation the world as a whole is bound to be somewhat peculiar.
The last ten years have been an extraordinary period in world financial markets. There have been a number of important contributing factors but the combination of near-zero Japanese rates, the weak yen and the consequent flood of money into world asset markets has been one of them. I cannot tell you when but some day someone is going to lose an awful lot of money betting on a continuing weak yen.
You can, but if you do you wipe out the profit because the forward rate of exchange (the rate at which you can contract now to exchange in the future) always differs from the spot rate by the extent of the differential in interest rates. So in order to make a profit you have to leave the exchange risk unhedged. And that is risky - big time.
If the yen were to rise then what seems like a no-brainer becomes a no-profit-maker. Indeed, it could be a huge loss-maker. For an asset held for a year, where the interest differential is 5pc, the currency only has to move by 5pc for the gain to be wiped out. And currencies can move by 5pc in a day. Now there is no necessary link between higher interest rates and a stronger yen. After all, even if Japanese rates rise, they would be well below rates elsewhere.
But a higher Japanese rate would also increase the risks of the yen strengthening and thereby set up the conditions for a self-fulfilling prophecy. For the fear of the yen rising could deter people from the carry trade, thereby helping to bring about a rising yen. The consequence would be major losses sustained by financial operators around the world and downward pressure on asset prices outside Japan.
For all the hype about China, for the time being anyway, Japan is the world's second-largest economy and while it remains in rehabilitation the world as a whole is bound to be somewhat peculiar.
The last ten years have been an extraordinary period in world financial markets. There have been a number of important contributing factors but the combination of near-zero Japanese rates, the weak yen and the consequent flood of money into world asset markets has been one of them. I cannot tell you when but some day someone is going to lose an awful lot of money betting on a continuing weak yen.
21 February 2007, 08:54 PM
#12
there was another article about the carry trade last year - basically said that if cheap money dried up from places like Japan it could have catastrophic effects on British and American economies.
How 'stoozing' could bring down the global economy - Money Week
How 'stoozing' could bring down the global economy - Money Week
Last edited by KiwiGTI; 21 February 2007 at 08:57 PM.
22 February 2007, 08:20 AM
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John i've asked around further about this as i wasn't entirely satisfied with my answers yesterday. Here's the situation as i see it;
1. The carry trade still works. The differential between Yen and USD for example, is still wide enough to make it worthwhile.
2. The hike yesterday was anticipated and hence the FX markets had completely priced it in.
3. Any strengthening of the Yen from here *could* result in a rather unpredictable unwinding of the position.
4. Since it requires massive FX exposure lines, this is a trade undertaken primarily by hedge funds.
5. As such, UK credit isn't really affected as there is minimal wholesale/retail crossover, so i'd expect any impact in that particular area to be minimal.
About four years ago when Yen went to 0%, the Yen/USD exchange rate fluctuated wildly over a two week period, and there has to be a point when the reverse will happen, either from the States cutting or Japan hiking further. You might see a few headlines regarding the ensuing volatility, but as far as a long term impact on the UK consumer, no, really don't think it will affect us.
Hope this helps further.
1. The carry trade still works. The differential between Yen and USD for example, is still wide enough to make it worthwhile.
2. The hike yesterday was anticipated and hence the FX markets had completely priced it in.
3. Any strengthening of the Yen from here *could* result in a rather unpredictable unwinding of the position.
4. Since it requires massive FX exposure lines, this is a trade undertaken primarily by hedge funds.
5. As such, UK credit isn't really affected as there is minimal wholesale/retail crossover, so i'd expect any impact in that particular area to be minimal.
About four years ago when Yen went to 0%, the Yen/USD exchange rate fluctuated wildly over a two week period, and there has to be a point when the reverse will happen, either from the States cutting or Japan hiking further. You might see a few headlines regarding the ensuing volatility, but as far as a long term impact on the UK consumer, no, really don't think it will affect us.
Hope this helps further.
22 February 2007, 11:07 AM
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Thanks again.
Although there is little direct connection between retail and wholesale, surely market movements in one will indirectly affect the other as the effects ripple across the financial systems?
I've seen the opinion stated that the interest rates set by the BOE might not affect the availability/ease of credit as much as previously because global markets are now so much more closely linked than in previous cycles and money is going through many more hands.
Although there is little direct connection between retail and wholesale, surely market movements in one will indirectly affect the other as the effects ripple across the financial systems?
I've seen the opinion stated that the interest rates set by the BOE might not affect the availability/ease of credit as much as previously because global markets are now so much more closely linked than in previous cycles and money is going through many more hands.
Last edited by john banks; 22 February 2007 at 11:10 AM.
22 February 2007, 11:44 AM
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Yes there's no doubt that we're operating on a much more global scale than ever before, but i'm still not convinved that the unwinding of the carry trade will do anything other than take away focus from that particular trade and towards something else. I could be completely wrong, but i don't see the availability (or cessation thereof) of cheap credit in the UK as being a particularly strong candidate for being the fall-guy in all this. Although if it is, you can bet there will be some far greater casualties than that before it happens. All should become clear over the next few years!!
22 February 2007, 11:56 AM
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Still being youngish, I don't have the benefit of personal experience of lots of previous business cycles, being busy in training during the dot com boom/bust and only seeing my parents and how they coped with the 80s/90s cycles. Things seem to have been eerily benign for quite a while now so that people are expecting it to be the norm. I wonder how many young hedge fund managers that have almost been able to do no wrong by luck will be caught with their trousers down?
A few years ago I had confidence in the UK/US markets, and of course housing, and it has paid well. Now I have little confidence in anything and am holding cash, which is risky in its own way.
A few years ago I had confidence in the UK/US markets, and of course housing, and it has paid well. Now I have little confidence in anything and am holding cash, which is risky in its own way.
28 February 2007, 07:39 AM
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Well, i have to hand it to you John, we read it here first 
Shanghai down 9.1%, Dow down 416 points last night, FTSE down 148 points yesterday, and more of the same today probably. USD/JPY now at 118.50 and looking to strengthen further.
Strap yourself in and hold on tight
Shanghai down 9.1%, Dow down 416 points last night, FTSE down 148 points yesterday, and more of the same today probably. USD/JPY now at 118.50 and looking to strengthen further.
Strap yourself in and hold on tight
28 February 2007, 09:12 AM
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I'm holding 12% in FTSE-100 or FTSE-All Share trackers, rest in cash, except I did start a drip feed into Japan on Monday. Need to work out now when to time putting more into Japan.
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