when, if at all, carry trading would return as per function of declining volatility and appreciation of risky assets

TO BE NOTED: From A Fistful Of Euros:

"Japanese Housewives Back in the Game? by Claus Vistesen

I am sure all those deadly serious investors, analysts, and commentators we hear so much from have been hard at it of late, trying to keep track of the broadest possible range of indicators in an attempt to to discern whether all those shoots of green would continue sprout, or whether what we have been seeing was merely a blip on the horizon of what may well be a very long recession. Clearly, what we have been seeing in the economic data does now seem to be a bit more than a mere blip, although what actually happens next may well take many of the consensus analysts completely by surprise.

Interestingly we have been getting some pretty clear signals of late, and from one of the “usual suspects”, that something somewhere may well be changing. I am of course talking about the recent Bloomberg report (also here) that Japanese housewives are once again making their presence felt in currency markets by playing the carry wheel.

Individual investors in Japan increased bets to the most in six months that the yen will weaken as the economy stabilizes, jumping back into a trade that was all but wiped out last year.

Businessmen, housewives and pensioners held 153,326 margin contracts at the end of last month that will make money if the yen declines against currencies ranging from the euro to the Australian and New Zealand dollars, according to the Tokyo Financial Exchange. All told, they may have as much as $125 billion in yen so-called short positions, RBC Capital Markets strategists said. “Investors believe the worst of the global recession is over and higher-yielding currencies are bottoming out,” said Yoshisada Ishide, who oversees $1.8 billion as a Tokyo-based fund manager at Daiwa SB Investments Ltd., a unit of Japan’s second-biggest investment bank.

Now, I have had my eyes on the Japanese housewives on more than one occasion (especially here) because I think that the tendency of Japanese retail investors to scour the global economy for yield runs a bit deeper than a simple carry trade play. Well, it is of course a carry trade but the underlying impetus for Japanese retail investors to act as they do also has something to do with a decline in home bias due to a low domestic interest rate environment as a result of demographics and subsequent sluggish domestic demand. The point is simply that one of the only ways Japan can achieve sustained is to mobilize its large stock of savings and, more importantly, to mobilize it abroad (e.g. through the purchase of samurais) in order to get the yield which is not obtainable in the domestic capital markets.

In the current environment of financial crises, great depressions, and credit crunches Ms Watanabe et al. have of course, in line with most other risky asset punters, been pulling back their fangs. However, with the recent narrative of green shoots and second derivatives it was also always going to be the question of when, if at all, carry trading would return as per function of declining volatility and appreciation of risky assets. As I have suggested lately, tentative signs have emerged that carry trading activity has slowly been coming back.

Now, it can be debated whether the apparent return of the Japanese housewives to the carry trough represents evidence of a solidification of the green shoots or, as a friend suggested to me, a contrarian indicator that things will soon hit the fan again. This particular friend of mine is an investor, so you are probably better off listening to him than me. There is also the small question of the targets for Ms. Watanabe’s allure in the form of the usual, OECD, suspects such as the Kiwi, the Aussie, and the Euro.

Looking at the chart to the right the recent three months which have been marked heavily by the green shoots discouse, it is quite obvious to see that the JPY has depreciated accross the board against the usual suspects. It is difficult to say whether MS. Watanabe has had a hand in this, but more interestingly is also the fundamental question of where the carry trade activity is going to be conducted in the future?

Specifically, it will be interesting to see whether there is going to be a change in the game whereby the OECD economies currently engaged in QE and with subsequent credible commitments by the central bank to keep rates low become funding for a carry trade to exploit the potentially “low volatility” growth (yield) in places such as India, Brazil and Turkey - see Edward’s piece on India yesterday for a good example of how all this could work.

Clearly, the BOJ has the mother of all credible commitments here in the sense that nominal interest rates have hardly budged the zero bound for more than a decade even in the midst of booms. This last point need careful watching I think as well as of course we might as well get another bout of volatility which could fold the, after all, fragile green shoots.

So, it does indeed seem as if the Japanese housewives are back in the game, but another fundamental question is whether the housewives ever left the game. This is to say that we need to look at structural long term outflows as well as more short term punting in order to really understand the what drives MS Watanabe and her fellow Japanese retail investors."

the developments in currency markets as a result of moves by major central banks towards quantitative easing

TO BE NOTED: From the FT:

"Carry trade makes a comeback

By Peter Garnham

Published: March 27 2009 15:50 | Last updated: March 27 2009 15:50

A rebound in global equity markets appears to have prompted the return of a familiar investment theme: the carry trade.

The strategy, which involves selling lower-yielding currencies, such as the yen, to fund the purchase of higher-yielding assets elsewhere, was popular among investors ahead of the financial crisis.

The strategy rests not just on interest differentials, but also on stability in asset markets since a sharp fall in the value of an investor’s target investment can wipe out any yield advantage of funding through a low-yielding currency.

Indeed, the turmoil on financial markets saw investors scramble to unwind carry trades as asset prices plunged. This deleveraging sent the yen sharply higher.

Against the dollar, the yen has risen 8 per cent since the collapse of Lehman Brothers in mid-September last year.

It’s rise against the higher-yielding New Zealand and Australian dollars has been more acute, rising 18 per cent and over 28 per cent respectively. But analysts say the rally in global equities has paved the way for investors to return to the carry trade.

Since hitting a 13-year low on March 6, the benchmark S&P 500 index of US stocks has notched up three straight weeks of gains, helped by the aggressive fiscal and monetary policy stance of the US authorities.

Some investors believe that the equity market sell-off has run its course.

Larry Kantor, head of research at Barclays Capital, says after the rally in markets over the past few weeks, the question foremost in the minds of investors is whether it is sustainable or yet another false start.

“We believe that the latest rally will have stronger legs, and thus marks an inflection point,” he says. “We are now recommending that investors become more aggressive and take risks across a broader range of assets.”

Hans Redeker, at BNP Paribas, says the performance of equities are important for carry trade investors.

First, reduced asset volatility allows investors to increase the size of positioning which is important for the asset side of carry trades. Second, rising asset prices will reduce deleveraging pressure.

“Deleveraging pushed the yen lower in the autumn and winter, but those days are gone,” said Mr Redeker. “Financial markets look brighter.”

Indeed, the New Zealand dollar and the Australian dollar, the two major target currencies for carry trade investors ahead of the financial crisis have performed strongly so far this month.

Buoyed also by a rally in commodity prices, the New Zealand dollar is up 14 per cent against the yen and 14 per cent stronger against the dollar since the start of the month, while the Australian dollar has climbed 8 per cent against the yen and gained 8.4 per cent against the dollar.

Mr Redeker believes there could be more gains in store, especially for the New Zealand dollar, the favourite currency of Japanese margin traders.

Rising Japanese shares are likely to increase the risk appetite of Japanese retail investors, encouraging them to send funds abroad in search of yield. “Japanese margin accounts are heavily long on the yen and when this position is reversed the New Zealand dollar will benefit most,“ says Mr Redeker.

Steve Barrow, at Standard Bank, prefers to see the developments in currency markets as a result of moves by major central banks towards quantitative easing.

He says one thing noticeable from currency movements is that the “periphery” currencies, such as the Australian dollar, New Zealand dollar, Norwegian krone and Swedish krona, have out-performed the core – or G7 – currencies.

Indeed, since the start of the month, the Norwegian krone is up 9 per against the dollar and the Swedish krona has gained 13 per cent.

All four of those countries, unlike other major economies are expected to avoid debasing their currencies by moving towards quantitative easing.

“We could, of course, throw in emerging market currencies as well although we feel they are a little more dependent on a persistence of recent stock market strength, which leaves us a little uncomfortable,” says Mr Barrow.

He says if currency investors can ride through any temporary stock market setbacks, the best returns are to be had in these periphery countries unless, they too, take the quantitative easing bait."

"Yields on 10 year Japanese government bonds are now around 1.20%… you see the reversal of the yen carry trade happening… yes …"

Shopyield with an important post:

The view from Nihonbashi…

Imagine that you are sitting in your office at the Bank of Japan building in Nihonbashi, Tokyo … you’re clicking through the news stories on your Bloomberg terminal and you come across the following about American consumers:

~~~~ ” ….Retailers, which started offering discounts of 50 percent or more weeks ago, had been counting on post - Christmas sales to help rescue what will probably be the worst holiday season in four decades. That’s not going to happen, said Burt Flickinger, managing director of Strategic Resource Group, a retail-industry consulting firm in New York.

“This week isn’t going to do it,” Flickinger said in a Bloomberg Television interview. “Consumers are more cash- and credit-constrained than ever before. After a 25-year spending tsunami, they’ve shifted from spending to savings.” ~~~~

Uhmmm… you think… American consumers are shifting to savings … this will have implications for Japanese and US monetary policy… significant ramifications… you consider the actions of your central banking counterparts at the Federal Reserve who have begun engaging in “quantitative easing (QE)” like the Bank of Japan did between 2001 and 2005…

~~~~ ” … The Bank of Japan is the only major central bank in modern times to rely on quantitative easing — the strategy of injecting more reserves into the banking system than needed to keep the target interest rate at zero.

Steps Bernanke has taken so far have prompted some Fed officials and economists to say the central bank is already pursuing such a policy. With an array of emergency-loan programs aimed at easing the worst credit crisis in seven decades, Bernanke has expanded the Fed’s balance sheet to $2.11 trillion as of last week, more than double the year-earlier level…

… Bank of Japan Governor Masaaki Shirakawa said in May that while the strategy “was very effective in stabilizing financial markets,” it had “limited impact” in remedying Japan’s economic stagnation because banks wouldn’t lend and companies wouldn’t borrow…. ” ~~~~

$$$ $$$ $$$ $$$ $$$ $$$

A nice primer on Quantitative Easing

Quantitative easing from Marketplace on Vimeo.

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Now many beyond the precincts of Nihonbashi, Threadneedle and Liberty Streets have broader visions for the role of the central banks in restarting the various frozen economies … from the FT.com Economists Forum blog via Libertarian Democrat Point of View …

This passage describes the Federal Reserve purchasing US Treasuries to push down Treasury yields in an effort to force banks to lend instead of buying Treasuries to capture the yield spread …

The authors are arguing that the Federal Reserve extend this practice beyond the debt of the national government to the debt of private corporations… this would represent a massive intrusion into the economy on the part of the Federal Reserve… the authors argue…

~~~~ ” … Quantitative easing will be much more effective if the central bank uses its balance sheet to buy not government bonds but better quality illiquid and undervalued structured and mortgage-backed securities. This eases bank funding constraints and so directly expands the stock of credit.

Moreover, as the economy recovers, credit spreads will fall and so the central bank can make a profit.

Quantitative easing will be more powerful still if the central bank takes pure credit spread exposures, using interest rate swaps to remove its exposure to fluctuations in nominal interest rates.

It can also conduct equivalent synthetic transactions, purchasing government bonds alongside an interest rate swap and the acquisition of negative net worth credit default swaps. Unlike a private sector participant, as the monopoly supplier of outside money it can always meet margin calls and so cannot be squeezed out of credit default swap trades.

Finally, to guide expectations, it should set forward targets for credit spreads.

Perhaps the clearest way to present this point is to put the question in another way: what is the most appropriate alternative instrument of monetary policy, during the period when money market interest rates are reduced to their zero floor?

Aggregate bank reserves or money stock are poor choices, since in present circumstances they can increase by huge amounts without impacting credit or expenditure. A better choice is market credit spreads. The Bank of England’s monetary policy committee can use its regular meetings to announce its preferred levels for average market credit spreads. Bank monetary operations can enforce this decision.

By setting credit spreads at appropriate levels the bank will put a floor under market values, restore credit market liquidity and economic activity and make a handsome profit to boot.” ~~~~

$$$ $$$ $$$ $$$ $$$ $$$

Back to Nihonbashi… after pouring your second cup of tea for the morning you pull out the most recent Bank of International Settlements quarterly report… you are trying to remember the relative scale of open market operations during the credit market panic of 2008… the Federal Reserve, the European Central Bank and the Bank of England have all conducted operations and lent in significant volume… see below…

This means that central banks have inserted “significant liquidity” into the global financial system… “significant liquidity” … ( VERY TRUE )

Sipping your tea you wonder … how much of this “significant liquidity” will be funnelled into a carry trade? ( GOOD QUESTION )

The carry trade definition…

~~~~ ” A strategy in which an investor sells a certain currency with a relatively low interest rate and uses the funds to purchase a different currency yielding a higher interest rate. A trader using this strategy attempts to capture the difference between the rates, which can often be substantial, depending on the amount of leverage the investor chooses to use.” ~~~~

Yields on 10 year Japanese government bonds are now around 1.20%… you see the reversal of the yen carry trade happening… yes … making monetary policy with the new activities of Federal Reserve Chairman Bernanke will be complex… all the old patterns are breaking down…

~~~~ ” … By early year 2007, it was estimated that some US$1 trillion may be staked on the yen carry trade. Since the late-1980’s, the Bank of Japan has set Japanese interest rates at very low levels making it profitable to borrow Japanese yen to fund activities in other currencies. Many of these activities included matters like subprime lending in the USA, yet also include funding of emerging markets especially BRIC countries and resource rich countries.

According to Gary Dorsch of Global Money Trends, the yen carry is a “weapon of mass destruction” of $5.9 trillion, with yen loans another 1.2 trillion dollars on top of it, making Arabian oil wealth or Chinese reserves look small at $1.5 trillion and $1.9 trillion respectively.” ~~~~

BIS Charts via the Capital Spectator"

As I've said, I don't think that Japan can change from an export driven, high savings, and low interest country.

"seizing the world financial crisis as the greatest buying opportunity in a generation. "

A interesting post on the NY Times:

"Since last month, Japan’s legions of household savers have poured into the market by the tens of thousands — many of them first-time investors — seizing the world financial crisis as the greatest buying opportunity in a generation.

Sitting atop $15 trillion in personal savings, they are snapping up equities, currencies and even riskier investments like index futures, to some extent replacing foreign investors and even helping drive a limited rally in Tokyo’s beleaguered exchanges, say stock analysts.

“The stock market rout has popularized stock trading like nothing before,” said Yuji Kusunoki, president of Rakuten Securities. “It’s a paradox, but all the grim news has actually ended up making the market seem more attractive.”

This makes sense to me. And:

“I’m usually quite conservative,” Ms. Fujiwara said. “But prices were just so cheap, it looked better than leaving my money in the bank.” She says she has broken even since she started investing in early October."

Sounds good. And:

"The change has helped end a large outflow of yen overseas known as the yen-carry trade. For years, Japanese households poured money into overseas assets, where they could earn better returns than in Japan with its near-zero interest rates. But in October, net investment in domestic stock mutual funds surpassed investment in foreign bond funds for the first time in 27 months, according to Nomura Research Institute, a Tokyo-based consulting company. "

So they are investing in Japan now, keeping the money in the country.

"Stock analysts said the risks of buying in the teeth of a global recession were huge, and trying to call the bottom as stocks appear likely to face further declines is potentially costly. But they said the long time frame of most small investors, who tend to buy and hold shares for years, meant they may come out ahead eventually.

“They are wading into a treacherous market,” said Katsuyasu Murata, deputy general manager of sales planning at Daiwa Securities, “but prices have fallen to the point that they make no sense.”

I would say the bull market that we had was a treacherous market, but that's just me.

“Japanese individuals are natural contrarians,” said Tsuyoshi Ogata, a spokesman for SBI Securities, a Tokyo-based online brokerage firm. “They only come in on the big dips” that come every half decade or so, he said."

Again, makes sense to me.

“Regular office workers have no chance to get rich, and it’s hard to imagine Japan become much wealthier, either,” Mr. Mukai said. “I’m doing this to take care of myself, by myself.”

I like his attitude.

"The important thing to know about Mrs Watanabe is that, temporarily at least, she has all but stopped flapping her wings"

Who is Mrs. Watanabe?

"Mrs Watanabe is crude shorthand for Japan’s $15,000bn pool of savings, the deepest in the world and worth more than the annual economic output of the US. These vast resources are somewhat apocryphally marshalled by Japanese women, who have traditionally held a firm grip on family finances."

Let's see:

1) Rising yen
2) Lower interest rates
3) Next bubble

David Pilling in the FT:

"The yen carry trade has not been the only cheap source of liquidity in recent years. But Ashraf Laidi, chief currency strategist at CMC Markets, reckons it has been the biggest. He quotes figures suggesting that Japanese households alone, discounting savings mediated through life assurers and other institutions, have mobilised $500bn in outbound funds. That leaves aside speculators, who have borrowed unknowable amounts of yen to invest abroad, often on highly leveraged terms.

Just as state bank bail-outs risk moral hazard, more recklessness and the need for future bail-outs, so the unwinding of the carry trade carries with it the danger of the next great bubble. In Japan, the central bank appears to have reacted to a rising yen and sinking stock market by contemplating the uncontemplatable: a rate cut. Even the rumour of such has provoked a mini equity rally and a weakening of the currency.

This is poison for the BoJ. It hated having to keep rates low, fearing that cheap money can cause bubbles in real estate, in capital investment and in the carry trade. Its sightings of inflationary danger everywhere provoked mirth among outside experts. But few are laughing now."

And so:

"If Japan really is about to reverse course towards zero interest rates, it will once again become the source of almost free money for anyone with an appetite to invest. Worse even than that, says Mr Laidi, is the potential for an even more dangerous dollar carry trade. The Federal Reserve has been desperately cutting rates, and lopped another half point off again on Wednesday. The nearer US interest rates approach zero, the greater the incentive to move dollars into higher-yielding assets elsewhere.

These gyrations do nothing to solve the underlying problem, which is that Asia has an excess of savers and the US and Europe an excess of spenders. Unless that is solved, the world seems condemned to repeat the swings of recent years, as capital is arbitraged between countries where money is cheap to those where it is expensive."

Problems:

1) Dollar carry trade

2) Asia saves, the West spends

3) Here we go again

Is this real?