Carry Trade & Its Consequence


Mervin Yeung Editor/Publisher

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This article was written on Dec. 2, 1999. Since we notice that there is a high correlation between 1989 Japanese Government Bond price movement and 1999 US T-Bond price movement, we try to investigate if this is significant.



"Carry Trade", on the long run, is a risky trade. We know the "Dollar Carry" in Indonesia. In early 90's, interest rates in the US were low because the Fed was cutting rates to "bail out" commercial banks from the real estate fiasco. In the meantime, in South East Asia, there was an economic boom caused by lax commercial bank lending. The situation was the most severe in Indonesia. See the "Dec. 30, 1997" issue of Wall Street Journal, we know what had happened in Indonesia. The article was at A1 and the title was "Speculators Didn't Sink Indonesian Currency; Local Borrowing Did". Local bankers in Indonesia in early 90's found out that the interest rates in Indonesia were much higher than those in America because (1) high demand for credit and money in the midst of an artificial boom; (2) high inflation due to the lax lending of the local banks. So these "bright" local bankers found an easy way to make money: be a middleman, borrow money from the US at low interest rates and re-lend the money in Indonesia at high interest rates and then take profit at the spread. How popular was this activity? "'Borrowing US Dollars was part and parcel of life in Indonesia. It was like going to McDonald's, ' says Kenny Tjan, who runs Nomura Asset Management Co.'s Jakarta Growth Fund from Singapore. " That was free money, wasn't it? The only risk was the forex rates. Borrowing was done in USD and lending was done in Rupiah. Hence, the cost was USD while the profit was Rupiah. If USD rose against Rupiah, this "Dollar Carry" had to be unwound, which was exactly the case in the second half of 1997.

Since 1995, there has been a "Yen Carry" trade. Japanese interest rates were (and still are) very low because of the recession there and Bank of Japan's (BoJ) attempt to "jump-start" the economy by cutting rates. Meanwhile, the US economy has been booming as a result of the liquidity that the Fed had injected into the system during early 90's (huge). Therefore, "bright" middlemen borrowed in Japan and then bought US T-Bond and made the difference. As the capital flowed into the US, USD rose against Japanese yen and made this carry trade even more profitable. Was this free money? Maybe not. There was only one risk. Borrowing was done in yen and lending was done in USD. Hence, the cost was yen while the profit was USD. If yen rises against USD, this "Yen Carry" has to be unwound.

BoJ is still fighting against the soaring yen precisely because BoJ wants to prevent this "Yen Carry" trade from unwinding. Of course, BoJ is insisting that it is selling yen only because BoJ people are nice and want to help Japanese exporters. Really? Since crude oil is priced in USD, a rise in yen means cheap crude oil for Japanese manufacturers.

If a patient is sick, then we check his blood, urine, etc. If there is no virus, fine. No big deal. The patient is going to be fine. However, if the virus is found, then there is a problem.

If there is a high correlation between 1989 Japanese Government Bond and 1999 US T-Bond, then we check yen-USD cross. If there is no surge in yen price, fine. No big deal. T-Bond will not crash. However, if the rise of yen is unstoppable, then we have a problem.

All of the above are for general information only, not for trading purpose.


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