Asian Contagian: Leveraged Carry Trade Unwinding

Discussion in 'Trading' started by ByLoSellHi, Mar 1, 2007.

  1. Consider this article in the context of the Japanese Finance Minister's comments this morning. He basically said they have no idea how large the YCT is, but that it may be "many times larger" than anyone knows of.

    How the carry trade unwound the markets

    China may have had a lot/nothing at all to do with Tuesday’s global markets rout - but Japan also had a part to play, reports the Wall Street Journal.

    Their argument: blame an unwinding of the carry trade.

    While concerns about the US economy and overheated stock markets around the world helped trigger market drops Tuesday, investors told the WSJ the unwinding of yen loans accelerated the declines. “It is likely that when some investors grew nervous, they began to sell their holdings in everything from Indian stocks to the Australian dollar and used the proceeds to buy yen to pay back their loans,” the WSJ said, noting the rush to buy yen pushed up the value of the yen against the dollar by more than 2 per cent on Tuesday.

    “Everything that happened was consistent” with the unwinding of carry trades, Jay Bryson, global economist with Wachovia Corp told the WSJ. “We had the Japanese yen strengthening and high-yielding currencies declining.” Mr Bryson thinks such unwinding could continue over the next week or two if investors reduce their positions in stock markets that have posted big gains in recent months.

    Asian contagion, anyone?

    GLOBAL MARKETS-Rising yen batters equities, sell off resumes

    Thu Mar 1, 2007 8:29am ET146
    By Jeremy Gaunt, European Investment Correspondent

    LONDON, March 1 (Reuters) -
    Equities turned tail and demand for safe haven bonds jumped on Thursday as worries about the strengthening Japanese yen again combined with overall worries about the U.S. economy to spook investors.

    Temporary calm across financial markets dissolved as the yen -- which investors have borrowed to fund other investments -- rose against the dollar and euro.

    Wall Street looked set to join sinking European bourses with a sharply lower start.

    The yen is the key funding currency in the so-called carry trade in which investors borrow in low-yielding currencies to invest in assets of higher-yielding ones.

    "Global liquidity has been the main driver for the market, and the carry trade is a major contributor to that liquidity," said Michael Malone, trading analyst at Cowen & Co.

    European shares fell more than 1 percent and expectations of future volatility as measured by the VDAX-NEW volatility index <.V1XI> jumped.

    The FTSEurofirst index of top European shares <.FTEU3> tumbled out of positive territory and was down 1.2 percent adding to a 1.6 percent loss on Wednesday.

    MSCI's main world stock index <.MSCI> was down around half a percent.

    Emerging market assets took a hit. The MSCI emerging markets stock index <.MSCIEF> is off 1.2 percent. The South African rand and Turkish lira both fell more than 1 percent in value against the dollar.

    Emerging debt markets, which showed tepid signs of recovery, also gave up early gains. The benchmark JP Morgan Emerging Markets Bond Index Plus (EMBI+) <11EMJ> <.JPMEMBIPLUS> shows yield spreads wider by 4 basis points to 189 over U.S. Treasuries.

    Earlier, the Nikkei average <.N225> dropped 0.86 percent or 150.61 points to 17,453.51, the lowest close since Feb. 8. The benchmark fell 2.85 percent on Wednesday, logging its biggest one-day fall in eight months.


    The yen hit a three-week peak against the euro and nearing a recent 10-week high versus the dollar.

    The dollar was down 0.7 percent on the day at 117.56 yen <JPY=> -- nearing Tuesday's 10-week low of 117.48. The euro touched a three-week low of 155.43 yen <EURJPY=>.

    "Investors are still very nervous and still want to cut more carry trade positions," said Nordea FX strategist Niels Christensen.

    Demand for safe haven government bonds jumped.

    "We might as well all be equity traders at the moment," said a bond trader in London. "That's all that's driving the market, it's that simple."

    Ten-year cash yields <EU10YT=RR> were 3.5 basis points lower at 3.929 percent, while two-year yields <EU2YT=RR> were off 2.4 basis points at 3.844 percent.