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Yesterday was another turbulent day for stock markets worldwide.
After the Nikkei 225 lost 575 points, ending at 16,642, the FTSE 100 unsurprisingly had a nasty start to the day, falling more than 100 points, before recovering some of its poise to end the session down 57 points, at 6,058. In the States, the S&P 500 shed 0.9%.
As the jitters continue, we’ve been looking at some of the reasons behind the sudden increase in volatility we’re seeing, including worries over the US economy and the sub-prime mortgage market.
But one of the biggest factors – and arguably the one that was most responsible for last May’s correction too – is our old friend, the yen carry trade…
In early trading yesterday, the yen hit a 12-week high against the dollar, says the FT, ending the day up 0.7%. Meanwhile, higher-yielding currencies were hit harder still. Sterling fell 1.5%, the Australian dollar 1.7% and the New Zealand dollar (Kiwi) 2% against the Japanese currency. Since Monday, the yen is up 8.5% on the rand, 8.3% against the Kiwi, 6.2% on the Australian dollar and 5.7% on sterling. This is all bad news for those with open carry trades.
A quick reminder – the yen carry trade is basically the practice of borrowing in yen (where interest rates are low, and therefore borrowing is cheap) and investing the money in a higher-yielding currency, like the New Zealand dollar (where interest rates are much higher). You profit by pocketing the difference in yield, and can also benefit if the yen weakens further against your currency of choice.
It sounds like a ‘no-brainer’. But if the yen strengthens against the currency you‘ve invested in, you could rapidly be left with a situation where all your gains are eaten up and you end up owing more than you borrowed in the first place – that’s why some people describe the carry trade as ‘picking up nickels in front of a steamroller’.
The steamroller – in the form of a rising yen – has been trundling forward a little more rapidly than many had expected, which means lots of people are rushing to close down their carry trades, which in turn sends the yen higher, sending more fleeing for the exit.
It’s difficult to know exactly how big the carry trade is – no one records exactly why they’re borrowing or buying a currency – but at the end of February, the number of net short positions betting on a falling yen, stood at a record 173,005 on the Chicago Mercantile Exchange, says Merrill Lynch’s David Rosenberg.
“As of last week, those net speculative shorts have been unwound to 114,626 contracts, which is still the 10th biggest reading on record,” he tells the FT. “So a lot of this reflects unwinding of short yen positions but they are still so large that this process may well continue for weeks or months.”
The other worry is that Japanese investors themselves – who have also been investing in foreign currencies, due to the poor returns available at home – will now be less keen to invest abroad, and may either repatriate their money, or start hedging their foreign currency positions.
Hans Redeker of BNP Paribas warns: “As a result, the yen will be boosted further, equities will come under additional pressure, asset volatility will rise, forcing carry traders to reduce the size of positions, and the yen sub-prime mortgage market – to erupt. We reckon investors will have to hang on to the edge of their seats for a while longer.will rise again.”
Whichever way you look at it, there’s the potential for a vicious spiral – just as in the US
Turning to the wider markets…
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The FTSE 100 closed 57.5 points weaker yesterday at 6,058, as fears over weakening Chinese demand sent miners down. But the biggest faller was British Airways, which fell 6.6% to 496.5p over concerns that the proposed ‘Open Skies’ deal would lead to greater competition on transatlantic routes. For a full market report, see: London market close (/file/26448/london-close-footsie-halves-losses.html)
Elsewhere in Europe, the Paris CAC-40 ended the day 39 points lower, at 5,385, whilst the Frankfurt DAX-30 fell 68 points to end the day at 6,534.
Meanwhile, on Wall Street the Dow Jones finished 63 points down at 12,050, while the Nasdaq lost 27 points to close at 2,340. The S&P 500 fell 13 points, to close at 1,374.
In Asia, a strengthening yen and worries over the unwinding of the carry trade sent the Nikkei down 575 points to end the day at 16,642.
Crude oil was trading just below $60 this morning, while Brent spot was slightly higher, at $60.87.
Spot gold was trading at $646 this morning.
And in the markets this morning, Asian and European markets regained ground following five days of losses. The Bombay Stock Exchange was up 2%, the Nikkei 1.2% and the FTSE 100 had climbed 22 points to 6,079.
And our two recommended articles for today…
Why fund managers are seeking alpha in Mongolia
-With bond yields near multi-decade lows, fund managers are searching for alpha in ever more exotic – and high-risk – locations. But is anyone crazy enough to offer them insurance? asks Adrian Ash. For more on the more extreme investments blowing more hot air into the global credit bubble, see: Why bond fund managers are seeking alpha in Mongolia
Take a gamble on the vice sector
– The online gambling ban has hit US betting stocks hard, but the outlook for their UK counterparts is much brighter. Glynn Davis looks at what’s going on in the sector. To find out which companies have the most potential, click here: Take a gamble on the vice sector