WEBVTT - Carry Trades, Explained

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<v Speaker 1>Bloomberg Audio Studios, Podcasts, radio news.

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<v Speaker 2>Hello from Hong Kong, David Gura, What hi, Hello from

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<v Speaker 2>New York. It is great to talk to you across

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<v Speaker 2>the ocean. And it looks like if I squint here

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<v Speaker 2>and look at my zooms when you're having dinner in the.

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<v Speaker 1>Studio, very good eyes, I am. And it's at the

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<v Speaker 1>heart of our episode today. It explains the rocking global

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<v Speaker 1>currency markets. Right now, let me show you what I'm

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<v Speaker 1>having so you can drool over it through zoom. You

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<v Speaker 1>see here, see if you can see this, can you see?

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<v Speaker 2>I just look at that chopsticks in hand, and it

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<v Speaker 2>looks like a dumpling. Is it a dumpling?

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<v Speaker 1>It is, But it's not just any dumpling, David. This

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<v Speaker 1>is a Shao longboo, a soup dumpling, right. It's got

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<v Speaker 1>yummy broth inside, and it's from a famous Taiwanese restaurant

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<v Speaker 1>called Didn't Tai Phong. They've got branches in New York

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<v Speaker 1>and here in Hong Kong, all over the world.

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<v Speaker 2>And let me get this straight. Their soup dumplings are

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<v Speaker 2>behind what's rocking the global currency markets.

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<v Speaker 1>They are in a way. I'll let Shuley Wren explain

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<v Speaker 1>she's a Bloomberg opinion columnist to covers Asian markets.

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<v Speaker 3>Yes, so the challona in it's kind of like the

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<v Speaker 3>big mag indecks that tests out the purchasing power of

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<v Speaker 3>the world's biggest the cosmopolitan cities. Ding Typhoon was expanding

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<v Speaker 3>outside of Taiwan and the opening restaurants in the biggest,

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<v Speaker 3>the most posh cities. And the idea is that if

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<v Speaker 3>you look at the global cosmopolitans like Dubai, Hong Kong, Singapore, London,

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<v Speaker 3>New York, the cost of Shallon Bau should be the same,

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<v Speaker 3>and the it turns out they can be quite different.

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<v Speaker 1>So, David, we would have ordered you some dumplings from

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<v Speaker 1>the DN Typhoon in New York apparently, but apparently they

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<v Speaker 1>don't do takeout or delivery. And get this, you have

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<v Speaker 1>to book seats at midnight a month and.

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<v Speaker 2>A month in advance. My gosh, how good are these dumplings?

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<v Speaker 1>They are very delicious. Luckily for us here in Hong Kong,

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<v Speaker 1>they're much easier to get a hold of, so I

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<v Speaker 1>use the equivalent of ten US dollars to buy Dntai

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<v Speaker 1>Fung dumplings and I got around six shallong bows. Right,

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<v Speaker 1>And even though we didn't manage to get dumplings delivered

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<v Speaker 1>to you in the studio there, we did we will.

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<v Speaker 1>At some point we did look up the price and

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<v Speaker 1>get this, you'd only get about five dumplings.

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<v Speaker 2>Only five, only five.

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<v Speaker 1>But in Tokyo, once you traded your ten US dollars

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<v Speaker 1>for Japanese yen, you'd get around eight dumplings.

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<v Speaker 2>Okay, So ten US dollars goes further in Japan, and

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<v Speaker 2>I guess that's a sign that maybe the yen is

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<v Speaker 2>just a little bit undervalued. Oh, I get it. This

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<v Speaker 2>is all about all the carry trade news.

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<v Speaker 1>That's right. Carry trades, right, they're pretty technical inside market stuff.

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<v Speaker 1>You don't usually hear it in the broader news. But

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<v Speaker 1>recently a whole bunch of carry trades went south and

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<v Speaker 1>took the markets with them.

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<v Speaker 2>Yeah. I've watched the value of the en rise quite

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<v Speaker 2>a bit against the dollar, and that hammered a bunch

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<v Speaker 2>of these trades.

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<v Speaker 1>That's right. Not mentioned it left a lot of investors

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<v Speaker 1>with balance sheets that looked a little bit like, you know,

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<v Speaker 1>the watery inside of a soup dumpling.

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<v Speaker 3>Here.

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<v Speaker 1>So today, as part of our ongoing series. Bloomberg explains,

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<v Speaker 1>we're talking about carry trades, how they work, what went wrong,

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<v Speaker 1>and why it hammered global markets.

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<v Speaker 2>I'm one huh, and I'm David Gerret and this is

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<v Speaker 2>the big take Asia from Bloomberg News.

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<v Speaker 1>So, David, the news has been full of carry trades lately.

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<v Speaker 1>They've been making a lot of headlines.

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<v Speaker 2>Yeah, they're new to a lot of people, but the

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<v Speaker 2>trades themselves have a long history.

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<v Speaker 1>Here's Shuley renagain, a Bloomberg columnist who covers Asian markets.

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<v Speaker 3>Carrie trade has been going on for a long time.

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<v Speaker 3>It's really simple. It's basically taking out cheap loans from

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<v Speaker 3>countries that have very low interest rate, and then the

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<v Speaker 3>investors in turn exchange it into another currency and invest

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<v Speaker 3>in countries that have much higher yielding assets.

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<v Speaker 1>I've got to really simple example, David. Let's say I

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<v Speaker 1>borrow one thousand dollars worth of Japanese in from a

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<v Speaker 1>Japanese bank. Let's say you're that bank.

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<v Speaker 2>Okay, I'll lend you that one thousand, and I'm going

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<v Speaker 2>to charge you a little interest for that loan.

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<v Speaker 1>And in Japan it's very little interest, right, So for

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<v Speaker 1>a long time, the Bank of Japan's main interest rate

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<v Speaker 1>was basically zero. Now, assuming I get that rate, I'll

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<v Speaker 1>convert this money I've borrowed into US dollars and lend

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<v Speaker 1>out that money at around five and a half percent,

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<v Speaker 1>which is the rate in the US at the moment.

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<v Speaker 2>This sounds like a pretty good deal for you.

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<v Speaker 1>It is. Now, when the person I lent money to

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<v Speaker 1>pays back my loan, I get back that one thousand

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<v Speaker 1>dollars plus interest, let's say it's one thousand and sixty dollars.

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<v Speaker 2>Now you pay me back one thousand dollars I lent you,

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<v Speaker 2>but I didn't charge any interest or very little interest.

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<v Speaker 2>And assuming and this is a big assumption here, that

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<v Speaker 2>the exchange rate stays the same when you pay me back,

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<v Speaker 2>you get to keep that sixty bucks.

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<v Speaker 1>Right, not a bad profit?

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<v Speaker 2>Right, not at all. And that there is the appeal

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<v Speaker 2>of the en carry trade.

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<v Speaker 1>It's got a funny name. Why is it called a

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<v Speaker 1>carry trade?

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<v Speaker 3>It's an esoteric name. The traders like to use the

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<v Speaker 3>word carry. Basically Carrie Mings earning interest rate differentials, and.

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<v Speaker 1>You're essentially carrying that until you make.

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<v Speaker 3>A profit, yes, like you're carrying a baby. It's like

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<v Speaker 3>a pregnancy carry out baby.

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<v Speaker 1>A little profit baby, the kind the markets really love.

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<v Speaker 1>As Shirley said, the carry trade has been around for

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<v Speaker 1>a long time, but.

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<v Speaker 3>The most famous carry trades are done by the Japanese

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<v Speaker 3>retail investors, the so called a missus u watanabe.

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<v Speaker 1>The so called missus watanabi refers to Japanese housewives. It's

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<v Speaker 1>kind of hard to trace when the term started to

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<v Speaker 1>first be used, but we do know that the newspaper

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<v Speaker 1>The Economist popularize the current use in the late nineteen nineties.

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<v Speaker 1>That's when the Bank of Japan, desperate to stimulate economic activity,

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<v Speaker 1>turned to a policy of keeping interest rates near zero

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<v Speaker 1>or even get this negative.

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<v Speaker 3>So the missis wanta nabbies, they will be actually managing

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<v Speaker 3>the family wealth, right, and then they know that you

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<v Speaker 3>cannot put money in the bank because you're not getting

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<v Speaker 3>any interest in return. So what they do is that

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<v Speaker 3>they invest their money in other countries, and they were

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<v Speaker 3>actually quite adventurous. They will buy Mexican passle, Turkish lira, Indonesia, rupia.

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<v Speaker 3>These are all the emergent market currencies that they can

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<v Speaker 3>earn a higher interest rate from.

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<v Speaker 1>But it wasn't just the missus wattonabbies who saw opportunity

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<v Speaker 1>with the weekend. The yen carry trade, in its various permutations,

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<v Speaker 1>is now carried out by hedge funds, investment firms, and

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<v Speaker 1>traders all over the world.

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<v Speaker 2>And these trades have only gotten bigger and more popular

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<v Speaker 2>in the past few years as the Japanese yen has

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<v Speaker 2>weakened against other currencies. You could get more yen for

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<v Speaker 2>your dollar, your euro, pound, sterling, or.

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<v Speaker 1>More soup dumplings. That's right, And just like the soup dumplings,

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<v Speaker 1>people were saying that the yen were undervalued a great

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<v Speaker 1>deal for investors, so they began to borrow even more

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<v Speaker 1>yin and use that money to fund all kinds of trades.

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<v Speaker 1>According to Shuley, Now some economists say that carry trade

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<v Speaker 1>is a strategy that really shouldn't work. What do they

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<v Speaker 1>mean by that?

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<v Speaker 3>Economists like to look at things in the long term,

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<v Speaker 3>and that basically they will say the value of a

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<v Speaker 3>currency should reflect it's a purchasing power at home and

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<v Speaker 3>the interest rate that it earns. So in the purchasing

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<v Speaker 3>power parody situation, it doesn't matter whether you hold the

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<v Speaker 3>Japanese yen or the US dollar, you will be able

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<v Speaker 3>to get the same amount of goods.

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<v Speaker 2>But as we've demonstrated clearly, there isn't parody, and that's

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<v Speaker 2>why you can get more soup dumplings in Tokyo compared

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<v Speaker 2>to New York. And it's also why the Japanese yen

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<v Speaker 2>has been a popular currency for carry trades. But it's

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<v Speaker 2>far from the only currency that can be used to

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<v Speaker 2>make a carry trade.

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<v Speaker 3>It can be anything. Any currencies that have lower interest

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<v Speaker 3>rates can be used as a funding currency. For instance,

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<v Speaker 3>like I say, perhaps a decade ago, the US dollar

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<v Speaker 3>was not yielding any interest rates right, and there was

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<v Speaker 3>a very popular funding currency for traders to buy into

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<v Speaker 3>emergent market currencies such as the Indonesian rubia, the Turkish lera,

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<v Speaker 3>and the Mexican petzil.

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<v Speaker 1>And it's really hard to know how much money is

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<v Speaker 1>parked in carry trades because they're conducted via currency transactions

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<v Speaker 1>that aren't easy to track. Not to mention there's no

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<v Speaker 1>one central authority keeping tabs.

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<v Speaker 2>This lack of transparency was one contributing factor to the

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<v Speaker 2>market turmoil this summer, because no one knew just how

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<v Speaker 2>much money was in yen carry trades and how many

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<v Speaker 2>positions would need to be unwound.

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<v Speaker 1>And if we know one thing about markets, David, it's

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<v Speaker 1>that they hate uncertainty. After the break, we'll look at

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<v Speaker 1>whether this summer's meltdown has stopped the rising popularity of

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<v Speaker 1>carry trades or if they'll carry on nice sorry coundry resist.

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<v Speaker 1>So to recap, one of the most popular carry trades

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<v Speaker 1>of the past few years was the yen carry trade,

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<v Speaker 1>when investors all over the world were making a ton

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<v Speaker 1>of money barring Japanese yen at an interest rate of

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<v Speaker 1>almost zero and then lending it out for profit or

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<v Speaker 1>investing it.

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<v Speaker 2>Basically, as long as Japan kept its interest rate near zero,

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<v Speaker 2>and again this is the key point. As long as

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<v Speaker 2>the en was undervalued, these en carry trades were reliable,

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<v Speaker 2>little profit machines.

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<v Speaker 1>What possibly could go wrong?

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<v Speaker 4>Coming into the meeting, we actually had economists surveyed by

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<v Speaker 4>Bloomber thinking that the consensus would be no change in

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<v Speaker 4>the interest rate policy. But then this morning we woke

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<v Speaker 4>up to news that they were discussing a rate high.

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<v Speaker 3>Surprise, surprise, the Bank of Japan raised the interest rate

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<v Speaker 3>by twenty five basis points and that called a lot

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<v Speaker 3>of people by surprise.

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<v Speaker 1>Oh my goodness, it's a awful time.

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<v Speaker 4>I think to be at the Bank of Japan right now,

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<v Speaker 4>because they are in the between a rock and a

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<v Speaker 4>hard place.

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<v Speaker 2>I mean they have been now.

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<v Speaker 1>To be clear, an interest rate of zero point two

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<v Speaker 1>five percent is very low compared to most countries. But

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<v Speaker 1>that's not the only thing that happened. The yen strengthened

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<v Speaker 1>against a basket of currencies at nearly its fastest pace

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<v Speaker 1>in two decades. So a combination of the Fed cutting rates,

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<v Speaker 1>with the Bank of Japan raising rates, and a strengthening.

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<v Speaker 3>Yen led to panic selling, and the brokers started to

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<v Speaker 3>give our margin cause and a lot of the hatch

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<v Speaker 3>fans had no choice but to unwind their trades.

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<v Speaker 2>Hedge from sold stocks in Japan at the fastest pace

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<v Speaker 2>in more than five years. It is looking ugly out there.

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<v Speaker 2>Age inequities have been selling off aggressively.

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<v Speaker 3>This carry trade, which seemed like the easy trade, is

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<v Speaker 3>no longer, so you start exiting fast and it starts

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<v Speaker 3>to be self fulfilling.

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<v Speaker 2>On wines and on wines and on wines.

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<v Speaker 1>Billions of dollars worth of carry trades went up in smoke.

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<v Speaker 1>So here's what happened, David. Remember that thousand dollars loan

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<v Speaker 1>I took out from you.

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<v Speaker 2>Yes, I'm running the Japanese bank. I lent you one

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<v Speaker 2>thousand dollars worth of yen at basically no interest rate.

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<v Speaker 1>Right, and then I turned around and loaned that one

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<v Speaker 1>thousand dollars out in the US at an interest rate

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<v Speaker 1>of five and a half percent.

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<v Speaker 2>I remember, now you made sixty bucks. I think that's right.

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<v Speaker 1>But now when I borrow money from you, I won't

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<v Speaker 1>pay an interest rate of zero. I'll have to pay

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<v Speaker 1>you zero point two five percent on that loan.

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<v Speaker 2>Well, point twenty five percent is still a lot lower

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<v Speaker 2>than five and a half percent, So you would make

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<v Speaker 2>less money. But it does seem like you'd still make money. Right.

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<v Speaker 1>Well, you would be right about that, except that something

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<v Speaker 1>else happened. When Japan raised interest rates. The value of

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<v Speaker 1>the yen went up by a lot.

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<v Speaker 2>So when you convert your US dollars back to yen

0:11:50.760 --> 0:11:53.040
<v Speaker 2>to pay me back for that loan I gave you,

0:11:53.040 --> 0:11:55.960
<v Speaker 2>your US dollars aren't worth as much. A thousand US

0:11:56.080 --> 0:11:58.440
<v Speaker 2>dollars doesn't buy as much yen as it used.

0:11:58.280 --> 0:12:01.120
<v Speaker 1>To, exactly, so when I paid back that one thousand

0:12:01.160 --> 0:12:03.600
<v Speaker 1>dollars loan, I might have to pay more like eleven

0:12:03.679 --> 0:12:04.959
<v Speaker 1>hundred dollars now, So.

0:12:04.960 --> 0:12:07.840
<v Speaker 2>Between a higher interest rate from me and your dollars

0:12:07.840 --> 0:12:10.840
<v Speaker 2>buying fewer yen, that's sixty bucks you made in profit

0:12:10.880 --> 0:12:14.360
<v Speaker 2>on your carry trade is basically gone vanished.

0:12:14.440 --> 0:12:18.360
<v Speaker 1>If I'm lucky, I might actually now have lost money

0:12:18.440 --> 0:12:21.160
<v Speaker 1>on this carry trade. Shuley Wren said, it's like that

0:12:21.160 --> 0:12:23.960
<v Speaker 1>famous Warren Buffett quote about what happens to people who

0:12:24.000 --> 0:12:25.960
<v Speaker 1>haven't prepared for market change.

0:12:26.920 --> 0:12:30.320
<v Speaker 3>So basically, it's like a tide coming to the beach

0:12:30.360 --> 0:12:33.440
<v Speaker 3>and then stop, and then that tie suddenly receded, and

0:12:33.480 --> 0:12:36.679
<v Speaker 3>then we got to see who was swimming naked. Basically,

0:12:37.080 --> 0:12:40.880
<v Speaker 3>we actually see that the yen's movement was highly colerated

0:12:41.120 --> 0:12:45.360
<v Speaker 3>with the movement of NESTAC, so Japan's currency is affecting

0:12:45.600 --> 0:12:46.640
<v Speaker 3>US stall market.

0:12:51.480 --> 0:12:54.040
<v Speaker 2>For a long time, carry trades were mostly done via

0:12:54.120 --> 0:12:57.520
<v Speaker 2>bonds and other currencies like the yen peso carry trade,

0:12:57.880 --> 0:13:00.200
<v Speaker 2>But over the past few years, traders have been borrowing

0:13:00.280 --> 0:13:04.040
<v Speaker 2>yen to buy American tech companies, juicing their returns, which

0:13:04.080 --> 0:13:06.719
<v Speaker 2>was why the decision to unwind those trades sparked a

0:13:06.800 --> 0:13:09.040
<v Speaker 2>selloff on the Nasdaq a few weeks ago.

0:13:09.280 --> 0:13:11.640
<v Speaker 1>Now there must have been a lot of upset investors

0:13:11.679 --> 0:13:14.840
<v Speaker 1>when the Bank of Japan raised rates and the markets crashed.

0:13:15.240 --> 0:13:17.240
<v Speaker 1>Was there a lot of criticism of what the Bank

0:13:17.280 --> 0:13:18.240
<v Speaker 1>of Japan was doing.

0:13:18.520 --> 0:13:21.200
<v Speaker 3>Yes, there was a lot of criticism saying that the

0:13:21.280 --> 0:13:24.400
<v Speaker 3>Bank of Japan was bearing it it's head in the sand,

0:13:24.760 --> 0:13:28.000
<v Speaker 3>that it was raising interest rates too early.

0:13:28.720 --> 0:13:29.720
<v Speaker 1>But I have to.

0:13:29.679 --> 0:13:33.520
<v Speaker 3>Say that you know, this one sided bet on the

0:13:33.640 --> 0:13:35.680
<v Speaker 3>yen has been going on so long.

0:13:35.840 --> 0:13:37.600
<v Speaker 1>So it sounds like you think it was bound to

0:13:37.679 --> 0:13:38.640
<v Speaker 1>happen this correction.

0:13:39.120 --> 0:13:41.439
<v Speaker 3>Yes, it was already getting too big.

0:13:41.920 --> 0:13:44.360
<v Speaker 2>So now that the correction has happened, where does all

0:13:44.400 --> 0:13:46.280
<v Speaker 2>of this leave the yen? Carry trade?

0:13:46.400 --> 0:13:49.920
<v Speaker 3>The carria trade will only get very popular if people

0:13:49.960 --> 0:13:52.680
<v Speaker 3>can see it's a one way back and that that's

0:13:52.840 --> 0:13:55.800
<v Speaker 3>probably not what the Bank of Japan wants the yen

0:13:55.880 --> 0:13:58.880
<v Speaker 3>to behave, right, And then that's a problem that the

0:13:58.920 --> 0:14:02.080
<v Speaker 3>other central banks have seen as well, because if the

0:14:02.200 --> 0:14:05.600
<v Speaker 3>carry trade is too popular and the central bank suddenly

0:14:05.720 --> 0:14:09.480
<v Speaker 3>changes its interest rate regime, we will see this kind

0:14:09.520 --> 0:14:12.240
<v Speaker 3>of violent wine that we saw in August.

0:14:13.120 --> 0:14:14.120
<v Speaker 1>So there you go, David.

0:14:14.360 --> 0:14:17.199
<v Speaker 2>The carry trade, the carry trade, the en carry trade

0:14:17.240 --> 0:14:20.120
<v Speaker 2>in particular, was going strong on the idea that interest

0:14:20.200 --> 0:14:24.000
<v Speaker 2>rates in Japan would remain relatively low even as central

0:14:24.000 --> 0:14:26.960
<v Speaker 2>banks in the US and the UK cut rates, and

0:14:27.000 --> 0:14:29.280
<v Speaker 2>that would continue to make the en week relative to

0:14:29.320 --> 0:14:33.120
<v Speaker 2>other currencies, so borrowing money would essentially be much cheaper there.

0:14:33.440 --> 0:14:35.600
<v Speaker 1>In other words, people would be able to pay for

0:14:35.760 --> 0:14:37.720
<v Speaker 1>five dumplings and get eight.

0:14:38.520 --> 0:14:41.160
<v Speaker 2>Speaking of dumplings, Wind, any chance you could FedEx me

0:14:41.240 --> 0:14:43.200
<v Speaker 2>some of those dumplings. It doesn't look like I'll get

0:14:43.200 --> 0:14:45.320
<v Speaker 2>a reservation here in New York at any times.

0:14:45.360 --> 0:14:50.280
<v Speaker 1>Sued that will cost you a little more than ten dollars. David, Okay,

0:14:50.440 --> 0:14:51.920
<v Speaker 1>I'm going to go dig into one of these Shollong

0:14:52.000 --> 0:14:54.160
<v Speaker 1>bows before they get cold my permission.

0:14:54.160 --> 0:14:55.600
<v Speaker 2>I'm so jealous right now.

0:15:02.480 --> 0:15:04.840
<v Speaker 1>This is the Big take Asia from Bloomberg News.

0:15:04.960 --> 0:15:07.680
<v Speaker 2>I'm wanh and I'm David Gerre. For more on the

0:15:07.720 --> 0:15:10.680
<v Speaker 2>Carrie trade blow up, you can listen to our sister podcast,

0:15:10.760 --> 0:15:14.600
<v Speaker 2>Odd Lots. Tracy Alloway and Joe Wisenthal recently spoke with

0:15:14.680 --> 0:15:17.760
<v Speaker 2>Jon Song Shin of the Bank of International Settlements. That's

0:15:17.800 --> 0:15:20.240
<v Speaker 2>the bank of Banks that's been trying to track down

0:15:20.400 --> 0:15:23.320
<v Speaker 2>just how big the Yen Carrie trade is. You can

0:15:23.320 --> 0:15:25.359
<v Speaker 2>find that wherever you get your Podcasts.

0:15:25.760 --> 0:15:29.160
<v Speaker 1>This episode was produced by Young Young Name me Um,

0:15:29.240 --> 0:15:32.440
<v Speaker 1>Jessica Beck and Alex Huguiera, who also mixed it.

0:15:32.640 --> 0:15:35.840
<v Speaker 2>And Kim Gidtleson, who also edited this episode, along with

0:15:35.880 --> 0:15:39.360
<v Speaker 2>Stacy Vanick Smith, Nicholas Reynolds, and Caitlin Kenney. It was

0:15:39.360 --> 0:15:40.640
<v Speaker 2>fact checked by Eddie Dwan.

0:15:41.080 --> 0:15:44.440
<v Speaker 1>Our senior editor is Elizabeth Ponso, Nicole Beemster Bower is

0:15:44.480 --> 0:15:48.160
<v Speaker 1>our executive producer, and Sage Bouman is Bloomberg's head of podcasts.

0:15:48.720 --> 0:15:50.960
<v Speaker 1>If you like our show, please leave us a review

0:15:51.080 --> 0:15:54.120
<v Speaker 1>wherever you listen to podcasts, or tell your friends it

0:15:54.200 --> 0:15:57.120
<v Speaker 1>makes a big difference. Thank you and see you next time.