Speaker 1: Bloomberg Audio Studios, Podcasts, radio News. I'm Stephen Carol and
Speaker 1: this is Here's Why, where we take one news story
Speaker 1: and explain it in just a few minutes with our
Speaker 1: experts here at Bloomberg. It's been a popular trading strategy
Speaker 1: for many years, borrowing in one currency to invest in another,
Speaker 1: at least until recently.
Speaker 2: And the yen rally intensifies as carry trades onwind jgbs
Speaker 2: for the most since nineteen ninety nine, as the topics
Speaker 2: enters eight per market territory. This is the worst day
Speaker 2: since nineteen eighty seven for Japanese equities. What is happening
Speaker 2: and driving.
Speaker 3: These extreme moves in the market that are winding of
Speaker 3: the carry tree.
Speaker 2: I'll tell you.
Speaker 1: We talk about China exporting deflation to the rest of
Speaker 1: the world, tom in this case, Japan is exporting inflation
Speaker 1: to the rest of the world.
Speaker 3: Japan story. The carry trade is actually causing a little
Speaker 3: bit of chaos in the markets, and I think that
Speaker 3: you know, there really has been an immediate reaction to that.
Speaker 1: The carry trade was a key part of the market
Speaker 1: turmoil we saw in early August, which included big moves
Speaker 1: on currency, equity and bond markets over a number of days.
Speaker 1: Since then, lots of questions are being asked about the
Speaker 1: future of the strategy. So here's why the carry trade
Speaker 1: will carry on. Our managing editor for Foreign Exchange in Rates,
Speaker 1: Rachel Evans, is with us for more. Rachel, first of all,
Speaker 1: can you explain what exactly the carry trade is?
Speaker 3: Yeah, it's one of these terms that we tend to
Speaker 3: throw about willy nilly without really defining it particularly well.
Speaker 3: But basically it's pretty simple. It's just borrowing something at
Speaker 3: a low cost or low rate in one country to
Speaker 3: invest in something with a higher yield somewhere else. So
Speaker 3: for example, in this case, we've been talking a lot
Speaker 3: about kind of borrowing in the yen, which obviously is
Speaker 3: at kind of very very low levels right now, and
Speaker 3: investing it in places like Mexico whereon so yielding a
Speaker 3: really chunky, nice yield, or in US tech stock where
Speaker 3: obviously we've seen stocks like in video going on a
Speaker 3: real tear. So it's really just that kind of you know,
Speaker 3: looking for cheap money to invest in something that's going
Speaker 3: to pay you back in a bigger way.
Speaker 1: So what exactly happened to this trade then? During the
Speaker 1: market termoil. We saw at the start of August.
Speaker 3: We've seen a few wobbles in this trade for kind
Speaker 3: of prior weeks, US tech stocks having days where they'd
Speaker 3: sold off, for example, and we had been sort of
Speaker 3: talking a lot about kind of how stretch positioning had
Speaker 3: become in the end. We're just everybody seeming to expect
Speaker 3: the end to stay weak for a longer period of time,
Speaker 3: and then in a very short amount of time we
Speaker 3: had a few events that really rocked that expectation. We
Speaker 3: saw the FED holding rates but signaling that it would
Speaker 3: start to cut In September, we saw the Bank of
Speaker 3: Japan raising interest rates and this was the second hike
Speaker 3: that they'd done. And then we also saw job s
Speaker 3: data coming and suggesting that the US economy was weaker
Speaker 3: than previously anticipated. So all of that kind of put
Speaker 3: together the idea that Bank of Japan wasn't just going
Speaker 3: to keep rates really really low in definitely that they
Speaker 3: were going to start increasing those and kind of be
Speaker 3: on a path towards higher rates, and the fact that
Speaker 3: that the US economy perhaps was wabbling and the FED
Speaker 3: may maybe behind the curve. Those sort of sentiments really
Speaker 3: kind of combined to prompt everybody to take a really
Speaker 3: sharp look at some of the trades that they've been
Speaker 3: considering as no brainers for the year and really start
Speaker 3: unwinding those at breakdeck speed.
Speaker 1: Have we seen this sort of thing happen before where
Speaker 1: such a popular trading strategy in the carry trade has
Speaker 1: essentially become very unpopular very quickly.
Speaker 3: I mean, the carry trade is particularly prone to these
Speaker 3: rapid unwinds because it does rely on stability, It relies
Speaker 3: on a lack of volatility for it to really kind
Speaker 3: of work and pay off. So back in nineteen ninety eight,
Speaker 3: we saw a pretty sharp reversal. We saw the end
Speaker 3: then rise sixteen percent in one week, which is, you know,
Speaker 3: put things in perspective, Yeah, exactly. I think we saw
Speaker 3: a three percent rise on Monday when things were were
Speaker 3: at their worst here. But then we saw this in
Speaker 3: two thousand and seven when we were dealing with the
Speaker 3: ripple effects at the subprime crisis. So when we do
Speaker 3: see kind of some of these exogenous events like geopolitical
Speaker 3: turmoil come in and sort of boost currency like the yen,
Speaker 3: which has tended to be favored by carry traders to
Speaker 3: fund these positions, that can really disrupt this trade, and
Speaker 3: so this is not the first time it's kind of happened.
Speaker 1: What about the carry trade using currencies other than the yen,
Speaker 1: have they seen the same sort of effect that we've
Speaker 1: seen with the n trade.
Speaker 3: Yeah? Similar. I mean, the yen has very much been
Speaker 3: kind of the dominant currency for obvious reasons. It's very
Speaker 3: very liquid, it's easy to get in and out, and
Speaker 3: there has been this kind of very long narrative of
Speaker 3: low rates in Japan. But we have also seen people
Speaker 3: using the Chinese yuan to fund carry trades as well.
Speaker 3: So when we were seeing kind of the height of
Speaker 3: the gyrations last week, we did see the yuan also
Speaker 3: strengthening alongside the yen, and that's been a bit of
Speaker 3: a pattern. You know, when we have seen kind of
Speaker 3: the yen having days of strength, it's tended to kind
Speaker 3: of come alongside some Yuan strength too, with a sense
Speaker 3: of kind of like this unwind of carriers really fueling
Speaker 3: both both positions.
Speaker 1: Does this mean the carry trade has has last its shine?
Speaker 1: Is this a fundamental change?
Speaker 3: I certainly lost its shine for now, but like everything,
Speaker 3: you know, nothing really goes out of style for very long.
Speaker 3: And in fact, I was just looking at some of
Speaker 3: the gauges of carry on the Bloomberg terminal and noticed
Speaker 3: that there's a there's a gauge of dollar funded carry
Speaker 3: trades in emerging markets that's up two percent since last week.
Speaker 3: So clearly, you know, if you got in at the
Speaker 3: bottom when everybody was really sort of heading for the sidelines,
Speaker 3: you could have actually made a pretty nice profit. So
Speaker 3: these things sort of tender to kind of come around.
Speaker 3: But it does feel like we're getting a bit of
Speaker 3: a rethink of exactly how invested in this trade you
Speaker 3: really want to be. How far do you want to
Speaker 3: kind of sort of blow out your profit Marge and
Speaker 3: betting on this one strategy, And do you want to
Speaker 3: diversify perhaps a little bit beyond just using the end
Speaker 3: to kind of fund these these carry trades?
Speaker 1: So what sort of event could reinvigorate this trade? And
Speaker 1: can I take a gas and it's at the central banks?
Speaker 3: Central banks are always crucial to this.
Speaker 1: Yes, I actually the answer to everything pretty much pretty.
Speaker 3: Much in macroland. I think there are two things that
Speaker 3: kind of have the potential to reinvigorate the trade. The
Speaker 3: first would be a boring answer, stability. Everybody in this
Speaker 3: trade needs stability, They need a sense that they know
Speaker 3: what's going to happen and a sense of certainty. Now
Speaker 3: the Bank of Japan is keeping rates very low for
Speaker 3: quite a long time, it would seem like we're not
Speaker 3: talking about huge interest rate increases. We're at zero point
Speaker 3: two five percent now. This is this is not particularly
Speaker 3: dramatic given where we are in the US or in
Speaker 3: the UK in terms of where interustrates are. So once
Speaker 3: people get a sense of kind of certainty that they're
Speaker 3: not going to suddenly, you know, high rates to one percent,
Speaker 3: two percent or higher, then I think you could see
Speaker 3: some sort of re establishment of these bets. Given that
Speaker 3: the thesis of borrowing low and investing in higher yielding
Speaker 3: currency still really holds. You just need to be prepared
Speaker 3: that you're not going to get quite as much for that.
Speaker 3: The other possible reinvigoration would be if we see something
Speaker 3: idiosyncratic happen, where we see interest rates in one country
Speaker 3: cut a much much lower than elsewhere. It's very hard
Speaker 3: to predict what would cause that. It would be some
Speaker 3: sort of local political drama, local economic drama that would
Speaker 3: see interest rates somewhere become much much lower than the
Speaker 3: rest of the world. But yeah, we'll have to see
Speaker 3: exactly where and when that might happen.
Speaker 1: Thank you, Rachel Evans, our managing editor for Foreign Exchange
Speaker 1: and Rates. For more explanations like this one from our
Speaker 1: team of twenty seven hundred journalists and analysts around the world,
Speaker 1: search for quick take on the Bloomberg website or Bloomberg
Speaker 1: Business app. I'm Stephen Carol. This is here's why. I'll
Speaker 1: be back next week with more. Thanks for listening.