WEBVTT - Here's Why the Carry Trade Will Carry On 0:00:02.440 --> 0:00:10.240 Bloomberg Audio Studios, Podcasts, radio News. I'm Stephen Carol and 0:00:10.400 --> 0:00:12.880 this is Here's Why, where we take one news story 0:00:12.920 --> 0:00:14.880 and explain it in just a few minutes with our 0:00:14.920 --> 0:00:23.040 experts here at Bloomberg. It's been a popular trading strategy 0:00:23.160 --> 0:00:26.759 for many years, borrowing in one currency to invest in another, 0:00:26.960 --> 0:00:28.600 at least until recently. 0:00:28.840 --> 0:00:33.680 And the yen rally intensifies as carry trades onwind jgbs 0:00:33.840 --> 0:00:37.320 for the most since nineteen ninety nine, as the topics 0:00:37.600 --> 0:00:41.720 enters eight per market territory. This is the worst day 0:00:41.800 --> 0:00:45.879 since nineteen eighty seven for Japanese equities. What is happening 0:00:45.960 --> 0:00:47.240 and driving. 0:00:46.760 --> 0:00:49.720 These extreme moves in the market that are winding of 0:00:49.800 --> 0:00:50.640 the carry tree. 0:00:50.680 --> 0:00:51.159 I'll tell you. 0:00:51.200 --> 0:00:53.600 We talk about China exporting deflation to the rest of 0:00:53.600 --> 0:00:56.600 the world, tom in this case, Japan is exporting inflation 0:00:56.640 --> 0:00:57.280 to the rest of the world. 0:00:57.480 --> 0:01:00.680 Japan story. The carry trade is actually causing a little 0:01:00.720 --> 0:01:02.639 bit of chaos in the markets, and I think that 0:01:03.000 --> 0:01:05.280 you know, there really has been an immediate reaction to that. 0:01:05.680 --> 0:01:07.759 The carry trade was a key part of the market 0:01:07.760 --> 0:01:10.720 turmoil we saw in early August, which included big moves 0:01:10.720 --> 0:01:14.319 on currency, equity and bond markets over a number of days. 0:01:14.840 --> 0:01:17.400 Since then, lots of questions are being asked about the 0:01:17.440 --> 0:01:21.160 future of the strategy. So here's why the carry trade 0:01:21.400 --> 0:01:27.400 will carry on. Our managing editor for Foreign Exchange in Rates, 0:01:27.480 --> 0:01:30.600 Rachel Evans, is with us for more. Rachel, first of all, 0:01:30.680 --> 0:01:33.920 can you explain what exactly the carry trade is? 0:01:34.640 --> 0:01:36.360 Yeah, it's one of these terms that we tend to 0:01:36.400 --> 0:01:39.560 throw about willy nilly without really defining it particularly well. 0:01:39.560 --> 0:01:42.960 But basically it's pretty simple. It's just borrowing something at 0:01:43.000 --> 0:01:45.480 a low cost or low rate in one country to 0:01:45.560 --> 0:01:48.560 invest in something with a higher yield somewhere else. So 0:01:48.640 --> 0:01:51.520 for example, in this case, we've been talking a lot 0:01:51.560 --> 0:01:54.080 about kind of borrowing in the yen, which obviously is 0:01:54.120 --> 0:01:57.280 at kind of very very low levels right now, and 0:01:57.360 --> 0:02:00.960 investing it in places like Mexico whereon so yielding a 0:02:01.000 --> 0:02:04.200 really chunky, nice yield, or in US tech stock where 0:02:04.200 --> 0:02:07.000 obviously we've seen stocks like in video going on a 0:02:07.040 --> 0:02:09.160 real tear. So it's really just that kind of you know, 0:02:09.200 --> 0:02:11.680 looking for cheap money to invest in something that's going 0:02:11.760 --> 0:02:13.040 to pay you back in a bigger way. 0:02:13.360 --> 0:02:16.560 So what exactly happened to this trade then? During the 0:02:16.639 --> 0:02:18.520 market termoil. We saw at the start of August. 0:02:18.760 --> 0:02:21.680 We've seen a few wobbles in this trade for kind 0:02:21.720 --> 0:02:24.800 of prior weeks, US tech stocks having days where they'd 0:02:24.880 --> 0:02:27.400 sold off, for example, and we had been sort of 0:02:27.440 --> 0:02:30.240 talking a lot about kind of how stretch positioning had 0:02:30.280 --> 0:02:33.359 become in the end. We're just everybody seeming to expect 0:02:33.400 --> 0:02:36.040 the end to stay weak for a longer period of time, 0:02:36.320 --> 0:02:37.880 and then in a very short amount of time we 0:02:37.919 --> 0:02:41.920 had a few events that really rocked that expectation. We 0:02:41.960 --> 0:02:44.200 saw the FED holding rates but signaling that it would 0:02:44.240 --> 0:02:46.679 start to cut In September, we saw the Bank of 0:02:46.760 --> 0:02:49.560 Japan raising interest rates and this was the second hike 0:02:49.639 --> 0:02:52.239 that they'd done. And then we also saw job s 0:02:52.280 --> 0:02:55.239 data coming and suggesting that the US economy was weaker 0:02:55.280 --> 0:02:58.320 than previously anticipated. So all of that kind of put 0:02:58.360 --> 0:03:01.400 together the idea that Bank of Japan wasn't just going 0:03:01.480 --> 0:03:04.120 to keep rates really really low in definitely that they 0:03:04.160 --> 0:03:06.320 were going to start increasing those and kind of be 0:03:06.360 --> 0:03:08.720 on a path towards higher rates, and the fact that 0:03:08.720 --> 0:03:11.320 that the US economy perhaps was wabbling and the FED 0:03:11.400 --> 0:03:14.680 may maybe behind the curve. Those sort of sentiments really 0:03:14.720 --> 0:03:17.680 kind of combined to prompt everybody to take a really 0:03:17.720 --> 0:03:19.600 sharp look at some of the trades that they've been 0:03:19.720 --> 0:03:22.400 considering as no brainers for the year and really start 0:03:22.480 --> 0:03:24.360 unwinding those at breakdeck speed. 0:03:24.760 --> 0:03:27.520 Have we seen this sort of thing happen before where 0:03:27.800 --> 0:03:30.400 such a popular trading strategy in the carry trade has 0:03:30.520 --> 0:03:32.320 essentially become very unpopular very quickly. 0:03:32.600 --> 0:03:34.920 I mean, the carry trade is particularly prone to these 0:03:35.120 --> 0:03:38.800 rapid unwinds because it does rely on stability, It relies 0:03:38.840 --> 0:03:41.360 on a lack of volatility for it to really kind 0:03:41.360 --> 0:03:43.760 of work and pay off. So back in nineteen ninety eight, 0:03:43.760 --> 0:03:46.160 we saw a pretty sharp reversal. We saw the end 0:03:46.160 --> 0:03:48.440 then rise sixteen percent in one week, which is, you know, 0:03:48.480 --> 0:03:51.160 put things in perspective, Yeah, exactly. I think we saw 0:03:51.200 --> 0:03:53.840 a three percent rise on Monday when things were were 0:03:53.880 --> 0:03:56.120 at their worst here. But then we saw this in 0:03:56.120 --> 0:03:58.200 two thousand and seven when we were dealing with the 0:03:58.280 --> 0:04:01.800 ripple effects at the subprime crisis. So when we do 0:04:01.840 --> 0:04:05.320 see kind of some of these exogenous events like geopolitical 0:04:05.360 --> 0:04:08.600 turmoil come in and sort of boost currency like the yen, 0:04:08.680 --> 0:04:11.360 which has tended to be favored by carry traders to 0:04:11.400 --> 0:04:14.600 fund these positions, that can really disrupt this trade, and 0:04:14.680 --> 0:04:16.719 so this is not the first time it's kind of happened. 0:04:17.160 --> 0:04:20.560 What about the carry trade using currencies other than the yen, 0:04:20.760 --> 0:04:23.080 have they seen the same sort of effect that we've 0:04:23.080 --> 0:04:24.360 seen with the n trade. 0:04:24.640 --> 0:04:26.640 Yeah? Similar. I mean, the yen has very much been 0:04:26.680 --> 0:04:29.080 kind of the dominant currency for obvious reasons. It's very 0:04:29.200 --> 0:04:31.320 very liquid, it's easy to get in and out, and 0:04:31.360 --> 0:04:33.640 there has been this kind of very long narrative of 0:04:33.680 --> 0:04:36.200 low rates in Japan. But we have also seen people 0:04:36.320 --> 0:04:39.400 using the Chinese yuan to fund carry trades as well. 0:04:39.600 --> 0:04:41.200 So when we were seeing kind of the height of 0:04:41.200 --> 0:04:44.479 the gyrations last week, we did see the yuan also 0:04:44.560 --> 0:04:46.840 strengthening alongside the yen, and that's been a bit of 0:04:46.880 --> 0:04:48.880 a pattern. You know, when we have seen kind of 0:04:48.920 --> 0:04:51.400 the yen having days of strength, it's tended to kind 0:04:51.400 --> 0:04:54.520 of come alongside some Yuan strength too, with a sense 0:04:54.520 --> 0:04:56.800 of kind of like this unwind of carriers really fueling 0:04:56.880 --> 0:04:57.960 both both positions. 0:04:58.240 --> 0:05:01.239 Does this mean the carry trade has has last its shine? 0:05:01.560 --> 0:05:03.360 Is this a fundamental change? 0:05:03.520 --> 0:05:06.080 I certainly lost its shine for now, but like everything, 0:05:06.080 --> 0:05:08.080 you know, nothing really goes out of style for very long. 0:05:08.160 --> 0:05:09.719 And in fact, I was just looking at some of 0:05:09.760 --> 0:05:13.440 the gauges of carry on the Bloomberg terminal and noticed 0:05:13.440 --> 0:05:15.919 that there's a there's a gauge of dollar funded carry 0:05:15.960 --> 0:05:19.120 trades in emerging markets that's up two percent since last week. 0:05:19.200 --> 0:05:21.640 So clearly, you know, if you got in at the 0:05:21.640 --> 0:05:24.920 bottom when everybody was really sort of heading for the sidelines, 0:05:25.240 --> 0:05:27.440 you could have actually made a pretty nice profit. So 0:05:27.520 --> 0:05:29.560 these things sort of tender to kind of come around. 0:05:29.800 --> 0:05:31.440 But it does feel like we're getting a bit of 0:05:31.560 --> 0:05:34.560 a rethink of exactly how invested in this trade you 0:05:34.600 --> 0:05:36.919 really want to be. How far do you want to 0:05:37.000 --> 0:05:38.760 kind of sort of blow out your profit Marge and 0:05:38.800 --> 0:05:41.440 betting on this one strategy, And do you want to 0:05:41.480 --> 0:05:44.320 diversify perhaps a little bit beyond just using the end 0:05:44.320 --> 0:05:45.960 to kind of fund these these carry trades? 0:05:46.200 --> 0:05:49.919 So what sort of event could reinvigorate this trade? And 0:05:49.960 --> 0:05:51.640 can I take a gas and it's at the central banks? 0:05:52.320 --> 0:05:53.839 Central banks are always crucial to this. 0:05:54.000 --> 0:05:57.120 Yes, I actually the answer to everything pretty much pretty. 0:05:56.960 --> 0:05:59.320 Much in macroland. I think there are two things that 0:05:59.680 --> 0:06:02.320 kind of have the potential to reinvigorate the trade. The 0:06:02.360 --> 0:06:05.920 first would be a boring answer, stability. Everybody in this 0:06:06.000 --> 0:06:09.200 trade needs stability, They need a sense that they know 0:06:09.279 --> 0:06:11.640 what's going to happen and a sense of certainty. Now 0:06:11.640 --> 0:06:13.920 the Bank of Japan is keeping rates very low for 0:06:14.000 --> 0:06:16.080 quite a long time, it would seem like we're not 0:06:16.120 --> 0:06:19.120 talking about huge interest rate increases. We're at zero point 0:06:19.160 --> 0:06:21.799 two five percent now. This is this is not particularly 0:06:21.839 --> 0:06:24.280 dramatic given where we are in the US or in 0:06:24.320 --> 0:06:26.599 the UK in terms of where interustrates are. So once 0:06:26.600 --> 0:06:28.760 people get a sense of kind of certainty that they're 0:06:28.760 --> 0:06:30.919 not going to suddenly, you know, high rates to one percent, 0:06:30.960 --> 0:06:33.120 two percent or higher, then I think you could see 0:06:33.120 --> 0:06:35.960 some sort of re establishment of these bets. Given that 0:06:36.000 --> 0:06:39.520 the thesis of borrowing low and investing in higher yielding 0:06:39.640 --> 0:06:42.360 currency still really holds. You just need to be prepared 0:06:42.360 --> 0:06:44.560 that you're not going to get quite as much for that. 0:06:44.920 --> 0:06:48.040 The other possible reinvigoration would be if we see something 0:06:48.080 --> 0:06:51.960 idiosyncratic happen, where we see interest rates in one country 0:06:52.360 --> 0:06:55.360 cut a much much lower than elsewhere. It's very hard 0:06:55.400 --> 0:06:57.240 to predict what would cause that. It would be some 0:06:57.279 --> 0:07:01.640 sort of local political drama, local economic drama that would 0:07:01.640 --> 0:07:04.400 see interest rates somewhere become much much lower than the 0:07:04.400 --> 0:07:06.159 rest of the world. But yeah, we'll have to see 0:07:06.240 --> 0:07:08.000 exactly where and when that might happen. 0:07:08.600 --> 0:07:11.880 Thank you, Rachel Evans, our managing editor for Foreign Exchange 0:07:12.120 --> 0:07:15.080 and Rates. For more explanations like this one from our 0:07:15.120 --> 0:07:18.240 team of twenty seven hundred journalists and analysts around the world, 0:07:18.360 --> 0:07:21.080 search for quick take on the Bloomberg website or Bloomberg 0:07:21.160 --> 0:07:26.360 Business app. I'm Stephen Carol. This is here's why. I'll 0:07:26.400 --> 0:07:28.600 be back next week with more. Thanks for listening.