Speaker 1: Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 2: Hello and welcome to another episode of the Odd Thoughts Podcast.
Speaker 2: I'm Tracy Alloway.
Speaker 3: And I'm Joe Wisenthal.
Speaker 2: Joe, do you remember the carry trade unwined?
Speaker 3: It was so the carry trade, what's the deal? Basically
Speaker 3: people borrow yen and buy and video and then the
Speaker 3: yen went up and then the trades didn't work as well.
Speaker 2: Well, that was one aspect of the commentary.
Speaker 3: As like the Twitter version of what's happening?
Speaker 2: Yeah, but I think actually okay, So we are recording
Speaker 2: this on August twenty third, the carry trade unwind happened.
Speaker 2: What was it two weeks ago? Two or three weeks ago. Yeah,
Speaker 2: it feels like a lifetime ago, and it's kind of
Speaker 2: remarkable how quickly it failed into the background with the
Speaker 2: market rally and the recovery. But the conversation at the
Speaker 2: time was that there is this carry trade, which involves
Speaker 2: borrowing in lower yielding currencies or lower interest rate currencies
Speaker 2: such as the yen, and then investing in higher yielding
Speaker 2: assets like in theory, US technology stocks.
Speaker 3: Or you US treasuries.
Speaker 2: Yeah, but the problem is that some of the discourse
Speaker 2: around this has been. I've kind of been offended by
Speaker 2: some of it. I've seen things out there basically implying
Speaker 2: that the entire financial system is imploding because the carry
Speaker 2: trade is unwinding.
Speaker 3: I mean, it's really crazy, Like how quickly that disappeared,
Speaker 3: because you know, there was that megavol spike and we
Speaker 3: were talking like historically high level is on par with
Speaker 3: some of the financial crises, and then you know, the
Speaker 3: expectation is like, at a minimum, this takes a while
Speaker 3: to settle down. Yeah, and it's settled down in about
Speaker 3: fifteen minutes, in a day and a half. Absolutely, what
Speaker 3: was that? What is the carry trade? Because there is
Speaker 3: this sort of caricature version that is out there, who
Speaker 3: actually is engaging in it? Is it still going on?
Speaker 3: Many questions in my head remain unanswered.
Speaker 2: Yeah, and one of the big ones is just how
Speaker 2: big is it actually? And one of the funny things
Speaker 2: that happened a few weeks ago is people were basically
Speaker 2: looking at all the yen denominated assets in the world,
Speaker 2: like the entire Japanese banking system, and saying, this is
Speaker 2: the carry trade. This is how big it is.
Speaker 3: Okay, let's clear up some misconceptions.
Speaker 2: We are going to do that right now, and I
Speaker 2: am so pleased to say that we do, in fact
Speaker 2: have the perfect guest. We are recording here in Jackson, Haw,
Speaker 2: Wayoming for the Kansas Fed Economic Symposium, and we have
Speaker 2: once again run into one of our favorite all Thoughts guests,
Speaker 2: an expert on this exact topic. We're going to be
Speaker 2: speaking with Hyun Sung Shin. He is, of course, the
Speaker 2: economic advisor and head of research for the Bank for
Speaker 2: International Settlements and he's been looking at the carry trade
Speaker 2: for years now.
Speaker 3: So Ken he actually knows what he's talking about.
Speaker 2: Yes, Kian, thank you so much for coming on odd lots.
Speaker 4: Thank you for having me again.
Speaker 2: It's so good to see you again. Absolutely beautiful Jackson Hall. Absolutely,
Speaker 2: I'm so glad we could make this happen, and that
Speaker 2: I am kind of glad that the carry trade unwind
Speaker 2: happened just a couple.
Speaker 5: Of weeks ago.
Speaker 3: Something to talk about.
Speaker 2: Yeah, and you happen to be here and you're an
Speaker 2: expert on this, So let's start with something very basic.
Speaker 2: What is the carry trade?
Speaker 5: The carry trade is a financial transaction where you borrow
Speaker 5: a currency with a low interest rate and then investor
Speaker 5: proceeds in other higher yielding assets, and I think the
Speaker 5: you know, the classical version of a carriage.
Speaker 4: Trade would be where you borrow.
Speaker 5: I mean, it's basically a currency transaction where you borrow
Speaker 5: a currency with a low interest rate and invest in
Speaker 5: a in a higher interest rate currency. But the way
Speaker 5: that the carry trade was portrayed in the recent discussion,
Speaker 5: I think that was you know, described in much broader terms,
Speaker 5: where you were going into all kinds of different assets
Speaker 5: and Joe, as you describe, it was a very short
Speaker 5: lived episode of stress, but.
Speaker 4: At the time it was pretty intense.
Speaker 5: Yeah, and you know, I think, you know, we can
Speaker 5: now look back on it with some relief that nothing broke.
Speaker 5: You know, there was no financial market dysfunction as we
Speaker 5: saw during the March twenty twenty episode for example. So
Speaker 5: now we're now back to something which looks more normal.
Speaker 5: But I think we should try and learn some lessons
Speaker 5: from that episode.
Speaker 3: Absolutely, and you know, obviously there's a lot that's still
Speaker 3: out there and much to be learned before we even
Speaker 3: get to the future. I mean, you described what a
Speaker 3: sort of classical carrier trait is and what we're talking about,
Speaker 3: and I joked in the beginning, you know, it's like
Speaker 3: borrow yen cheaply and then by bitcoin or whatever. But actually,
Speaker 3: like when we talk about this, who are the actors involved?
Speaker 3: Is it seculators who see a spread? Is it institutions
Speaker 3: like insurance companies, etc. That have some sort of like
Speaker 3: larger structural reason. Like who actually is engaged in such
Speaker 3: type of activities.
Speaker 5: It's really the whole ecosystem, if you like, I think
Speaker 5: the main actors would shift from from time to time.
Speaker 5: I think one way that we could try and approach
Speaker 5: this question is, you know, as Tracy alluded to earlier,
Speaker 5: have large is this you know, what's the most reliable
Speaker 5: way of trying to gauge this? Now, one way of
Speaker 5: doing that is to look at the on balance sheet
Speaker 5: lending in yend and at.
Speaker 4: The BIS is.
Speaker 5: You know, we receive data from our member central banks.
Speaker 5: We collected and then we distributed, and we've been doing
Speaker 5: it since nineteen seventy seven, so in a way we
Speaker 5: are the curators of this very important banking data of
Speaker 5: international banking business. So one thing that we can look
Speaker 5: at in that data set would be what is the
Speaker 5: cross border lending that is yen denominated, or even if
Speaker 5: it's not cross border, what is the en denominated lending
Speaker 5: as a foreign currency, so you know, even if the
Speaker 5: loan is booked in a country outside Japan, it's it's
Speaker 5: in yen, and it's it's in foreign currency. Now, one
Speaker 5: of the things that I put in a tweet thread
Speaker 5: is that if you look at that that number, there
Speaker 5: was clearly a very sharp increase in yen borrowing as
Speaker 5: foreign currency in twenty two to twenty three. But it's
Speaker 5: something like forty trillion yen, So you know, that's quite large,
Speaker 5: you know, two hundred and seventy billion dollars roughly depending
Speaker 5: on exchange rate, But it's not the kind of numbers
Speaker 5: that were being banded about in the markets, and not
Speaker 5: all of that is going to be you know, engaged
Speaker 5: in yen carry trade. The other way of you know,
Speaker 5: thinking about this how is how does that borrowing take place?
Speaker 5: And one thing that is quite interesting is that a
Speaker 5: lot of the cross border lending is happening through the
Speaker 5: interoffice accounts, which is to say, if there's a foreign
Speaker 5: banking group which has an office in Japan, how much
Speaker 5: is the subsidiary or the office in Japan lending out
Speaker 5: to the headquarters in Yen. And that turns out to
Speaker 5: be a preciseable chunk of that. Of that forty trillion,
Speaker 5: it's around fourteen trillion would be you know that that interoffice.
Speaker 5: But much more important than this on balance sheet is
Speaker 5: the off balance sheet transactions. And here the crucial market
Speaker 5: is the FX swap market. And FX swaps are where
Speaker 5: you know, one party would deliver one currency. So if
Speaker 5: I deliver dollars to the counterparty, counterparty.
Speaker 4: Would give me the equivalent in yen.
Speaker 5: With the promise that that transaction would be reversed at
Speaker 5: a set date in the future at an agreed exchange rate.
Speaker 5: So the exchange rate is fixed at that point. And normally,
Speaker 5: if I'm a dollar provider, what I do is I
Speaker 5: provide the dollars, I receive the yen in return, But
Speaker 5: because I need to repay the yen, I need to
Speaker 5: keep it in a safe place, so I would park
Speaker 5: it in a safe in a yen asset.
Speaker 2: Just to be clear, Typically FX swaps it's it's not
Speaker 2: really a trade per se, or it's not often a trade.
Speaker 2: It's more of a hedging activity. So if I have
Speaker 2: a lot of yen exposure, I want to offset some
Speaker 2: of that by acquiring dollars and vice versa.
Speaker 5: Yeah, and that's exactly the classical the use case for
Speaker 5: a for a swap contract. But the but the issue
Speaker 5: here is if I receive the yen rather than parking
Speaker 5: it in a safe place, what if I just sell
Speaker 5: that yen on the spot market and acquire dollars, Then
Speaker 5: I have a naked yen obligation which I will need
Speaker 5: to meet at the time by repurchasing the yen on
Speaker 5: the spot market. And that market is pretty sizeable. It's
Speaker 5: around fourteen trillion dollars the swap market between yen and
Speaker 5: another currency.
Speaker 4: That's you know, that's.
Speaker 5: Quite a bit larger than the two hundred and seventy
Speaker 5: billion that I mentioned earlier.
Speaker 3: Just so as Tracy characterized it, there is sort of
Speaker 3: a natural hedging need for those sort of swaps. What
Speaker 3: types of institutions have that need to engage in the
Speaker 3: slot market.
Speaker 5: It's both financial and non financial. I think typically the
Speaker 5: textbook case is of a non financial institution. So, you know,
Speaker 5: if I am an exporter or an importer, you know,
Speaker 5: I would like to pay for you know, the goods
Speaker 5: in advance, but then I need to hedge the currency
Speaker 5: exposure in the meantime until the you know, the maturity
Speaker 5: of that swap. What we've seen though, is that since
Speaker 5: the global financial crisis, it's the financial uses of the
Speaker 5: FX swap market which has really grown much larger. So
Speaker 5: it's fair to say that it's the financial uses of
Speaker 5: the FX swaps which are the line share of the
Speaker 5: of the FX swap market. And I think it raises
Speaker 5: perhaps a deeper question, which is, if you're not constrained
Speaker 5: by the funding currency in what you can invest in
Speaker 5: by using the swap market. In other words, suppose I
Speaker 5: can only raise funding in one currency. Well, typically that
Speaker 5: means that, you know, unless you have balance sheet mismatches,
Speaker 5: you would need to invest mostly in that same currency.
Speaker 5: But through the swap market, you can basically overcome you know,
Speaker 5: that particular constraint. And what that means is it's much
Speaker 5: better to think of financial conditions in global terms rather
Speaker 5: than simply country by country, because you can you can always,
Speaker 5: you know, deploy the funding in one currency and invest
Speaker 5: in the assets of another currency.
Speaker 2: It sounds also like it's additional liquidity if you can
Speaker 2: use FX swaps to bypass you know, specific currency constraints
Speaker 2: in terms of funding capacity. If I was I don't
Speaker 2: know an emerging market like exporter, and I needed dollar funds.
Speaker 2: Obviously there's a limit to the amount of dollars that
Speaker 2: I can get in a situation like that. But if
Speaker 2: I know that I can go into the FX swap
Speaker 2: market and get that additional liquidity, it presumably expands credit
Speaker 2: in the overall system.
Speaker 5: In contractual terms, a swap is completely symmetric because you
Speaker 5: know one party is providing one currency in return for
Speaker 5: the other and vice versa for the other party. But
Speaker 5: from time to time, when financial conditions vary across different currencies,
Speaker 5: different markets, there is a if you like a lead
Speaker 5: party in asking for that transaction, and you know there
Speaker 5: is a market if you like response in supplying it.
Speaker 5: So let me give you an example. So if I
Speaker 5: am a let's say I'm a Euro area insurance company,
Speaker 5: and I would like a globally diversified portfolio including dollar assets.
Speaker 5: But most of my obligations are in euros, and so
Speaker 5: if I were to invest, you know, nakedly in dollars,
Speaker 5: there would be a currency you know, there'll be a
Speaker 5: currency mismatch on my balance sheet. And this is where
Speaker 5: I would go to the swap market. I would swap
Speaker 5: the euros into dollars and that I would invest the
Speaker 5: proceeds into dollar ponds, for example, in a way that's
Speaker 5: like borrowing dollars. I mean, the economic rationale is very
Speaker 5: similar to borrowing dollars in order to invest, but it's
Speaker 5: not treated as borrowing in the conventional accounting sets because
Speaker 5: you know it's a swap. There is also a countervailing,
Speaker 5: you know, a transaction the other way, but you can
Speaker 5: normally track what's called an EFFC swap basis to see
Speaker 5: which direction that transaction is going. So it turns out
Speaker 5: that typically normally it is more expensive to borrow dollars
Speaker 5: in the swap market then it is to borrow dollars
Speaker 5: in the dollar money market. And that extra premium is
Speaker 5: if you like the additional price you have to pay
Speaker 5: in order to access dollars. Now coming back to the
Speaker 5: yen story, although most of the time, you know, financial
Speaker 5: institutions are borrowing dollars in the swap market in order
Speaker 5: to invest in dollar acidence, that's typically the direction of
Speaker 5: the trade. This is why you know during financial stress periods,
Speaker 5: you know these effects swap bases, you know spike and
Speaker 5: then there has to be central bank swap lines to
Speaker 5: quill et cetera. But there's nothing in principle that says
Speaker 5: it always has to go towards a dollar, right if
Speaker 5: your intention is to engage in a yen carry trade,
Speaker 5: but through using EFFCS swaps, you know, you could borrow
Speaker 5: yen and then you know, acquire that en obligation by
Speaker 5: going through the swap. And so one telltale sign is
Speaker 5: what happened to the effects swap basis during this recent episode.
Speaker 5: And in fact, one of the interesting findings is that
Speaker 5: the dollar effects basis versus the yen you know, hardly budged.
Speaker 5: It's actually, you know, a very small movement, which is
Speaker 5: very atypical of a financial stress event.
Speaker 2: Yeah, how did Why is that? Because I would have
Speaker 2: assumed that the people providing swaps, who I assume are
Speaker 2: dealer banks of some sort, with such volatility in the
Speaker 2: currency rate, I would have thought that they would back
Speaker 2: away from providing that liquidity and so the basis would
Speaker 2: blow out.
Speaker 5: So there was definitely a little bit of that, but
Speaker 5: it was by no means the same magnitude as we saw,
Speaker 5: for example, in the March twenty twenty episode. And the
Speaker 5: reasoning would be that in that case, the if you like.
Speaker 5: The party that was driving that particular transaction wasn't borrowing dollars,
Speaker 5: which needed to be you know, repaid in this scramble
Speaker 5: for dollars, but rather it was the you know, repayment
Speaker 5: of yen. Oh I see, okay, so it goes the
Speaker 5: other way.
Speaker 3: So, you know, so much sort of happened during that
Speaker 3: I don't know, there's sort of like the mini crisis
Speaker 3: of July thirty first to August sixth of twenty twenty four,
Speaker 3: and it came in went.
Speaker 2: That should be the official name.
Speaker 3: Yeah, that's a name of that. So you know, there
Speaker 3: was a FED meeting that perceived perhaps to be a
Speaker 3: little hawkers. Then we got a week unemployment report. Then
Speaker 3: of course, you know, the end had been creeping up
Speaker 3: right now, and you know, we'll probably still be learning more.
Speaker 3: What is the story that you tell, like what actually
Speaker 3: happened in those six or seven days that triggered such
Speaker 3: a move and then triggered such a move that was
Speaker 3: able to reverse so easily. What you're basic what happened
Speaker 3: that week?
Speaker 5: Yeah, and clearly, Joe, there was quite a bit of
Speaker 5: action in the currency markets. But I think what you're
Speaker 5: referring to is the fact that equity markets were you know,
Speaker 5: impacted very broadly across the world in a way that
Speaker 5: you wouldn't have expected if it were a sort of
Speaker 5: narrow carriy trait story. And indeed, I think there is
Speaker 5: something to that in the probably we're we're putting too
Speaker 5: much weight on the carriage trade as a key theme
Speaker 5: of what happened in early August. In that yes, I
Speaker 5: mean there may have been the classical carriage traits going
Speaker 5: on where you borrow yen and then you invest in
Speaker 5: the high yielding currencies. You can see which currencies fell
Speaker 5: most in early August, and they were the Mexican peso,
Speaker 5: Columbian peso, and the rand. So these, you know, these
Speaker 5: were the destination currencies for those classical carriage trades. But
Speaker 5: I think it's it's not really enough to explain why
Speaker 5: there was this much more broad based stress, especially in
Speaker 5: the in the equity markets. And I think here we
Speaker 5: have to think about the broad issues to do with
Speaker 5: how you know risk is managed, how you know risk
Speaker 5: management itself.
Speaker 4: Risk management in.
Speaker 5: The form of loss mitigation also generates some potential for
Speaker 5: amplification that could actually you know, make things you know
Speaker 5: more volatile. So let me explain what I mean by that. So,
Speaker 5: if I have a value at risk rule that says,
Speaker 5: you know, if my risk is triggered beyond this this
Speaker 5: var level, then I cut my position. That means I sell,
Speaker 5: or if I'm lending, I cut my lines, et cetera.
Speaker 5: From the point of view of the borrower or from
Speaker 5: the point of view of the of the market as
Speaker 5: a whole. You know, that is something that would actually
Speaker 5: you know, amplify, you know, whatever stress that was there
Speaker 5: in the first place. If I'm a lender and I
Speaker 5: set margins, or if I'm a CECP, a central counterparty
Speaker 5: or an exchange, you know, there is a margin that
Speaker 5: I ask for, you know, the various contracts that I
Speaker 5: deal with. Typically during stress periods, those margins go up.
Speaker 5: So that's kind of deleveraging. Now, the way that we
Speaker 5: deal with risk is precisely to mitigate loss, and there
Speaker 5: is this you know, spillover effect that goes to the
Speaker 5: broader market. And I wonder whether we should you know,
Speaker 5: look back on the events of early August and if
Speaker 5: you like, apply that lens to you know, to the
Speaker 5: events back then. So if you know, for example, I
Speaker 5: was not you know, borrowing in and investing in technology
Speaker 5: stocks as you as you suggested, But it's just that
Speaker 5: you know, you know, within my firm, you know, there
Speaker 5: is a team that is doing a classical carrier trade,
Speaker 5: but there is also a team that is you know,
Speaker 5: leveraged the US tech stocks. But one team doesn't know
Speaker 5: what the other team is doing. So let's say, you know,
Speaker 5: one pod doesn't know what the other pod is doing.
Speaker 4: But from the.
Speaker 5: Firm's point of view, it looks as if you know
Speaker 5: in aggregate that you know there is a short end
Speaker 5: position and the long position in technology stocks, and if
Speaker 5: that you know, risk constraint is triggered somehow, it's going
Speaker 5: to have a much broader implication, much broader repercussion through
Speaker 5: all of the wholdings.
Speaker 2: This kind of reminds me there used to be that
Speaker 2: saying about in a crisis, you sell what you can,
Speaker 2: not necessarily what's most impact. Did So it might be
Speaker 2: that the most volatility is falling in the currency market
Speaker 2: and in the carry trade, but the thing that you're
Speaker 2: selling to reduce your risk exposure is something totally different.
Speaker 2: Just because you can, or because it's easier to do
Speaker 2: in an extremely volatile environment, and if you.
Speaker 5: Like, it's the it's the risk limits that are triggered.
Speaker 5: And the way that risk limits work is if the
Speaker 5: aggregate portfolio is suffering losses, then the risk limits are
Speaker 5: tightened for all the different you know, different assett that
Speaker 5: you own. And I think, you know, there is I
Speaker 5: think something that we need to think about in terms
Speaker 5: of how we can mitigate some.
Speaker 4: Of these some of these issues.
Speaker 5: And going back to the the FX swap discussion, the
Speaker 5: BIS also collects data on FX swaps. You know, we
Speaker 5: have the six monthly release of our over the counter
Speaker 5: derivative statistics and the numbers that I've given you you know,
Speaker 5: either all from from our data, it's all on our
Speaker 5: web page. I think there is probably more scope for
Speaker 5: us to have more refect fine data. For example, you know,
Speaker 5: who is the instigator in having the effects well, you
Speaker 5: know drawn up in the first place, So who is
Speaker 5: the lead party, where is it being booked? What are
Speaker 5: the sectors that the two parties are coming from. At
Speaker 5: the moment, we don't have that kind of data, but
Speaker 5: this is something that the BIS is working very hard
Speaker 5: to try and assemble. And given the shift away from
Speaker 5: the very bank centric system to something which is much
Speaker 5: more a market based system which we have now. I
Speaker 5: think this is really, you know, something that we need
Speaker 5: to do as a matter of vergency.
Speaker 3: So can we actually, I want to go back to
Speaker 3: your point about, you know, financial conditions being a global phenomenon,
Speaker 3: because that has been one of the questions here in
Speaker 3: the US, and there are people scratching their heads financial
Speaker 3: conditions by some measures being tight, but spreads being very
Speaker 3: narrow for credit and of course the stock market having
Speaker 3: rocketed up. Can you flesh that out a little bit
Speaker 3: more like this sort of like how we should rethink
Speaker 3: financial conditions in a world of sort of like easy
Speaker 3: swapping between currencies on a non bank basis.
Speaker 5: Sure, sure, I mean that's a very very important issue, actually, Joe.
Speaker 5: You know, when you look at the typical financial conditions index,
Speaker 5: let's say, you know, you take the Golden SAX index,
Speaker 5: which is probably the best known. There are two components there.
Speaker 5: One is really just about how high our interest rates,
Speaker 5: how high a yields. There's another set of indicators which
Speaker 5: measure how tight are the credit spreads? You know, what's
Speaker 5: the dollar doing that kind of thing. And what's really
Speaker 5: been quite surprising is that even though rates have been
Speaker 5: raised to quite high levels. So the rates, those indicators
Speaker 5: that point to how our interest rates are they've been
Speaker 5: quite tight. But stock markets, credit spreads, you know, they've
Speaker 5: been extremely accommodated.
Speaker 4: And I think one way that.
Speaker 5: You know, we could rationalize this is that, you know,
Speaker 5: if we have a world where essentially money is fungible
Speaker 5: across currencies, basically what swap does is to make money
Speaker 5: fungible across currencies. You know, five dollars I can get
Speaker 5: you know, yen vice versa. And in that kind of environment,
Speaker 5: it's not simply how much the US money supply is,
Speaker 5: how much you know, the Euro money supply is that matters.
Speaker 4: It's really about what the global picture is.
Speaker 5: And what are the marginal rates at which one is
Speaker 5: swapped into the other. And I think one potential explanation
Speaker 5: for why financial conditions have been, you know, so accommodative
Speaker 5: in spite of the very high rates is that, you know,
Speaker 5: money will flow to the most accompetentive section of the
Speaker 5: money market, and the swap is the instrument that's going
Speaker 5: to really you know, give you that fungibility. And when
Speaker 5: we look at the growth of the aggregates, it's been,
Speaker 5: you know, it's been quite rapid. So if we go
Speaker 5: back to the GFC. Before the GFC, the global financial
Speaker 5: system it was very much a bank based system, and
Speaker 5: the GFC was you know, in essence of banking crisis,
Speaker 5: and the existing BIS banking statistics covered that really well.
Speaker 5: You know, in some of my work as an academic,
Speaker 5: you know, I relied really a lot on the BIS
Speaker 5: banking data to really you know, document what happened in
Speaker 5: the lead up to and then the resolution. But since
Speaker 5: the GFC, we've moved very much to a market based
Speaker 5: system where the non bank financial intermediaries are taking on
Speaker 5: a much bigger role. And in that world, the banking
Speaker 5: statistics that the BIS puts out is only looking at
Speaker 5: a very small part of the overall universe, and increasingly
Speaker 5: it's the EFS, swap market and other market based intermediation
Speaker 5: figures that we need to keep track of. And so
Speaker 5: in that sense, it's quite important for us to update
Speaker 5: our perspective on how markets work, what kinds of indicators
Speaker 5: we need to keep track of, and basically make sure
Speaker 5: that the official statistics are really up to scratch.
Speaker 2: So in the two or three weeks since the carry
Speaker 2: trade hit the headlines, the yen dollar exchange rate has
Speaker 2: normalized somewhat. But if you had to, if you had
Speaker 2: to take an educated guess, how does the carry trade
Speaker 2: re establish itself or how does it evolve from here?
Speaker 2: Because I have to imagine there's some lingering memory, even
Speaker 2: if it feels like a lifetime ago, that this actually
Speaker 2: happened on the market. So what happens next in terms
Speaker 2: of the carry trades evolution?
Speaker 5: Well, actually, I think you know, you've had guests on
Speaker 5: on odd lots where one of their big themes was,
Speaker 5: you know, we're waiting for this big crash because it's
Speaker 5: going to present a huge opportunity for us to come
Speaker 5: and really pick up some bargains. And you know, if
Speaker 5: you were following this and you had spare powder on
Speaker 5: August fifth, for example, that was the Monday, then there
Speaker 5: were huge opportunities out there. I mean, you know, think
Speaker 5: about the Vics. The Vics hit sixty five on the
Speaker 5: morning of August fifth. So I think we have to
Speaker 5: assume that many of the people who are very who
Speaker 5: are very you know, agile, are already back in And
Speaker 5: I think what we need to think about is, well,
Speaker 5: first of all, we have to you know, we have
Speaker 5: to be thankful that nothing broke, But at the same time,
Speaker 5: you know, you know, we can't be complacent and say, well,
Speaker 5: that's it, we can forget about it. I think we
Speaker 5: have to learn some lessons from that episode, and one
Speaker 5: of those lessons is some of the standard ways I've
Speaker 5: been looking at markets may not be adequate. We have
Speaker 5: to look at some of these bigger pictures ues, especially
Speaker 5: those big aggregates that have been off the radar for
Speaker 5: various reasons, and we have to bring them back on
Speaker 5: the radar. And I think when we think about, you know,
Speaker 5: the broader policy questions as well, especially in monetary policy,
Speaker 5: financial conditions are absolutely key. They're a key input into
Speaker 5: how we conduct monetary policy. And so even for that question,
Speaker 5: how will financial conditions involve, we have to think about
Speaker 5: this big a picture.
Speaker 3: Thinking back to that week. From a sort of fundamentals standpoint,
Speaker 3: there was nothing that major that had happened, you know,
Speaker 3: like I think maybe the unemployment rate cod people will
Speaker 3: buy surprise, but data is noisy and there are surprises
Speaker 3: all the time in both directions. Maybe the FED, I
Speaker 3: don't know, the Bank of Japan, obviously, they're a little
Speaker 3: bit out of cycle, perhaps with other central banks. I
Speaker 3: think actually today we got a two point seven percent
Speaker 3: inflation reading, so maybe it's all higher, but there was
Speaker 3: nothing like that unexpected. Think about like risks going forward,
Speaker 3: the fact that you could have such a sharp move
Speaker 3: in such a short term. What does that say generally
Speaker 3: about the broader I don't know, structure of the financial system.
Speaker 3: And nothing broke and it did quiet down extraordinarily fast,
Speaker 3: But what does it say about the structure of the
Speaker 3: financial system or broadly that's something that sharp can happen
Speaker 3: without some seemingly you know, major fundamental surprise.
Speaker 5: And you're absolutely right. So the fundamental economic news was
Speaker 5: not you know, that bigger surprise. I mean, there were
Speaker 5: some surprises at the margin, but nothing major. I think
Speaker 5: what it does point to is the power of amplification
Speaker 5: effects of various sorts. Yeah, and you know, as officials,
Speaker 5: you know, as policymakers, we need to think about how
Speaker 5: do we dampen those amplification effects in a way that's
Speaker 5: going to you know, preserve financial stability and not have
Speaker 5: one of these episodes feed into the real economy. And
Speaker 5: you know, the typical response we would go to would
Speaker 5: be something like regulation. If these were banks, you know,
Speaker 5: that would be the sort of in the first port
Speaker 5: of call. But because if these are non banks, some
Speaker 5: of them, many of them are not regulated, that's not
Speaker 5: really you know, the first port of call. But you know,
Speaker 5: there are points of contact with a regulated financial sector
Speaker 5: where we can do something. I think one of the
Speaker 5: things that one of the lessons we learned during March
Speaker 5: twenty twenty, you know, with the treasury market, you know stress,
Speaker 5: was that we need to make sure that we don't
Speaker 5: have these hugely pro cyclical margin you know variation that
Speaker 5: means that there are four sellers onto the market. Now
Speaker 5: you know these huge swings are justified. Well, you know,
Speaker 5: some people were justified saying, look, I need to protect
Speaker 5: my solvency by you know, raising the margins. But that
Speaker 5: has huge repercussions for the others. So from a systemic perspective,
Speaker 5: you know, that has negative spillover effects. So that's one
Speaker 5: example where if we can make sure that margins are
Speaker 5: margins don't get eroded too thinly during good time so
Speaker 5: that you know, they're raised very sharply, that's that's really
Speaker 5: a no brainer, and that's something that the official sector
Speaker 5: has worked on we actually, of course, need to have
Speaker 5: much better data on these other aggregates that you know,
Speaker 5: have now emerged as being very very important, and the
Speaker 5: BIS is on that is on that case, you know,
Speaker 5: we are working very hard to make it much more
Speaker 5: detail so that it's going to be much more useful.
Speaker 5: But it's going to be a continual, you know, struggle, Joe,
Speaker 5: because you can never declare victory because you know, the
Speaker 5: financial system is always evolving and you're just you know,
Speaker 5: you're playing catch up all the time. It's just a
Speaker 5: case of how badly behind are you, you know, with
Speaker 5: the realities.
Speaker 2: I have just one more question, which is thinking back
Speaker 2: to August fifth, when markets were tanking, there were, or
Speaker 2: at least there was one prominent call for one hundred
Speaker 2: basis point emergency rate cut. And I really don't mean
Speaker 2: to be mean spirited here, because you know, hindsight is
Speaker 2: twenty twenty and we all get things wrong from time
Speaker 2: to time. But I'm just very curious we're here at
Speaker 2: Jackson Hall with a number of high profile policy makers.
Speaker 2: Is there any discussion of that call or any like.
Speaker 2: Are people talking about how ridiculous maybe that that call
Speaker 2: actually was at the time The idea that the FED
Speaker 2: was going to cut rates one hundred bases points, and
Speaker 2: now to two or three weeks later, we have markets
Speaker 2: near all time highs, the FX exchange rate has normalized
Speaker 2: to some degree, and a lot of this is just
Speaker 2: in the rear view mirror.
Speaker 5: I think we have to look at this with a
Speaker 5: bit more sympathy, Tracy. I don't think we can say
Speaker 5: definitively yes or no. You know, if we think back
Speaker 5: to the summer of nineteen ninety eight when LTCM Long
Speaker 5: Term Capital Management hedge fund failed, there was tremendous stress there,
Speaker 5: and you know, there was an intermeding cut at that
Speaker 5: point because what you know, we could see then was
Speaker 5: that the real economy looked to be, you know, showing
Speaker 5: signs of being affected. And similarly, I think with March
Speaker 5: twenty twenty, you know that was a treasury market. Clearly
Speaker 5: fixed income is much more closely tied with the real economy.
Speaker 5: So I would never say never, But you know, if
Speaker 5: it's so, what are we looking at in deciding whether
Speaker 5: you would go in and to intervene, Well, you're looking
Speaker 5: for signs of complete dysfunction in the market, where the
Speaker 5: market is just broken down and nothing is you know,
Speaker 5: being sold or bought, and this means that the flow
Speaker 5: of finance to real economic activity is really suffering. I
Speaker 5: think if you see signs of that, then I think,
Speaker 5: you know, there is a stronger argument for an extraordinary intervention.
Speaker 5: But as you say, I think, you know, looking back,
Speaker 5: although it was a pretty you know, intense period, those
Speaker 5: two days in retrospect, wasn't the kind of thing that
Speaker 5: needed extraordinary intervention.
Speaker 3: I just have one last question, and I guess it's
Speaker 3: sort of broad, but it's also one that I think
Speaker 3: some of our listeners are curious about, and I'm so
Speaker 3: I'm curious about from the BIS perspective, Like people are
Speaker 3: always very interested in the idea of like speculative excess bubbles,
Speaker 3: et cetera. I'm curious from the BIS perspective, do we
Speaker 3: have reliable measures that can observe that. Do we have
Speaker 3: you know, you could feel it in the error sometimes
Speaker 3: people are talking about AI or whatever it is at
Speaker 3: any given time, But do we have good tools to
Speaker 3: quantify sort of the level of what we'd call speculation
Speaker 3: in the market and at any given time.
Speaker 5: We always have good measures when in retrospect, so we
Speaker 5: can always look back to the previous crisis. Yeah, so,
Speaker 5: oh wow, we should have taken notice of that. So,
Speaker 5: you know, if we go back to the GFC, it
Speaker 5: was a growth rate of credit, it was growth rate
Speaker 5: of cross border lending and in particular the growth rate
Speaker 5: of crossborder lending and dollars, which was you know, making
Speaker 5: this round trip from the US to Europe back to
Speaker 5: the US. And what tends to happen. And I think
Speaker 5: the BIS, like any other efficiency institution, is guilty to
Speaker 5: some extent, is that, you know, we draw up a
Speaker 5: checklist and say, well, next time, let's not ignore A,
Speaker 5: B and C, and let's have a list that we
Speaker 5: check and of course, you know, we have this accumulated
Speaker 5: checklist that we take along with us we as we
Speaker 5: experience market. But it's never going to be adequate, right,
Speaker 5: So this time around, what happened was not really you know,
Speaker 5: central to some of our checklists. So, you know, I think,
Speaker 5: to be fair, I think the BIS is probably the
Speaker 5: best place to draw up.
Speaker 4: A checklist that is closest to you know, what's going on.
Speaker 5: You know, we are pretty close to the ground and
Speaker 5: in following these things, and we have very good data.
Speaker 5: But it's something that needs constant effort. Right, It's like
Speaker 5: it's not something that just comes easily and it's simply
Speaker 5: a matter of you know, effortless, you know brilliant that
Speaker 5: gives you that it's something that always needs effort. We
Speaker 5: have to keep you know, we have to keep studying,
Speaker 5: we have to keep looking, and so it's going to
Speaker 5: be a never ending struggle.
Speaker 2: All right, Well we both look forward to the BIS
Speaker 2: bubble index that you will inevitably be building. But h
Speaker 2: thank you so much for coming back on All Loots.
Speaker 5: That was amazing, Yeah, fantastic, Thanks for inviting me back,
Speaker 5: because yeah, great conversation, Joe.
Speaker 2: I'm so glad that we could catch up with him
Speaker 2: and that he was basically our first episode on the
Speaker 2: carry trade.
Speaker 3: I love I love talking to Hugh and it's always
Speaker 3: just like incredibly illuminating and pleasant and great, many interesting
Speaker 3: things there. I mean, for one, I sort of appreciated
Speaker 3: him just explaining what the carry trade is, that different
Speaker 3: types of actors, whether you're an import or export, or
Speaker 3: why you would want to engage in it. Like again,
Speaker 3: just I don't know misinformation is the right word, but
Speaker 3: the amount of people who want to appine on something
Speaker 3: like this for the first of the people who actually
Speaker 3: have some insight is a there's quite a gap.
Speaker 2: Well, I do think the nuance on causality is kind
Speaker 2: of important there, So the idea that okay, two things
Speaker 2: kind of happened at the same time, which is the
Speaker 2: carry trade unwound and US stock sold off, But that
Speaker 2: doesn't necessarily mean that one thing is directly causing the other.
Speaker 3: Right, And it gets to like the joke every time
Speaker 3: you know, there's some big market event and someone goes, oh,
Speaker 3: pod blew up. But it's sort of like that, which
Speaker 3: is basically it really if there is some volatility, if
Speaker 3: you're losing money, it doesn't really matter what strategy you're
Speaker 3: using or whether that strategy is central to it. You
Speaker 3: sell something right, and so you still have that effect.
Speaker 2: Someone taps you on the shoulder and says, reduce leverage,
Speaker 2: So you reduce leverage. The other thing I thought was
Speaker 2: really interesting was the idea of the fungibility yes of money.
Speaker 2: And I think we've talked about it on the podcast
Speaker 2: before and I've certainly mentioned in the newsletter, but I
Speaker 2: do feel there is a sense that okay, interest rates
Speaker 2: went up in the US, and so credit and dollars
Speaker 2: became more expensive, but that doesn't mean that they became
Speaker 2: less available.
Speaker 3: Yeah. No, that's such a fascinating idea, and the idea
Speaker 3: of like a global the need for a global financial
Speaker 3: Conditions Index or something like that. And if you're just
Speaker 3: looking at the US in isolation, there are things that
Speaker 3: don't seem to make total sense in terms of especially
Speaker 3: the disconnect between what happens with rates and what happened
Speaker 3: with spreads over the last couple of years. But that
Speaker 3: perhaps if you sort of aggregate everything together and recognize
Speaker 3: that any there are multiple places to get funding or
Speaker 3: get liquidity, maybe some of these puzzle pieces fit together
Speaker 3: a bit more.
Speaker 5: Yeah.
Speaker 2: So I'm looking forward to the Global Financial Conditions Index
Speaker 2: and the Bubble Index.
Speaker 3: Yes, many many indexes for the BIS to get out.
Speaker 3: But if there's any entity that I feel confident could
Speaker 3: do it, it'd be Hun in his team.
Speaker 2: All right, shall we leave it there?
Speaker 3: Let's leave it there.
Speaker 2: This has been another episode of the Odd Lots podcast.
Speaker 2: I'm Tracy Alloway. You can follow me at Tracy Alloway
Speaker 2: and I'm Joe Wisenthal.
Speaker 3: You can follow me at The Stalwart follow Hun Song Shin.
Speaker 3: He's at hun song Shin, follow our producers Kerman Rodriguez
Speaker 3: at Kerman Ermann, desh Ol Bennett at Dashbot, and Kilbrooks
Speaker 3: at Kilbrooks. Thank you to our producer Moses Ondem. For
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