More on the carry trade

May 8, 2007
By Ken Worsley

David Andrew Taylor, in a post at Seeking Alpha and also on his own (excellent) blog at dismally.com, has added some thoughtful bits to the recent speculation on the future of the carry trade. As he puts it:

BoJ governor Fukui has made it clear that with continued growth and inflation, that interest rates should be normalized. Perfect. Except… didn’t the inflation numbers pretty much fall flat on their face just two weeks ago? I believe they did. But, at the same time, we’ve seen some decent numbers with Japanese GDP. That puts the Bank in kind of a sticky situation.

Yes, GDP growth was high in the fourth quarter of 2006, but has been projected to be low in the first quarter of 2007. The consumer price index has fallen for two straight months. Household spending down 1.0% in March. Supermarket sales 15 straight months down. Auto production and domestic auto shipments down in March, but exports up. April New Auto Sales in Japan Down 10.2 Percent, 22nd Straight Month of Decline. Japan’s Department Store Sales Down 1.5% in March.

The Cabinet Office’s last index of business conditions for February was at its worst in years. March data is expected to be better (it almost couldn’t be worse).

What’s going on? Isn’t this Japan’s longest period of post-war economic expansion? It is, which I still think makes it all that more dangerous. What doesn’t help is that although income is now rising up, this expansion has been heavily fueled by exports, which seem to be cooling.

But seriously, where is the good news? Has someone been hiding it from me?

Back to the carry trade and Mr Taylor’s point…We know that all good things must come to an end, and that includes both Japan’s current economic expansion and the carry trade itself. As he puts it:

So, if we have most central bankers sitting about where they are going to be for some time, and we have a “normalization” period approaching in Japan, I’m having a tough time arguing that the trend will persist in the carry currencies. I think we’ll start to see some profits come off of the table as the differential begins to narrow.

But how much will it narrow and how fast can it do so? I don’t see a rate hike coming before the July Upper House elections (which I believe I read Mr Taylor agreeing with on one of his previous posts - forgive me if I’m wrong). Given that hurdle to Mr Fukui’s desire to be the man who sets Japan on the path to ‘normalization,’ and the stream of negative economic data coming from Japan, and the recent fears that a slowdown in the US economy could really start to apply some pressure, one has to wonder if the Bank of Japan could push rates past 1% before New Year’s. bear in mind, that would be a doubling of the current rate.

Carry traders, what do you think? It’s still profitable, right? Or is 1% cutting it too close? When does the squeeze really kick in, when do you start unloading?

<humor>By the way, answer those questions by email, not here…</humor>

Filed Under Bank of Japan, Carry Trade, Exchange Rates, Japan

Social Bookmarks:

Related Posts:
Get started in the yen carry trade!
Unwinding of the carry trade not so scary?
Bank of Japan: Damned if you do…
Yen/Dollar Swings: All About the Carry Trade?
Bank of Japan raises rates to 0.5%