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Sunday Reading: Morgan Stanley’s Stephen Jen on Risk and the Yen

If you’re in there trading yen right now, you will most likely be interested in what Stephen Jen has to say in a piece entitled Risk Reduction and the JPY over at the Morgan Stanley Global Economic Forum. Here are two quick bits:

Reduction of the ‘JPY carry trades’ may continue for a while, we concede. We have long argued that the primary type of outflows from Japan’s retail sector are not ‘carry trades’ – trades whose key motivation is interest rate differentials – per se, but investors’ desire to diversify their portfolios and take on more risk.

…[W]e still believe that Japan’s preference for risk has gone through a structural shift. With US$13 trillion in liquid financial assets and 50.5% of this in cash deposits, the scope for Japanese retail investors to diversify into risky assets is immense. (Note: If Japan reduces its cash deposits by 1% of total financial holdings a year, this translates to US$130 billion worth of ‘conversion’ from cash to risky assets a year, or a little more than US$10 billion a month.

It’s too bad we don’t have any numbers to stick on those, but the piece is somewhat of a summary. I think it would be important to look at the demographics behind those liquid assets and cash deposits. There will be a certain chunk of them that will never, ever be anything other than cash deposits, as they are held by older retirees who would never, ever risk even a single yen of their hard-earned capital.

It seems as though this considerably reduces the amount of money that we should consider as ‘cash deposits’ for the purpose of possible investment capital, as a hefty percentage of that amount is simply inheritance tax to-be.

At any rate, get over there and read Jen’s piece…

Retail flows having impact on yen rates; housewives to blame?

But you already knew about the first part of that headline, right? It’s been all around the news for a while now, with the Nikkei telling us that individuals are keen to sell yen even at 120 on May 22, and IHT/Bloomberg telling us that the yen’s retail outflows are putting the Bank of Japan in a “bind” on June 11.

Both of these are signs of an overheating; once the average investor is on to the trend, that usually means it about to change direction (according to bullish lines of thought). Yet, we’re aware that the ultra-low interest rates in Japan are helping feed the carry trade, so individuals might be protected for now. The danger is if the BOJ does make a slight rise and there is a panic - but not a trend reversal - that wipes out (or spooks) heaps of unsavvy individual investors.

That’s neither here nor there. What is here is an article published yesterday by the Financial Times entitled, “Yen absorbs ‘Japanese housewife effect’.” This is the blame twist we’ve been waiting for: the weak yen is due to housewives sitting around selling yen. Brilliant. How do we stop them? Here’s my favorite quote from the article:

The gnomes of Zurich were accused in their day of destabilizing markets. The housewives of Tokyo are apparently acting to stabilize them.

That’s from none other than Bank of Japan board member Kiyohiko Nishimura.

The article gives us a rough estimate that exposure from margin trading could currently be at 20,000 billion yen, but does not say how much of this is driven by housewives.

Given the amount of capital tied up in yen-selling, Derek Halpenny, an economist at the Bank of Tokyo-Mitsubishi UFJ, is of the opinion that Japanese authorities might be reluctant to intervene in the foreign exchange market in order to strengthen the yen given the potential financial consequences for the general population.

I wonder if a Cabinet member will go on record with this?

Yen/Dollar Swings: All About the Carry Trade?

Are the headlines making your head spin yet? Back on Tuesday (June 26), Finance Minister Koji Omi told reporters, “Foreign exchange markets should reflect Japan’s economic fundamentals…We will keep a watchful eye on foreign exchange rates…The weak yen symbolizes the shrinking presence of the Japanese economy. It is obviously bad news.”

It caught my eye, but I knew it wasn’t policy. Nonetheless, we saw these headlines start to pop up on June 27:

Yen Rises Most in 10 Weeks as Investors Scale Back Carry Trades (Bloomberg)
Yen Rises for a Third Day as Investors May Unwind Carry Trades (Bloomberg)
Yen climbs on risk aversion, carry trade unwinds (Reuters)
A Meltdown From The Yen-Carry Trade? (Forbes)
FOREX-Yen rises on risk aversion, carry trade worries (Reuters)

Then, a day later:

Yen Weakens on Speculation Investors Are Restoring Carry Trades (Bloomberg)
FOREX-Yen’s rise fizzles as risk-aversion eases (Reuters)
BOJ’s Inoue Sees `Huge Amount’ of Capital Flows Leaving Japan (Bloomberg)

The writers must be having a ball. Once they have software to write these articles automatically, the news firms will save a quite a bit of money.

Meanwhile, the human beings will continue to do analysis. On June 26, writing at Seeking Alpha, Jordan Kahn (author of the excellent In the Money blog) published a piece entitled “The Yen Carry Trade is Alive and Kicking.”

As Mr Kahn put it:

The Yen has actually slid to a 4 1/2-year low versus the dollar. This indicates that the Yen Carry trade is alive and well…At some point, the Yen is likely to rally, and concerns about the unwinding of this massive trade will resurface.

It’s a short piece, but to the point: The trend is still there and still very alive, despite the major media’s panic over a swing down to 122.20 and up to 123.35 over two days (and we have to wonder if they’re forgetting about those low 121s earlier in the month - better chance to sell yen on ‘discount’).

The carry trade still has legs.

Darryl Whitten on the BIS Annual Report

On Tuesday, we reported on the recent annual statement from the Bank of International Settlements, which called the yen’s current value ‘Anomalous’. Since then, there has been little commentary about the report in any media. Today, a piece entitled BIS Report Calls Recent Yen Depreciation ‘Anomalous’ from The Japan Investor’s Darryl Whitten appeared on Seeking Alpha.

It’s a short article, but good. Mr Whitten has been on the ground in Japan for a long time and knows what he’s talking about, and in this piece he offers a view of the risks surrounding a weak yen. Here’s a snippet:

The negatives for Japan from a weak yen include,

1. Rising raw material purchasing costs for companies.
2. Increased reliance on exports.
3. Problems attracting foreign capital (even though Japan is actively encouraging FDI).
4. Growing inflation pressures (from rising corporate service prices).
5. The prospect of a tsunami of domestic savings flowing overseas to chase higher yields, which already is a structural component of the so-called yen carry trade.

Get over there and read the rest of the article.

More on the carry trade

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>

Unwinding of the carry trade not so scary?

On Sunday, Vice Finance Minister for International Affairs Hiroshi Watanabe came out and said that not only has the size of the so-called ‘carry trade’ been exaggerated, but that concerns over its unwinding has been overblown. Although Watanabe agreed that the carry trade might be valued at $100 billion, he feels that this is such a significantly small portion of the annual $500 trillion worth of trade in currency markets per year that the unloading of those funds would not have a significant impact on Japan’s economy:

It could move the market somewhat for one day, but the world won’t go upside down…The size and the impact of unwinding is over-exaggerated. That’s my understanding.

Watanabe declined to make comments regarding the effect of economic fundamentals on yen-based exchange rates, which we have to say is a wise move for anyone in the government.

Still, if he is right: one day of fun will be better than nothing.

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